World central banks unite to ease credit strain
WASHINGTON (Reuters) – The U.S. Federal Reserve and four other central banks on Tuesday teamed up to get hundreds of billions of dollars in fresh funds to cash-starved credit markets, allowing financial firms to use securities backed by home mortgages as collateral for central bank loans.
Stocks surged, bonds fell and the long-suffering U.S. dollar soared in reaction to the moves, a sign financial markets saw the plan as a step in the right direction to ease a crisis that has threatened world economic growth. The Dow Jones industrials closed nearly 3.6 percent higher.
In the latest effort to ease a credit contraction that has disrupted global finance, the Fed, Bank of Canada, Bank of England, European Central Bank and Swiss National Bank announced a series of aggressive measures to boost liquidity. It was the second time in three months that central banks from around the globe had launched coordinated efforts.
Wall Street economists were quick to call the new lending facility a step in the right direction, but what’s most needed is time for the de-leveraging of billions of dollars in loans globally.
“What we’ve seen is really a seizing of the money markets and it will help to alleviate this by injecting much needed cash,” said Kathleen Stephansen, director of global economics at Credit Suisse in New York. “It doesn’t take away the credit crunch because deleveraging will still have to take place. But this will make it a more orderly process.”
Policy-makers are particularly concerned that tightening credit conditions, sparked by the U.S. subprime housing meltdown, will curb the flow of money to the people and businesses that power the global economy.
The Fed expanded its securities lending program, offering up to $200 billion of highly liquid U.S. Treasuries to primary dealers, secured for 28 days, and said it could increase the size of the program if needed. It also significantly expanded the types of securities that can be used as collateral for the loans. In effect, the plan allows banks to exchange unwanted mortgage notes for easy-to-sell government securities.
“Is this going to cure what ails the economy? I would guess everyone realizes the answer to that is going to be ‘no.’ Is this going to be helpful in addressing the strains in financial markets? For sure, the answer is ‘yes’,” the first deputy managing director of the International Monetary Fund, John Lipsky, told Reuters.
The yield spreads on interest rate swaps over U.S. Treasuries, which investors use to hedge or to speculate on rate moves, made their biggest single-day move since the day after the September 11 attacks.
The U.S. central bank said it would not accept private mortgage-backed securities that credit ratings agencies had put under review for possible downgrades.
Michael Youngblood, director of fixed-income research at FBR Investment Management, said there was $2.1 trillion worth of private mortgage-backed securities as of the fourth quarter, and just over half of that was highly rated “AAA”. It was not clear how much of that was at risk of potential downgrade.
SMALLER RATE CUT?
The Fed’s moves came after some huge holders of mortgage-linked debt received demands for more cash as the value of the securities they held plunged. Investors, paralyzed by fears of a market shutdown, have shunned large sectors of the debt market, causing prices to tumble and leaving many offers for sales unfilled.
The action came on the heels of an announcement from the Fed on Friday that it would expand auctions of short-term cash to $100 billion in March and launch a series of repurchase agreements expected to be worth $100 billion, bringing the total of recently announced steps to a hefty $400 billion.
In addition to its efforts to increase financial market liquidity, the U.S. central bank has shaved 2.25 percentage points from benchmark interest rates since mid-September in an effort to offset the impact of the credit tightening.
Economists widely expect at least another half-point reduction when the Fed’s policy-setting committee meets next week. Goldman Sachs economist Jan Hatzius said the latest steps make a more aggressive cut less likely.
“This announcement makes clear that Fed officials are pulling out all the stops they can think of to deal with financial stress through the increased provision of liquidity into the system,” he wrote in a note to clients. “To the extent they see this as substituting for rate cuts, this should reduce the probability of a 75 basis point rate cut next Tuesday.”
As part of the latest effort, the ECB said it would auction up to $15 billion for a term of 28 days, the Swiss National Bank said it would auction $6 billion, and the Bank of Canada said it would provide about $4 billion.
Despite the positive market reaction, some analysts questioned whether the latest central bank efforts could solve the deeper problem of banks’ constrained balance sheets. Earlier steps by the Fed and its counterparts revived markets only for a short time.
“As with the other liquidity measures introduced, the new facility will not alleviate the current credit crunch or economic recession,” Merrill Lynch economist David Rosenberg wrote in a research note.
“The size of the auctions, while sizable in terms of the Fed’s balance sheet, are actually fairly small in light of the overall credit situation and in no way does this solve — or is intended to solve — the massive write-downs and losses in the banking sector that are ongoing in this cycle.”
The Fed said its new lending facility will operate through weekly auctions that start on March 27. It also said it was increasing existing currency swap lines with the ECB and SNB, allowing those two central banks to offer more U.S. dollars in their respective markets. Both the ECB and SNB said they would provide dollar liquidity for as long as needed.
(Additional reporting by Al Yoon and Richard Leong in New York and Lesley Wroughton and Joanne Morrison in Washington; writing by Emily Kaiser; editing by Leslie Adler)