Wednesday, July 30, 2008

Fed Extends Emergency Loan Programs Through January (Update4)

By Scott Lanman

July 30 (Bloomberg) -- The Federal Reserve extended its emergency lending programs to Wall Street firms through January after policy makers judged that markets are still ``fragile.''

The Fed also plans to give securities dealers options for tapping one of the loan programs to ensure financing through the ends of quarters, when funding needs can jump. Commercial lenders will be able to borrow from the central bank for a longer period, and the Fed boosted its swap line with the European Central Bank.

Today's action reflects continued financial turmoil, with premiums banks charge each other for three-month funds over the Fed's expected benchmark rate little changed since May. It's the latest step in officials' efforts to combat the yearlong credit crisis, after the Fed's March rescue of Bear Stearns Cos. and the Treasury's backstop for Fannie Mae and Freddie Mac this month.

``The U.S. is pulling out all the stops here to make sure we don't have a terrible downturn or a collapse in the financial system,'' said Allen Sinai, chief global economist at Decision Economics in Boston. ``There isn't anything else the Federal Reserve can do but to keep pumping liquidity into the system.''

The Primary Dealer Credit Facility for direct loans to securities firms and the Term Securities Lending Facility for loans of Treasuries, both begun in March, will now extend through Jan. 30. They would then be canceled if the Fed judges that markets ``are no longer unusual and exigent,'' the Fed said in a statement today in Washington.

Outlook for Rates

``These facilities do indicate strains that are part of the risks in the economic outlook,'' said Brian Sack, a former Fed research manager who is now senior economist at Macroeconomic Advisers LLC in Washington. Sack added that today's decision bolstered his expectation for the Fed to hold off on raising interest rates until next year.

The Fed made today's announcement ``in light of continued fragile circumstances in financial markets,'' the central bank said today. Officials made the decisions in a July 24 conference call and worked out details in the following days.

The gap between the three-month London Interbank Offered Rate and the overnight index swap rate, one measure of bank funding strains, is at 0.73 percentage point today, compared with an average of 0.66 percentage point so far this year. Former Fed Chairman Alan Greenspan says the crisis will be over once the spread narrows past 0.25 percentage point.

Policy makers are forecast to keep their benchmark rate at 2 percent when they next meet on Aug. 5. Traders still see a 71 percent chance of at least a quarter-point increase by year-end, futures prices show.

Bernanke, Geithner

Chairman Ben S. Bernanke and New York Fed President Timothy Geithner spearheaded the introduction of three lending programs since December as the credit crisis engulfed Wall Street.

Bernanke flagged the likelihood of the extension in a July 8 speech, saying the Fed is ``strongly committed'' to financial stability. The programs represent a provision of Fed credit to nonbanks unprecedented since the Great Depression.

The Fed will start auctions of options of as much as $50 billion in the TSLF on top of the $200 billion program, which loans Treasuries to securities firms in exchange for asset-backed securities and other collateral.

New York Fed officials plan to consult with the primary dealers of U.S. government bonds on the TSLF options program, the district bank said in a separate statement. The options plan is aimed at providing liquidity for two weeks or less surrounding key financing periods to be identified. Further details are planned on or before Aug. 8, the New York Fed said.

TAF Overhaul

The central bank also will start selling 84-day loans to commercial banks under the Term Auction Facility beginning next month, in addition to the sales of 28-day loans that have occurred since the program began in December. The biweekly sales will alternate between auctions of $75 billion in 28-day loans, and $25 billion in 84-day loans.

The Fed plans to keep the TAF program at $150 billion and released a schedule indicating it will remain at that size through November.

In related moves, the European Central Bank and Swiss National Bank are also extending their operations to include auctions of 84-day funds, the Fed said in a press release. The Federal Open Market Committee authorized an increase in the ECB's swap line with the Fed to $55 billion from $50 billion; the SNB's swap line is unchanged at $12 billion. The swaps are authorized through Jan. 30.

The Fed started the lending programs for investment banks under its authority to lend to nonbanks in ``unusual and exigent circumstances.'' Officials said at the time the Primary Dealer Credit Facility, which provides direct loans, would last for ``at least'' six months. The central bank had not previously given an end date for the TSLF.

Demand Falls

The PDCF has shown a zero balance for four straight weeks. The loans, once as high as $37 billion, fell to zero after the Fed took on a $30 billion portfolio of assets in June to facilitate Bear Stearns's acquisition by JPMorgan Chase & Co.

``I would be surprised if Jan. 30 marks the end of the measures,'' said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. ``The credit crunch is very much with us and, if anything, spreading a bit to consumer borrowing.''

Regulators took over IndyMac Bancorp Inc., a California lender, on July 11 after a run on deposits. First National Bank of Nevada and California-based First Heritage Bank were shuttered July 25.

Housing Bill

Today, President George W. Bush signed into law a housing bill that provides Treasury Secretary Henry Paulson the power to make equity purchases in Fannie Mae and Freddie Mac. Paulson asked for the authority July 13 after the shares of the firms, which own or guarantee almost half of the $12 trillion of U.S. mortgages, slid to the lowest level in more than 17 years.

The Fed provides loans to commercial banks of as long as 90 days through the traditional discount window, which carries an interest rate of 2.25 percent, a quarter-point higher than the Fed's benchmark rate. Lending rose to a record daily average of $16.4 billion in the week ended July 23.

Economists compared the TSLF options program to a Fed initiative aimed at potential money shortages during the 2000 computer-system changeover. The Fed sold options on almost $500 billion of repurchase agreements for standby financing. None were exercised.

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