Fed Cuts Discount Rate, Expands Loans to Avert Crisis

Fed Cuts Discount Rate, Expands Loans to Avert Crisis

By Scott Lanman and Craig Torres

March 17 (Bloomberg) — The Federal Reserve, struggling to prevent a meltdown in financial markets, cut the rate on direct loans to banks and became lender of last resort to the biggest dealers in U.S. government bonds.

In its first weekend emergency action in almost three decades, the central bank lowered the so-called discount rate by a quarter of a percentage point to 3.25 percent. The Fed also will lend to the 20 firms that buy Treasury securities directly from it. In a further step, the Fed will provide up to $30 billion to JPMorgan Chase & Co. to help it finance the purchase of Bear Stearns Cos. after a run on Wall Street’s fifth-largest securities firm.

It is a serious extension of putting the Federal Reserve's balance sheet in harm's way,'' said Vincent Reinhart, former director of the Division of Monetary Affairs at the Fed and now a scholar at the American Enterprise Institute in Washington.That’s got to tell you the economy is in a pretty precarious state.’’

The move is Chairman Ben S. Bernanke’s latest step to alleviate a seven-month credit squeeze that’s probably pushed the U.S. into a recession. The dollar tumbled to a 12-year low against the yen and Treasury notes rallied as traders increased bets that officials will reduce their main rate by 1 percentage point when they meet tomorrow.

Race to the Bottom' <span class="base64" title="PGNvZGUgY2xhc3M9InNwaXBfY29kZSBzcGlwX2NvZGVfaW5saW5lIiBkaXI9Imx0ciI+Q2xlYXJseSwgdGhlIEZlZCBpcyB0cnlpbmcgdG8gcHJvdmlkZSBtb3JlIGxpcXVpZGl0eSB0byBwcmV2ZW50IGEgbW9yZSB2aWNpb3VzIGN5Y2xlIGFuZCByYWNlIHRvIHRoZSBib3R0b20sJycgc2FpZCBHYXJ5IFNjaGxvc3NiZXJnLCBzZW5pb3IgZWNvbm9taXN0IGF0IFdlbGxzIENhcGl0YWwgTWFuYWdlbWVudCBpbiBTYW4gRnJhbmNpc2NvLCB3aGljaCBvdmVyc2VlcyAkMjAwIGJpbGxpb24uPC9jb2RlPg=="></span>The problem is there's so much concern about credit quality that now there are solvency issues, and it's something the Fed has a more difficult time dealing with.'' Asian stocks tumbled. The Nikkei 225 Stock Average lost 3.7 percent at the close in Tokyo, and the Hang Seng Index was 5.1 percent lower at 3:52 p.m. in Hong Kong. <span class="base64" title="PGNvZGUgY2xhc3M9InNwaXBfY29kZSBzcGlwX2NvZGVfaW5saW5lIiBkaXI9Imx0ciI+V2UndmUgZ290IGEgY3JlZGl0IGNydW5jaCBzaXR1YXRpb24gaW4gZXZlcnkgY29ybmVyIG9mIHRoZSBtYXJrZXQsJycgc2FpZCBUZXRzdXJvIFN1Z2l1cmEsIGNoaWVmIGVjb25vbWlzdCBhdCBNaXp1aG8gUmVzZWFyY2ggSW5zdGl0dXRlIEx0ZC4gaW4gVG9reW8uPC9jb2RlPg=="></span>The near collapse of Bear Stearns has shocked the authorities.'' Officials from the Fed and the Treasury Department, including Treasury Secretary Henry Paulson, worked with the firms over the weekend to forge an agreement on the sale of Bear Stearns. Paulson kept President George W. Bush informed through the weekend, said White House spokesman Tony Fratto. Interest-Rate Difference The Fed reduced the difference between the discount rate and the main federal funds rate to a quarter point. In August, at the onset of financial-market pressures, the Fed narrowed the spread to a half point from 1 percentage point. The funds rate, currently 3 percent, is the rate banks charge each other for overnight loans. Opening up lending to firms other than commercial banks represents a shift in the Fed's 94-year history. The so-called primary dealers include firms that are units of commercial banks and several that aren't, including Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. Bernanke, 54, is increasing efforts to keep strains in financial markets from spiraling into a full-blown meltdown. Last week the central bank agreed to emergency loans to a non-bank, Bear Stearns, for the first time since the 1960s. Fed officials also announced a program to swap $200 billion in Treasuries for debt including mortgage-backed securities.Sense of Urgency’

These moves underscore the extreme sense of urgency at the Fed,'' said David M. Jones, a former New York Fed economist who has written four books on the central bank.It seems unlikely the measures taken so far will calm the market down, but eventually they will stabilize the market.’’

JPMorgan yesterday agreed to buy Bear Stearns, the second- biggest underwriter of U.S. mortgage securities, for $240 million, less than a 10th of its value last week. In order to strike a deal before the opening of Tokyo trading, the Fed agreed to help JPMorgan finance up to $30 billion of Bear Stearns’s less liquid assets.'' The Fed is in effect assuming responsibility for managing the assets, a Fed official told reporters in a conference call. The central bank will manage the positions to minimize any market strains and maximize long-term value, said the official, who spoke on condition of anonymity.We learned that Bear Stearns’s balance sheet on close examination was worth a 10th of its market value,’’ said Reinhart. Second, the Federal Reserve wants to be sure the other entities coming to them are covered by a broader umbrella,'' he said, referring to the primary dealers. Volcker's Saturday Night Shifting policy on a weekend is rare, though not unprecedented. About two months after Paul Volcker took office as Fed chief in 1979, he called a Saturday meeting of the Federal Open Market Committee to raise interest rates. Yesterday's events arenothing like the 1970s, which was about fighting inflation,’’ said Jones. This is fighting a negative, self-reinforcing process'' of sliding collateral values, tighter bank credit and weakening of economic conditions, he said. Starting today, the dealers who trade with the New York Fed bank daily will be able to borrow at the discount rate under a new lending facility, to be in place for at least six months, the Fed said. The Fed will accept abroad range’’ of investment- grade collateral.

These steps will provide financial institutions with greater assurance of access to funds,'' Bernanke said during a conference call with reporters after the announcement. Investors expect the Fed to lower its separate benchmark rate by as much as a full percentage point, to 2 percent, when policy makers meet tomorrow. That would exceed the 0.75-point emergency reduction on Jan. 22, which is the largest since the overnight interbank lending rate became the main tool of monetary policy about two decades ago. Exodus Yesterday's steps indicate the Fed is increasingly concerned about the investor exodus from mortgage debt, which threatens to deepen the housing contraction. New York Fed President Timothy Geithner said on the call thatthis 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.’’

Fed governors agreed that the ``unusual and exigent circumstances,’’ as stated in the Federal Reserve Act, existed for approving the lending to primary dealers, a Fed official said on the conference call. The actions were approved by all five members, a Fed official said.

Following is a list of primary dealers in government
securities:

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Bear, Stearns & Co., Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Countrywide Securities Corporation
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Dresdner Kleinwort Wasserstein Securities LLC.
Goldman, Sachs & Co.
Greenwich Capital Markets, Inc.
HSBC Securities (USA) Inc.
J. P. Morgan Securities Inc.
Lehman Brothers Inc.
Merrill Lynch Government Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
UBS Securities LLC.

Source: Federal Reserve Bank of New York

To contact the reporter on this story: Scott Lanman in Washington at slanman HCC bloomberg.net
Last Updated: March 17, 2008 03:53 EDT

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