WASHINGTON — The Federal Reserve and four foreign central banks took action Wednesday to inject cash into the global banking system in an effort to ease a worldwide credit squeeze.
The Fed's action, which was paralleled by the European Central Bank, the Bank of England, The Bank of Canada and the Swiss National Bank, is intended to stimulate bank borrowing by ensuring that money is available for short-term lending.
Banks have been reluctant to lend to each other or to large corporations because of fears about bonds backed by U.S. mortgages and other so-called structured finance investments. The Fed and foreign central banks are fearful that tightening credit increasingly threatens the broader world economy.
In two auctions over the next two weeks, the Fed will make as much as $40 billion available to banks at interest rates that are expected to be lower than its discount rate, which the Fed reduced to 4.75 percent on Tuesday. It will hold two more auctions in January and then evaluate whether the moves helped to stimulate credit markets.
While the action won't directly affect lending to consumers, it's designed to prevent problems in the credit markets from spilling over into the broader U.S. economy and perhaps pitching the nation into recession.
The Fed action Wednesday initially calmed markets after stocks had plunged on Tuesday in response to interest rate cuts that were smaller than Wall Street wanted. By mid-afternoon, however, stocks fell on rising oil and import prices, but they rose again in the final minute of trading. The Dow Jones Industrial Average closed up 41.13 points at 13,473.90, and the S&P 500 closed up 8.94 points at 1,486.59.
Normally, the Fed's discount window, which makes loans to banks to cover their short-term needs, is a lender of last resort to ensure that credit doesn't dry up. Although the Fed on Tuesday lowered this discount rate to encourage such borrowing, there have been few takers, in part because banks fear that nervous investors would view tapping the discount window as evidence that a bank's in trouble.
Senior Fed officials explained Wednesday that the auctions are intended to remove the stigma of borrowing from its discount window. The interest rate will be set by bidders, not by the Fed, and the auctions could provide rates for these 28-day loans that are below the discount rate, or even the benchmark federal funds rate that affects lending rates charged to consumers.
"This is not about particular financial institutions with particular problems," said a senior Fed official, who spoke only on condition of anonymity under rules for the technical briefing. "It is about market functioning."
"It seems the problem here is that banks simply don't trust each other and are hoarding their liquidity, rather than share it," said Ed Yardeni, an economist with investment manager Oak Associates Ltd., who dismissed the latest Fed action as a "group hug" by central bankers.
The auction also accepts a broader range of collateral than banks normally can offer, including the mortgage bonds that are at the heart of stock-market fears and complex financial instruments such as collateralized debt obligations (CDOs), which combine mortgages and other forms of debt.
Financial markets have been shunning many of these bonds and bond-like financial instruments, and by accepting them as collateral the Fed can help price them when the market is unable to do so. This pricing usually involves a loss on the original value of these instruments, something that bankers call a haircut.
ON THE WEB
To read the Fed's announcement, go to:
http://www.federalreserve.gov/newsevents/press/monetary/20071212a.htm
To read the details of the auctions, go to: http://www.federalreserve.gov/monetarypolicy/taf.htm
Frequently asked questions about the auctions are at:
http://www.federalreserve.gov/monetarypolicy/files/TAFfaqs.pdf
The Bank of Canada's statement is at:
http://www.bankofcanada.ca/en/notices_fmd/2007/not121207.html
The Bank of England statement is at:
http://www.bankofengland.co.uk/publications/news/2007/158.htm
The European Central Bank statement is at:
http://www.ecb.int/press/pr/date/2007/html/pr071212.en.html
The Swiss National Bank statement is at:
http://www.snb.ch/en/mmr/reference/pre_20071212/source/pre_20071212.en.pdf