Martin Crutsinger and Jeannine Aversa | The Associated Press
December 13, 2007
The Federal Reserve announced a novel approach Wednesday for injecting money into the banking system as it struggles to combat a severe credit crunch that threatens to drag the country into a recession.
It's the Fed's biggest concentrated effort to inject liquidity into the banking system since the Sept. 11, 2001, terrorist attacks in New York and Washington, D.C. The hope is that the extra funds will spur increased lending by banks and offset the credit crunch, which has made it harder for many businesses and consumers to obtain loans.
Here are some details about what the Fed is doing.
Question: How does the Fed's plan help?
Answer: At the heart of the Fed's plan is the creation of a Temporary Auction Facility to provide banks with up to $40 billion in emergency loans. The Fed is trying to shore up the finances of the banking system.
Q: How does the core of the plan work?
A: The Fed's facility will lend $40 billion in emergency funds to banks through two auctions next week, on Monday and on Dec. 20. Banks that need cash and are judged to be in "generally sound financial condition" by their local Federal Reserve bank can participate in the auction. Banks place bids to get a slice of the money. The loans are expected to be at rates lower than the 4.75 percent the Fed currently charges banks for direct loans through its discount window. To secure the short-term, 28-day loans, banks can pledge the same type of collateral -- such as corporate bonds, real-estate loans, agricultural loans and collateralized mortgage obligations-- allowed if they borrowed through the discount window. Two more auctions are scheduled for Jan. 14 and Jan. 28; the Fed has not yet determined how much money would be available then. If the new facility proves popular, the Fed may consider making it permanent.
Q: Why set up this new, temporary facility if cash-strapped banks already have the option of going to the Fed's discount window for an emergency loan?
A: Tapping the Fed's discount window can place a stigma on a bank if word gets out. Analysts say it is akin to getting branded with a financial scarlet letter. Since the credit crisis intensified in August, the Fed has been working hard to remove that blot. But banks remain fearful that market watchers will find out if they get a loan through the window, which could undermine customers' confidence in the institution's soundness. (The Fed does not reveal the identity of banks using the discount window and said it won't reveal which banks tap the new auction facility.) Banks using the discount window also pay a higher, penalty rate -- currently 4.75 percent -- on those loans. That compares with the 4.25 percent federal funds rate that banks now charge each other on overnight loans. The Fed sliced both rates Tuesday by a moderate one-quarter percentage point.
Q: What else is in the Fed plan?
A: The Fed also set up lines of credit with the European Central Bank and the Swiss National Bank. It said that this temporary arrangement would supply as much as $20 billion in reserves to the Europeans' central bank and up to $4 billion to the Swiss central bank.
Q: How long was this plan in the works?
A: The Fed has been negotiating with other central banks since August, when the credit crisis worsened. When the situation took yet another bad turn during the past couple of weeks, the negotiations intensified. It had become clear that inter-bank lending markets had deteriorated. One of the problems that has plagued the global financial system since the summer has been a high London Interbank Offered Rate, known as the LIBOR, which reflected banks' unwillingness to lend to each other. The rate also is popular for making adjustments to adjustable-rate mortgages. The Fed's announcement Wednesday was part of a globally coordinated response involving the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.
http://www.orlandosentinel.com/business/orl-fed1307dec13,0,4336708.story