Saturday, January 5, 2008

Fed Boosts Next Two Special Auctions to $30 Billion (Update2)

By Daniel Kruger

Jan. 4 (Bloomberg) -- The Federal Reserve will increase the size of two scheduled auctions of emergency loans by 50 percent to $30 billion as part of a global attempt by central bankers to restore faith in the money markets.

The Fed reiterated that it will continue the loan auctions, designed to increase the amount of cash available in the banking system, ``for as long as necessary,'' in a statement released today. The third and fourth auctions will be conducted on Jan. 14 and 28. The central bank will announce on Feb. 1 whether further auctions will be conducted.

Since the first of the auctions on Dec. 17, companies' cost to borrow in dollars for three months has fallen to the lowest in two years, suggesting central banks are succeeding in spurring bank lending.

``It's a step in the right direction,'' Bill Gross, the founder and chief investment officer of Pacific Investment Management Co., said in a Bloomberg Television interview from Newport Beach, California. ``They're making some progress.''

The Board of Governors of the Federal Reserve System established the temporary Term Auction Facility, dubbed TAF, in December to provide cash after interest-rate cuts failed to break banks' reluctance to lend amid concern about losses related to subprime mortgage securities. The program will make funding from the Fed available beyond the 20 authorized primary dealers that trade with the central bank.

Rate Cuts

Policy makers have cut the Fed's target rate for overnight loans between banks by 100 basis points to 4.25 percent since mid-September, and the discount rate by 150 basis points. A basis point is 0.01 percentage point.

Futures show the probability of the Fed cutting rates another half percent point at the end of the month increased to 68 percent today after the Labor Department said unemployment rose to a more than two-year high of 5 percent and job growth was less than forecast in December. Traders had factored in a zero percent probability a week ago.

The Fed uses the TAF to auction funds to institutions that are eligible to borrow at its discount window. All TAF credit must be fully collateralized, and TAF accepts a broad range of collateral at the same values and margins applicable for the other Fed lending programs.

On Dec. 21 the Fed and European Central Bank loaned a total of $30 billion in 35-day funds at an interest rate of 4.67 percent, 2 basis points more than at the initial auctions four days earlier. The rates were less than the 4.75 percent banks are charged to borrow directly at the Fed's discount window, suggesting the central bank was making progress in alleviating a credit crunch. The Fed auctioned $20 billion in each of those instances.

`It's Working'

The three-month London interbank offered rate, a lending benchmark that fluctuates depending on how willing banks are to lend to each other, fell to 4.62 percent today, the lowest since January 2006, according to the British Bankers' Association. The rate is 37 basis points above the Fed's target, down from a difference of 86 basis points last month, the highest since 1999.

The Fed's decision to increase the auction size ``tells you they think it's working,'' said Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Ltd. The Fed wants to employ ``surgical strikes against the problem and not just a general overall easing,'' he said.

Results will be announced the day following each auction and the sales will settle three days after that.

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