Fed Boosts Lending to Banks as Credit Rout Continues

The Federal Reserve moved to add as much as $200 billion to the banking system over the next month to offset a deepening credit crisis that may have already pushed the U.S. economy into a recession.

The central bank raised to $50 billion each from $30 billion the amount intended for auctions of funds on March 10 and March 24. The Fed also said in a statement in Washington today that it will make $100 billion available through weekly 28-day repurchase agreements, where the central bank will lend cash in return for assets including mortgage-backed bonds.

The decision is the central bank's latest attempt to reduce the threat to the economy from banks curtailing loans to companies and households. Banks and securities firms have posted losses exceeding $188 billion since the start of last year as the impact of surging defaults on subprime mortgages rippled through world financial markets.

Given what we have seen in terms of illiquidity in the financial markets in the last four or five days, this came right in time, Ajay Rajadhyaksha, head of fixed-income strategy at Barclays Capital in New York, said in an interview with Bloomberg Television.

The Fed said it will increase the sizes of both the so- called Term Auction Facility operations and the repurchases if conditions warrant.

Interest Rates

Traders increased bets that the Fed will lower its benchmark interest rate by three quarters of a point this month after a government report showed the biggest job loss in five years, adding to evidence the economy is contracting. Odds of a smaller, half-point reduction fell to 6 percent from 26 percent yesterday, futures prices showed.

Fed officials said today's announcement wasn't related to the jobs report, and instead was aimed at addressing the deterioration in credit markets. The officials, speaking on condition of anonymity in a conference call with reporters, also said the measures won't expand the Fed's balance sheet.

At the same time, the central bank's balance sheet will likely change in composition as a result of today's announcements. Changes in the way the Federal Reserve Bank of New York accepts bids for repos will probably boost the level of mortgage-backed debt the Fed holds, while reducing the level of Treasuries, a Fed official said.

In effect, the Fed is using its own balance sheet to help banks and bond dealers finance assets riskier than U.S. government debt.

Investor Exodus

The move comes as investors are questioning the worth of even the highest-rated securities after Standard & Poor's and Moody's Investors Service assigned AAA grades to bonds backed by mortgages to borrowers who are now struggling to make their payments.

Carlyle Group's mortgage-bond fund was suspended in Amsterdam today after creditors forced the sale of some holdings, jeopardizing shareholders' capital. The fund borrowed to buy about $22 billion of AAA rated mortgage debt issued by Fannie Mae and Freddie Mac.

Citigroup Inc., the fourth-largest U.S. home lender by new loan volume, said March 6 it plans to pare its mortgage and home-equity loan holdings by about $45 billion, or 20 percent, over the next year.

Federal Open Market Committee members are next scheduled to meet on March 18. As credit stresses increased since the last gathering on Jan. 29-30, speculation has increased among traders that officials will consider lowering rates before the next meeting, as they did on Jan. 22.

Rate Target

Officials said they will keep the benchmark federal funds rate target around the level set by the FOMC, indicating they don't plan for the liquidity measures to drive the rate lower.

The central bank introduced the TAF, a lending tool that allows banks to give the Fed a range of collateral in return for loans, in December. The TAF loans for this month have a 28-day maturity.

What the Fed's saying with the TAF changes is, `We hear you and we want to ensure everybody has financing for good collateral,' said Joe Tully, managing director of the money- market desk in Newark, New Jersey, at Prudential Investment Management, which oversees about $55 billion.

The New York Fed said in a statement that the first of the 28-day repo operations will be conducted today, in the amount of $15 billion. It also said it will sell $10 billion of Treasury- bill holdings, to maintain a level of reserves consistent with keeping the federal funds rate around the current target.

Helping Banks

Repos allow the central bank to inject funds into primary dealers, a group of 20 banks that trade securities directly with the New York Fed. By contrast, the TAF operations offer funds to deposit-taking institutions; the most recent auction included 72 banks.

The Fed said it is in close consultation with other central banks. In December, the Fed loaned $24 billion to the European Central Bank and Swiss National Bank through a swap agreement to make more dollars available to banks in Europe.

If need be, we could certainly continue to coordinate with the Fed, ECB spokeswoman Regina Schueller said, citing remarks by President Jean-Claude Trichet.

The SNB said it has no plans to join in dollar auctions, spokesman Werner Abegg said.

Job Losses

The Fed is also trying to contain the fallout on the broader U.S. economy, which is moving closer to recession. Employers cut payrolls by 63,000 after a loss of 22,000 in January, the Labor Department said today.

The central bank said that the TAF operations will be continued for at least the next six months. Fed Chairman Ben S. Bernanke said in January that officials may make the resource a permanent addition to the Fed's toolbox.

Former Fed Chairman Alan Greenspan yesterday said March 5 that the credit markets won't recover until house prices stop falling. He said in a conference call organized by Deutsche Bank AG that home construction needs to decline to clear a surfeit of unsold properties and stabilize home prices.

I don't think there's that much the Fed can do about this, Harvard University economist Kenneth Rogoff, a former chief economist of the International Monetary Fund, said in an interview in Paris. It's very limited what monetary policy can do in the wake of a once-in-many-decades housing-price crash.

Bernanke Says Fed to Judge Market Turbulence Impact

Federal Reserve Chairman Ben S. Bernanke said volatility in credit markets has affected the economys prospects and policy makers must decide whether the risks between growth and inflation have now shifted.

The outlook has also been importantly affected over the past month by renewed turbulence in financial markets, Bernanke said in a speech in Charlotte, North Carolina. The committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially.

