Fed, European Banks Team to Ease Credit Squeeze

May 2, 2008
Move aims to speed up slowing world economy.

The U.S. Federal Reserve announced May 2 joint action with European banks to step up a battle against a persistent global credit crisis that has shackled lending and slowed the world economy. The Fed, the European Central Bank (ECB) and the Swiss National Bank (SNB) decided to expand their efforts to open up credit "in view of the persistent liquidity pressures in some term funding markets," the U.S. central bank said in a statement.

The Fed raised the amount of monthly lending available to banks by $50 billion to $150 billion under the so-called Term Auction Facility, beginning May 5. The Federal Reserve also increased the size of its swap agreements with the ECB and the SNB and expanded the type of collateral that investment banks can use to obtain its loans.

Fed Chairman Ben Bernanke has led a series of steps to help get credit flowing in the global financial system that seized up in August amid rising defaults on U.S. subprime, or high-risk, mortgages. The worst U.S. housing slump in decades, combined with tightening credit as mortgage-backed securities plunged in value, has had a domino effect on the financial system.

The Fed has poured billions of dollars into the banking system and slashed its base federal funds interest rates in a series of cuts by 3.25 percentage points since September to keep credit flowing. Still, the Fed interest rate cuts have not budged mortgage rates and some other corners of the financial system. Home foreclosures have spiked as borrowers with adjustable mortgages, often linked to the LIBOR benchmark index rate, face higher rates as the loan resets from tantalizingly low entry rates.

The Fed's move Friday appeared to be targeted to reach those areas, analysts said. "Since many floating rate mortgages in the U.S. are tied to LIBOR, the Fed certainly is making an attempt to have the recent rate cuts feed through to these mortgage holders," said Andrew Busch, analyst at BMO Capital Markets.

A move of this kind had been expected to address the credit crunch, said Joel Naroff of Naroff Economic Advisers. "They're trying to address every aspect of the problem," he said. "The problem is no longer are rates low enough, it's that there's got to be enough liquidity in the system for banks to start lending again."

The Fed expanded a new auction for commercial banks and brokerages that was launched in March to allow the swap of thinly traded mortgage-backed securities and other collateral for safer Treasury obligations. The Fed said it would now accept AAA/Aaa-rated asset-backed securities beginning Wednesday, in addition to the already eligible mortgage-backed securities and agency mortgage-backed securities.

"The wider pool of collateral should promote improved financing conditions in a broader range of financial markets," the Fed said.

The Fed boosted its swap agreement with the ECB by $20 billion to $50 billion, and doubled that with the SNB to $12 billion, extending the agreements through Jan. 30, 2009.

Separately, the ECB said it would raise its liquidity offers to banks to $50 billion from $15 billion over 28 days and continue to provide support "as long as necessary." The SNB said it would offer $6 billion on a 14-day basis, doubling the amount of funds available to $12 billion per month.

Copyright Agence France-Presse, 2008

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