Friday, March 7, 2008

Fed Boosts Lending to Banks as Credit Rout Continues

Fed Boosts Lending to Banks as Credit Rout Continues

By Craig Torres and Vincent Del Giudice

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The Federal Reserve moved to add as much as $200 billion to the banking system over the next month to offset a deepening credit crisis that may have already pushed the U.S. economy into a recession.

The central bank raised to $50 billion each from $30 billion the amount intended for auctions of funds on March 10 and March 24. The Fed also said in a statement in Washington today that it will make $100 billion available through weekly 28-day repurchase agreements, where the central bank will lend cash in return for assets including mortgage-backed bonds.

The decision is the central bank's latest attempt to reduce the threat to the economy from banks curtailing loans to companies and households. Banks and securities firms have posted losses exceeding $188 billion since the start of last year as the impact of surging defaults on subprime mortgages rippled through world financial markets.

``Given what we have seen in terms of illiquidity in the financial markets in the last four or five days, this came right in time,'' Ajay Rajadhyaksha, head of fixed-income strategy at Barclays Capital in New York, said in an interview with Bloomberg Television.

The Fed said it will increase the sizes of both the so- called Term Auction Facility operations and the repurchases ``if conditions warrant.''

Interest Rates

Traders increased bets that the Fed will lower its benchmark interest rate by three quarters of a point this month after a government report showed the biggest job loss in five years, adding to evidence the economy is contracting. Odds of a smaller, half-point reduction fell to 6 percent from 26 percent yesterday, futures prices showed.

Fed officials said today's announcement wasn't related to the jobs report, and instead was aimed at addressing the deterioration in credit markets. The officials, speaking on condition of anonymity in a conference call with reporters, also said the measures won't expand the Fed's balance sheet.

At the same time, the central bank's balance sheet will likely change in composition as a result of today's announcements. Changes in the way the Federal Reserve Bank of New York accepts bids for repos will probably boost the level of mortgage-backed debt the Fed holds, while reducing the level of Treasuries, a Fed official said.

In effect, the Fed is using its own balance sheet to help banks and bond dealers finance assets riskier than U.S. government debt.

Investor Exodus

The move comes as investors are questioning the worth of even the highest-rated securities after Standard & Poor's and Moody's Investors Service assigned AAA grades to bonds backed by mortgages to borrowers who are now struggling to make their payments.

Carlyle Group's mortgage-bond fund was suspended in Amsterdam today after creditors forced the sale of some holdings, jeopardizing shareholders' capital. The fund borrowed to buy about $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac.

Citigroup Inc., the fourth-largest U.S. home lender by new loan volume, said March 6 it plans to pare its mortgage and home-equity loan holdings by about $45 billion, or 20 percent, over the next year.

Federal Open Market Committee members are next scheduled to meet on March 18. As credit stresses increased since the last gathering on Jan. 29-30, speculation has increased among traders that officials will consider lowering rates before the next meeting, as they did on Jan. 22.

Rate Target

Officials said they will keep the benchmark federal funds rate target around the level set by the FOMC, indicating they don't plan for the liquidity measures to drive the rate lower.

The central bank introduced the TAF, a lending tool that allows banks to give the Fed a range of collateral in return for loans, in December. The TAF loans for this month have a 28-day maturity.

``What the Fed's saying with the TAF changes is, `We hear you and we want to ensure everybody has financing for good collateral,''' said Joe Tully, managing director of the money- market desk in Newark, New Jersey, at Prudential Investment Management, which oversees about $55 billion.

The New York Fed said in a statement that the first of the 28-day repo operations will be conducted today, in the amount of $15 billion. It also said it will sell $10 billion of Treasury- bill holdings, ``to maintain a level of reserves'' consistent with keeping the federal funds rate around the current target.

Helping Banks

Repos allow the central bank to inject funds into primary dealers, a group of 20 banks that trade securities directly with the New York Fed. By contrast, the TAF operations offer funds to deposit-taking institutions; the most recent auction included 72 banks.

The Fed said it is ``in close consultation'' with other central banks. In December, the Fed loaned $24 billion to the European Central Bank and Swiss National Bank through a swap agreement to make more dollars available to banks in Europe.

``If need be, we could certainly continue'' to coordinate with the Fed, ECB spokeswoman Regina Schueller said, citing remarks by President Jean-Claude Trichet.

The SNB said it has no plans to join in dollar auctions, spokesman Werner Abegg said.

Job Losses

The Fed is also trying to contain the fallout on the broader U.S. economy, which is moving closer to recession. Employers cut payrolls by 63,000 after a loss of 22,000 in January, the Labor Department said today.

The central bank said that the TAF operations will be continued for at least the next six months. Fed Chairman Ben S. Bernanke said in January that officials may make the resource a ``permanent addition to the Fed's toolbox.''

Former Fed Chairman Alan Greenspan yesterday said March 5 that the credit markets won't recover until house prices stop falling. He said in a conference call organized by Deutsche Bank AG that home construction needs to decline to clear a surfeit of unsold properties and stabilize home prices.

``I don't think there's that much the Fed can do about this,'' Harvard University economist Kenneth Rogoff, a former chief economist of the International Monetary Fund, said in an interview in Paris. ``It's very limited what monetary policy can do in the wake of a once-in-many-decades housing-price crash.''

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