Fed promises infinite money as long as banks want it

Fed to Offer Special Auctions 'As Long As Necessary'

By Liz Capo McCormick
Bloomberg News Service
Friday, December 21, 2007

http://www.bloomberg.com/apps/news?pid=20601087&sid=a0jFvw9NueL4&refer=home

NEW YORK -- The Federal Reserve will conduct biweekly emergency auctions of loans as "long as necessary" as part of a global attempt by central bankers to restore faith in the money markets.

The Fed and European Central Bank loaned $30 billion in 35-day funds today at an interest rate of 4.67 percent, 2 basis points more than the initial special auctions four days ago. The rates are less than the 4.75 percent banks are charged to borrow directly at the Fed's discount window, suggesting the central bank is making progress in alleviating the credit crunch.

"The Fed finally gets it," said Andrew Brenner, co-head of structured products in New York at MF Global Ltd. "This allows the Fed to postpone easing, which they prefer due to inflation."

The U.S. central bank had scheduled four special auctions, with the final two slated for Jan. 14 and Jan. 18. The central banks, along with those in Canada, Switzerland and the U.K., announced plans on Dec. 12 to move in concert to alleviate the credit squeeze threatening global growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks.

Policy makers have cut the Fed's target rate for overnight loans between banks by 100 basis points to 4.25 percent since September, and the discount rate by 150 basis points. The U.S. central bank has also provided $8 billion in long-term repurchase agreements through year-end and let $35.2 billion in short-term securities mature so the proceeds could be used to provide liquidity in the banking system.

...TED Spread Narrows

"The fact that the Fed said they will continue every two weeks with these auctions will help yields on Treasuries to move higher, spreads to come in, and stocks" to rise, said Richard Gilhooly, an interest-rate strategist in New York at BNP Paribas Securities Corp., one of the 20 primary dealers that trade directly with the central bank.

Benchmark 10-year note yields rose 8 basis points to 4.13 percent, the biggest increase in a week. Yields on three-month bills, seen as a haven from turmoil by investors, increased 4 basis points to 2.97 percent. The Dow Jones Industrial Average gained 1.2 percent to 13,406.84, while the Standard & Poor's 500 Index increased 1.13 percent to 1,477.42.

The difference between three-month Treasury bills and the three-month London Interbank Offered Rate, known as the TED spread, narrowed 7 basis points to 1.89 percentage point. That's down from a four-month high of 2.21 percentage points Dec. 11.

...Fewer Bids

Financial institutions submitted $57.66 billion in bids to the Fed at their $20 billion auction of 35-day funds, resulting in a bid-to-cover ratio of 2.88, lower than the prior auction. There were 73 bidders, compared with 93 banks and securities firms earlier, the central bank said in a statement today.

"The rate wasn't so high that it should cause concern about any dire need for liquidity," said Michael Pond, an interest-rate strategist in New York at Barclays Capital Inc., another primary dealer. "People were looking for funds and liquidity on a competitive basis."

All the funds were made available at the stop-out rate, or the lowest rate that the Fed accepted at the auction. Bids at the stop-out rate were prorated at 73.40 percent, compared with 1.96 percent at the $20 billion auction of 28-day funds.

...'Being Nimble'

The minimum accepted bid rate set by the Fed for today's auction was 4.15 percent, a rate based on a measure, known as the overnight indexed swap rate, of the average overnight fed funds rate over the term of the credit being auctioned.

Overnight indexed swaps are derivatives in which one person agrees to pay a fixed rate in exchange for receiving the average of a floating central bank rate over the life of the swap. For such swaps based in U.S. dollars, the floating rate is the daily effective federal funds rate.

"It's a sign the Fed is being nimble in terms of managing reserves and these temporary liquidity problems," said Kenneth Kim, an economist at Stone & McCarthy Research Associates in Skillman, New Jersey. "I don't think they will have to do much more but it's a good sign."

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