Bernanke spoke a day after remarks by Vice Chairman Donald Kohn stoked investors expectations for the central bank to lower interest rates for a third straight meeting Dec. 11. While the Fed chief discussed both the risks to growth and inflation, he indicated the central bank is watching for additional signs of a pullback in spending.

Neither Bernanke nor Kohn repeated the language in last months Federal Open Market Committee statement that risks between growth and inflation were roughly balanced. Economists interpreted the Oct. 31 statement as a signal policy makers preferred to leave rates unchanged for a time.

Uncertainty around the outlook is even greater than usual, requiring the Fed to be exceptionally alert and flexible, Bernanke said at an annual meeting of the Charlotte Chamber of Commerce.

Consumer Headwinds

The combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead, Bernanke said. Continued good performance by the labor market is important for maintaining the economic expansion.

Kohn said yesterday that officials must take account of the deterioration in credit markets when they next meet. Bernanke echoed that view.

The Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy, Bernanke said.

Federal funds futures show traders see a 100 percent chance of a reduction in the benchmark rate next month, with a 26 percent probability of a half-point move. After the 0.75 percentage point of cuts the past two meetings, that would make the most aggressive easing since the last recession in 2001.

Treasuries Rally

Treasuries have climbed this week, sending three-month bill yields below 3 percent for the first time since August, as concern over banks willingness to lend drove investors to the relative safety of U.S. government debt.

At the same time, stocks rallied on optimism the Fed will act to keep alive the economic expansion, now entering its seventh year. The Standard & Poors 500 Index rose 4.4 percent in the past three days, to 1,469.72 at the close in New York.

Economists also predicted lower rates amid concern mounting losses on assets linked to subprime mortgages will cause banks to cut borrowing. Citigroup Inc., Merrill Lynch & Co., Barclays Plc and other banks have already warned of about $50 billion of losses.

Economic reports today indicated growth may falter after accelerating in the third quarter. New-home prices dropped the most since 1970 and jobless claims rose to a nine-month high. Government figures yesterday showed durable goods orders fell for a third month, the longest slump in 3 1/2 years.

Household spending data have been on the soft side, Bernanke said. The committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting.

Mixed Data

Economic data have been mixed since last months FOMC meeting, the Fed chairman said. He noted that officials will have further reports, including November payroll figures, when they gather Dec. 11.

President George W. Bushs economic advisers today followed Fed officials move last week to lower their outlook for growth next year. Fed policy makers now expect U.S. gross domestic product to increase 1.8 percent to 2.5 percent in 2008, notably below the 2.5 percent to 2.75 percent they predicted in July.

Bernanke said inflation has remained moderate. Still, increases in the prices of food, imported goods and energy products may raise inflation and inflation expectations, he said.

The effectiveness of monetary policy depends critically on maintaining the publics confidence that inflation will be well- controlled, Bernanke said. We are accordingly monitoring inflation developments closely.

Higher Risk

In financial markets, risk spreads have increased since the Fed met Oct. 30-31, an index tracked by Citigroup Global Markets Inc shows. The index rose to a high of 0.99 on Nov. 22 from 0.77 on Nov. 1, with 1 being the highest level of risk aversion. It was at 0.94 today.

Fed officials have tried to meet the surge in demand for cash, first lowering the cost of direct loans to banks in an unscheduled meeting in August. The central bank cut both the discount rate and its key rate in September and October. The New York Fed also said this week it plans a series of long-term repurchase agreements through year-end to ease funding shortages.

Source - Bloomberg

Early signs of easing seen in subprime lending

Former Federal Reserve chairman Alan Greenspan defended the U.S. subprime mortgage market Monday, arguing that the securitization of home loans for people with poor credit not the loans themselves were to blame for the current global credit crisis.

Greenspan also said there were some early signs of an easing in the crisis, but warned that the longer term effects on the economy were still being determined.

"Subprime mortgages were and are risky, but they are worth it," Greenspan said, adding that is better to have a larger property owning class with a vested interest in the system.

"I'm terribly concerned that we would cut back on the availability of subprime that has enabled a very significant increase in mortgages among minorities in the United States," he added.

The current credit market turmoil began with rising defaults in the United States on subprime mortgages. Those problems have since spread as banks repackaged risky loans with the more reliable and sold them to a wide range of investors, including several European banks.

Credit dried up in early August, roiling financial markets, as banks became wary of exposure to the risky loans.

Greenspan acknowledged that a number of people should not have been taking out those mortgages, but that the current crisis was due "not the subprime problem itself, but to the securitization of subprime."

Greenspan said there are "some positive signs" that the crisis is calming.

"For example, the yields on what has been the poster child of this crisis, asset backed commercial paper, have jumped up sharply," he said. "It has since come down, but not all the way."

Similarly, the interbank lending rate, which jumped in recent weeks amid fears about insolvencies, have started to come down, but "not all the way," he said.

"We are not through with this yet," he added, suggesting there could still be what he termed an "Act II," in which falling house prices feed into slower consumer spending.

However, he reiterated earlier comments that he believed the probability of a recession in the United States was "less than 50/50."

Greenspan also implicitly criticized the role of ratings agencies in the crisis.

"The problem was that people took that as a triple-A because ratings agencies said so," he said. Yet when they tried to sell the products they ran into difficulties, which shook confidence.

"What we saw was a 180 degree swing from euphoria to fear and what we've learned over the generations is that fear is a very formidable challenge," Greenspan said.

Ratings agencies such as Standard & Poor's Corp., Moody's Investors Service Inc. and Fitch Ratings have come under fire for being slow to lower their ratings on securities based on mortgage loans to U.S. borrowers with poor credit records.

Source - The Associated Press