Federal Reserve works with other central banks to deal with credit crunch; Wall Street rallies
WASHINGTON (AP) — The Federal Reserve announced today it was coordinating with other central banks to deal with the global credit crunch. Wall Street rallied after the surprise announcement.
In a statement timed to occur before the start of trading in New York, the Fed said it planned to offer $40 billion in emergency funds to banks next week through an auction process.
The Fed said that it was creating a temporary auction facility to make funds available to banks and was also setting up lines of credit with the European Central Bank and the Swiss Central Bank that could be used for additional resources.
The first two auctions of $20 billion each will occur next week on Dec. 17 and Dec. 20.
Wall Street investors applauded the Fed’s latest effort to combat the country’s worst credit crisis in nearly a decade. The Dow Jones industrial average was up by more than 200 points in early trading. A day earlier the Dow had plunged 294 points as investors expressed disappointment with what they saw as a lack of urgency on the part of the central bank for dealing with a credit crunch which threatens to push the country into a recession.
The Fed cut a key interest rate today but by a smaller quarter-point rather than the bolder half-point move that many investors had hoped for.
Economists looked more favorably today’s action, although they cautioned that the Fed’s experiment at finding another way to inject cash into the banking system had not been tested.
“Clearly, the Fed is feeling its way in the dark here. Current conditions are unprecedented in modern times,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics.
Analysts said the use of auctions to try to get more money into the banking system was an acknowledgment that efforts to spur direct loans from the Fed to banks through the Fed’s discount window had not worked as well as hoped because of banks’ fears that investors could become worried if they started utilizing the Fed’s discount window to any large extent.
In its announcement, the Fed said it had reached an agreement with the European Central Bank as well as the Bank of England, the Bank of Canada and the Swiss National Bank to address what it termed “elevated pressures” in credit markets.
The Fed said that commercial banks would be able to bid at auction for funds that would be drawn from the Temporary Auction Facility. The money would be intended to help cash-strapped banks raise money needed to keep making loans to businesses and consumers.
The action represented another step by the Fed to deal with a serious credit crunch stemming from the tightening of bank lending standards in the wake of multibillion dollar losses from a rising tide of defaults on mortgage loans.
The Fed said all banks judged to be in generally sound financial condition by their Fed regional bank would be eligible to participate in the auctions for funds.
The first auction of $20 billion was scheduled for next Monday, followed by another auction of $20 billion on Dec. 20. The third and fourth auctions will be on Jan. 14 and 28 with the amounts not yet set.
The Fed said that the new auction process should “help promote the efficient dissemination of liquidity” when other lines of credit were “under stress.”
The experience gained from the four scheduled auctions would be “helpful in assessing the potential usefulness” of this new process to provide funds to U.S. banks, the central bank said.
It said that the temporary swap arrangements being set up would provide up to $20 billion in reserves for the European Central Bank and up to $4 billion for the Swiss National Bank. The reserves would be available for up to six months.
Since the global credit crunch hit with force in August, other central banks as well as the Federal Reserve have been injecting massive amounts of money into the banking system in an effort to keep credit flowing.
However, those efforts have only been partially successful. Many businesses and consumers report rising trouble in obtaining loans as banks become more fearful about extending credit in the wake of a surge in bad loans stemming from the U.S. housing crisis.
Published in The Messenger 12.13.07