Fed Lets Europe Central Banks Offer Unlimited Dollars, Removes Swap Limits

Fed Releases Flood of Dollars, Market Rates Fall

Oct. 13 (Bloomberg) — The Federal Reserve led an unprecedented push by central banks to flood the financial system with as many dollars as banks want, backing up government efforts to revive confidence and helping to reduce money-market rates.

The European Central Bank, the Bank of England and the Swiss National Bank will offer European banks unlimited dollar funds with maturities of seven, 28 and 84 days at fixed interest rates against “appropriate collateral,” the Washington-based Fed said today. The Fed had capped at $380 billion the currency it would swap with the three central banks.

Global economic leaders have redoubled efforts to unfreeze credit markets and avert the worst worldwide recession in thirty years after last week’s 20 percent slide in the MSCI World Index. Policy makers from the Group of Seven nations are committed to taking “all necessary steps” to stem a market panic, and European and U.S. governments today outlined plans to avoid banks failing.

“Like high waves that have gathered tremendous pace, global policy initiatives are coming to crash on the markets’ shores,” said Alex Patelis, chief international economist at Merrill Lynch & Co. in London. “A turning point could be reached.”

The cost of borrowing in dollars for three months today fell to 4.75 percent from 4.82 percent, the highest this year. The rate for euros over the same timeframe declined to 5.32 percent from 5.38 percent.

`Funding Stresses’

On foreign exchange markets, the euro rose as much as 2 percent against the dollar. Equities rallied worldwide and the MSCI World Index climbed 2 percent. Morgan Stanley soared 56 percent, while Bank of America Corp. and Citigroup Inc. jumped more than 10 percent.

“Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses,” Dominic Wilson and other economists at Goldman Sachs Group Inc. wrote in a note today. “This is because bank solvency risk should decline as the government offers protection.”

As well as slashing interest rates in concert last week, global central banks are expanding their toolkits to push down money-market rates. The Fed on Oct. 7 said it will create a special fund to buy U.S. commercial paper and the ECB last week said it would offer financial firms unlimited euro funds. The Bank of England is scheduled to revamp its own money-market operations later this week.

Until now, central banks and governments have failed to gain traction in markets, with investors criticizing them for adopting a scattershot and uncoordinated approach.

`Work Together’

The ECB, the BOE and the Swiss National Bank “can provide U.S. dollar funding in quantities sufficient to meet their demand” into 2009, the Fed said today. The Bank of Japan may introduce “similar measures.”

The aim is to keep the financial system flowing with the world’s reserve currency. Banks are hoarding cash for fear they will lose the money if it’s loaned or held elsewhere, or because they need it for their own funding needs.

“Central banks will continue to work together and are prepared to take whatever measures are necessary to provide sufficient liquidity in short-term funding markets,” the Fed’s statement said.

What began last December as a $24 billion arrangement between the Fed, the ECB and Swiss central bank was boosted over the past year to $620 billion and broadened to additional countries. The Fed didn’t announce changes to the $240 billion of swap lines with six other central banks, including those in Japan, Canada, Denmark, Norway, Sweden and Australia.

`More Important’

Today’s “action is unprecedented,” said Neil Mackinnon, chief economist at ECU Plc in London and a former U.K Treasury official. Andrew Milligan, who helps oversee about $260 billion as head of global strategy at Standard Life, said it’s a “much more important” move than the coordinated rate cut.

G-7 finance chiefs pledged Oct. 10 to take “urgent and exceptional action” after stocks plunged and as a global recession looms.

France, Germany and Spain today committed 960 billion euros ($1.3 trillion) to guarantee lending between banks and take stakes in them. That followed a summit of European leaders in Paris yesterday focused on achieving a more united front to battle the crisis.

Royal Bank of Scotland Group Plc, HBOS Plc, and Lloyds TSB Group will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government. The U.K. stole a march on its counterparts by saying last week it would guarantee lending between banks and invest in lenders.

In a New York Times column published today before the announcement that he had won the Nobel Prize in economics, Paul Krugman said the U.K.’s “combination of clarity and decisiveness hasn’t been matched by any Western government.”

U.S. Proposal

The U.S. Treasury today fleshed out its new proposal to buy stakes in financial firms. The program will be optional and aimed at “healthy firms,” Treasury Assistant Secretary Neel Kashkari, who oversees the $700 billion rescue package, said in a speech in Washington. U.S. Treasury Secretary Henry Paulson has identified purchasing stocks as his top priority.

The U.S. may now have to match Europe in guaranteeing interbank loans, said Win Thin, an economist at Brown Brothers Harriman & Co. in New York. “It would appear that it has no choice but to follow suit,” he said.

The collapse of New York-based Lehman Brothers Holdings Inc. precipitated the latest chapter of the 14-month crisis, causing banks to stop lending to each other out of concern they may not get their money back. The world’s largest financial companies have posted more than $635 billion in writedowns and credit losses since the start of last year after the U.S. housing market slumped.

Today’s move by central banks is “another welcome measure,” said Ross Walker, an economist at Royal Bank of Scotland in London. “We’ll have to see what comes out of it. We all expect more rate cuts, whether they’re coordinated or not is another matter.”

To contact the reporter on this story: John Fraher in London at jfraher@bloomberg.net; Simon Kennedy in Washington at skennedy4@bloomberg.net

Last Updated: October 13, 2008 12:56 EDT
By John Fraher and Simon Kennedy

Source: Bloomberg

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