Cash-Starved Banks Jam The Fed's First Auction
Cash-strapped banks took the Federal Reserve up on its offer of $20 billion in short-term loans to help them overcome credit problems, but the interest rate wasn't as low as some had hoped.
The central bank said Wednesday that it had received bids for $61.6 billion worth of loans, more than three times the amount that was made available. The loans carried an interest rate of 4.65 percent, which is slightly less than the 4.75 percent the Fed charges banks on emergency loans through its "discount" window.
Banks have been reluctant to use the Fed's discount window because of the fear that investors will believe they are having trouble getting funds in a normal manner.
There were 93 bids for the loans, the Fed said. Each bank could submit up to two bids. The auction for the 28-day loans was conducted on Monday, and the results released on Wednesday.
Asked how the first auction fared, T.J. Marta, a fixed-income strategist at RBC Capital Markets, replied: "I was standing next to two seasoned traders and one thought this auction was fantastic and another one thought it was horrible." For his own part, Marta said it was "unsatisfying" because investors had thought the rate on the loans would have been lower, around 4.30 percent or 4.40 percent, rather than 4.65 percent.
"There was a hope that things really weren't that bad and that the market would have been able to bid down the Fed and take the money at a cheaper rate," Marta explained. "The fact that the market wasn't really willing to, was evidence of the stress."
A second auction will be conducted on Thursday, offering banks another chance to get a slice of another $20 billion in 35-day loans. The Fed said it would conduct two more auctions in January and then assess whether the process was worth continuing.
The Fed announced last week that it was creating an auction facility that would give cash-strapped banks a new way to get short-term loans from the central bank to help them over the credit hump. A global credit crisis has made banks reluctant to lend to each other, which can crimp lending to individuals and businesses.
The smooth flow of credit is the econony's life blood. It permits people to finance big-ticket purchases, such as homes and cars, and helps businesses to expand their operations and hire workers.
The Fed's actions are part of a global response in which other central banks also are taking steps to curb the credit crisis.
The European Central Bank on Tuesday opened its credit tap wide, pumping a record amount of cash -- more than $500 billion -- into markets to keep banks from Finland to France flush with the cash they need to operate.
The move, along with another liquidity infusion by the Bank of England, was aimed at keeping jittery markets calm amid a credit squeeze. It appeared to calm stock markets.
In the United States, the Fed also has been slicing its most important interest rate, called the federal funds rate, to help deal with the tight credit situation. The Fed has lowered this rate three times this year. Its most recent rate cut on Dec. 11 dropped the rate down to 4.25, a two-year low.
The funds rate is the rate banks charge each other on overnight loans. It affects a wide range of interest rates charged to people and businesses, making it the Fed's main tool for influencing U.S. economic activity.
The credit problems and a severe housing slump are raising the odds that the country could fall into a recession. Financial companies have taken multibillion-dollar hits because of bad mortgage loans. Home foreclosures have hit record highs. Wall Street has been badly shaken.
The Bush Administration and the Democrat-controlled Congress have been scrambling to limit the fallout.