Fed auctions $30 billion to banks

January 15, 2008 12:34:49 PM PST
The Federal Reserve, working to combat the effects of a serious credit crisis, said Tuesday it had auctioned $30 billion in funds to commercial banks at an interest rate of 3.95 percent.It marked the third in a series of innovative auctions the Fed began last month as a way to provide cash-strapped banks with the reserves they need. The hope is that the increase in resources will keep banks lending to consumers and businesses and prevent the credit turmoil that hit in August from pushing the country into a recession.

There are indications the Fed's efforts are having an impact. The 3.95 percent interest rate was the lowest of any of the three auctions it has held. The other two auctions saw rates of 4.65 percent and 4.67 percent.

Analysts said the significant drop in rates reflected in part the view of markets that the Fed will cut a key interest rate by a half-point at the end of the month and keep reducing rates as needed to try to keep the country out of a recession.

"These auctions are helping the Fed do what it wants to do which is narrow the gap between interbank lending rates and the federal funds rate," said David Wyss, an economist at Standard & Poor's in New York.

The funds rate, the Fed's target for loans between banks, is currently at 4.25 percent, down a full percentage point from where it stood in early August, before a severe credit crisis sparked by rising mortgage defaults hit.

The auction result Tuesday means banks were able to borrow the fresh reserves at a rate below the Fed's current target for the funds rate. The Fed's discount rate, the interest it charges for direct loans to banks, is currently at 4.75 percent.

Last week, Federal Reserve Chairman Ben Bernanke said the auctions so far have been successful and would continue for as long as they were needed. He said that these auctions might become "a useful permanent addition to the Fed's tool box" of strategies it can employ at times when the credit markets have seized up.

Bernanke, in a Washington speech, said that before the new auctions are made permanent, the Fed would seek public comment on how they should be designed so that they can be best used by financial institutions.

There is one more auction scheduled for Jan. 28 but the Fed has already said it will announce later this month details of auctions it expects to hold in February.

The new auction process was unveiled by the Fed in mid-December in a coordinated action with other central banks around the world trying to address a global credit crunch.

The Fed decided to try the new process because their efforts to inject funds into the banking system through the Fed's discount window, which makes loans to banks, had proven less successful than Fed officials had hoped.

Many banks had avoided using the discount window out of concern that investors would see the move as an indication of underlying problems at their financial institutions.

The auction process was developed as an alternative way to get money into the banking system with the hopes that it would not carry the perceived stigma of the discount window.


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