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Fed acts to protect financial system

17/03/2008 - 3:28

By Mark Felsenthal

WASHINGTON (Reuters) - The U.S. Federal Reserve on Sunday announced fresh emergency measures to stem a fast-spreading global financial crisis, using tools it has not used since the Great Depression.

The Fed cut the discount rate it charges on direct loans to banks and setting up a new program to provide cash to a wider range of big financial firms.

Senior Fed officials said the extraordinary measures, which follow a sequence of emergency steps over the last ten days, were necessary to ensure the broad spectrum of financial firms have access liquid funds as problems at investment bank Bear Stearns on Thursday and Friday put the broader financial system at risk.

"The Federal Reserve in close consultation with the Treasury is working to promote liquid, well functioning financial markets, which are essential for economic growth. To that end we took two steps today," Fed Chairman Ben Bernanke said in a rare conference call with reporters.

"These steps will provide financial institutions with greater assurance of access to funds," he added.

ASSET-BACKED SECURITIES MARKETS

The action was the latest in a series of crisis response tools the U.S. central bank has broken out to try to contain a broadening financial crisis that threatens to push the economy into a deep recession. The Fed is further expected to cut benchmark borrowing costs by as much as a full percentage point on Tuesday, a rate reduction that would be unprecedented in the central bank's modern era.

"This is designed to help get liquidity to where it can help play an appropriate role in helping address the range of challenges facing, particularly asset backed securities markets," New York Fed President Timothy Geithner said on the same call as Bernanke.

Senior Fed officials said during that call that the unusual weekend announcement came at the culmination of several turbulent weeks in financial markets, with difficulties at Bear Stearns posing what officials described as a major set of challenges for the financial system as a whole. The officials spoke on condition they not be named or quoted directly.

The timing of the announcements should be thought of as driven by the situation at Bear Stearns, one senior official specified.

In a surprise statement, the central bank said it cut the discount rate to 3.25 percent from 3.5 percent, effective immediately, an action that puts that rate just a quarter point above the interbank overnight federal funds rate -- the Fed's primary policy tool.

It also said it was setting up a new lending program under which so-called primary dealers could borrow directly from the Fed at the discount rate.

"Liquid, well-functioning markets are essential for the promotion of economic growth," the Fed said.

PRE-EMPTING AD HOC LENDING

The central bank said the new lending facility for the primary dealers -- big Wall Street firms with which it deals directly in financial markets -- would be open for business on Monday and would be kept in place for at least six months.

It is aimed "to improve the ability of primary dealers to provide financing to participants in securitization markets," the central bank said. The loans extended under the new program can be backed by a broad range of investment-grade debt securities as collateral.

Both actions were approved unanimously by the Fed's Board of Governors, which took the steps in concert with a decision to approve special financing to facilitate the purchase of ailing investment bank Bear Stearns by JPMorgan Chase & Co. Under the deal, the Fed agreed to fund up to $30 billion of Bear Stearns' less liquid assets.

The Fed also said it was increasing the maximum term for discount window loans to 90 days from 30 days.

On Friday, the Fed said it would provide emergency funds to cash-strapped Bear Stearns through its discount window using JPMorgan Chase as an intermediary. Bear Stearns, which is one of 20 primary dealers, was unable to borrow directly from the window because -- until the latest action -- it had been open only to deposit-accepting banks.

"This evening's decision appeared to pre-empt the possibility of continuing to arrange ad hoc lending arrangements to other primary dealers who could face funding difficulties," said Michael Feroli, an economist at JPMorgan Chase.

The central bank began lowering the overnight rate in mid-September and has taken it down to 3 percent from 5.25 percent, but the impact of the Fed's monetary easing has been undercut by credit markets that remain unusually tight.

(with additional writing by Tim Ahmann)


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