Fed Moves to Ease Credit, But Will It Be Enough?

The U.S. Federal Reserve and other central banks teamed up to get hundreds of billions in fresh funds to cash-starved credit markets, allowing financial firms to use home mortgages as collateral.

Stocks surged and bonds fell in reaction to the moves, in a sign that the financial markets saw the plan as a viable remedy to ease a crisis that has threatened world economic growth. The
Dow industrials lurched 250-points higher at the start of trading.

Ben Bernanke

In the latest effort to ease a credit contraction that has disrupted finance and rescued the the world economy from a credit contraction, the Fed, Bank of Canada, Bank of England, European Central Bank and Swiss National Bank announced a series of aggressive measures to boost liquidity.

"In the near term, the Fed and global central banks have provided the thing everyone needed, and that's cash," said Martin Blum, head of emerging markets research at UniCredit in Vienna. "The actions ... deal with this issue by making it easier for banks to get cash, and that's important."

The Fed expanded its securities lending program, offering up to $200 billion of highly-liquid U.S. Treasury securities to primary dealers, secured for 28 days. The amount of cash the Fed has offered to primary dealers significantly expands what mortgage securities can be used as collateral. In effect, the plan allows them to replace easy-to-sell securities for the
unwanted mortgage notes.

The moves were made after some huge mortgage concerns were receiving demands for more cash as the value of their securities plunged on credit markets. Investors, paralyzed by fears of a market shutdown have shunned large sectors of the debt market, causing prices to tumble and leaving many offers for sales unfilled.

The action came on the back of an announcement from the Fed on Friday that it would expand auctions of short-term cash to $100 billion in March and launch a series of repurchase agreements expected to be worth $100 billion, bringing the total of recently announced action to a hefty $400 billion.

Stock markets rallied in Europe, and Wall Street opened sharply higher on the news. Prices for U.S. government bonds plunged, while the long-suffering dollar climbed.

As part of the latest effort, the European Central Bank said it would auction up to $15 billion for a term of 28 days, the Swiss National Bank said it would auction $6 billion and the Bank of Canada said it would it provide C$4 billion.

Despite the positive market reaction, some analysts questioned whether the latest round of central bank efforts would have much staying power. Earlier efforts by the Fed and its counterparts were successful in reviving markets for a short time, only to see them unravel again when the next bout of credit turmoil emerged.

"This Fed action is good for a day or two," said Michael Cheah, senior portfolio manager at AIG SunAmerica Asset Management in Jersey City, New Jersey.

"There are three problems in the market. One is the price of money, then liquidity and counterparty risk. The Fed can do all it can in the first two areas by trying to reduce Fed funds and the price of money. However, these moves are not going to mitigate the counterparty risk," he said.

In essence, banks have lost faith in each other after seven months of market unrest, making them reluctant to lend money to one another and driving up borrowing costs for the consumers and companies that power the world economy.

The U.S. central bank said the purpose of its latest action was to "promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of
financial markets more generally."

The new Fed lending facility will operate through weekly auctions that will start on March 27, the U.S. central bank said. It said it still was consulting primary dealers regarding the specific design of an auction.

The Fed also announced that its policy-setting Federal Open Market Committee has authorized increases in existing swap lines with the ECB and the SNB.