Fed under pressure to do more on credit crunch

By James Politi and Krishna Guha
Financial Times, London
Sunday, October 5, 2008

http://www.ft.com/cms/s/0/fd884db2-9311-11dd-98b5-0000779fd18c.html

WASHINGTON -- The Federal Reserve and US Treasury were on Sunday night under increasing pressure to follow passage of the $700 billion financial rescue plan with further measures to shock the ailing credit markets back to life.

Among the options available to policymakers are additional liquidity operations and an emergency rate cut -- possibly in co-ordination with other central banks. A combination of the two is also possible.

The Fed is likely to further expand both the size and scope of its liquidity operations. Experts believe it could address a shortage of US Treasuries that has emerged as investors have looked increasingly to government paper as a safe-haven investment and collateral for trades. This could happen through an expansion of the Term Securities Lending Facility, which was created by the Fed in March to help banks access liquidity during the crisis.

Another potential target of intervention is the commercial paper market, which has been shrinking substantially in recent weeks. Money market funds could, for example, be allowed to borrow money via banks to fund their holdings of commercial paper. Some experts think the Fed could take the radical step of offering term loans on an unsecured basis to regulated banks at a fixed spread over its main interest, therefore capping the interbank lending rate, which has risen sharply during the crisis. This possibility has become more realistic following passage on Friday of the "troubled asset relief programme," which gave the Treasury the authority to guarantee the Fed against any losses incurred in such an operation.

The Tarp legislation also gives the Fed the power to pay interest on reserves to help smoothe liquidity operations -- authorities the US central bank is soon expected to announce it will use.

Mounting expectations of another intervention to shore up the credit markets highlights the extent to which enactment of the $700 billion bailout is not the sole instrument of the US government’s response to the financial turmoil.

"The Tarp bill is a condition necessary but not remotely a condition sufficient to recovery," Orin Kramer, chairman of the New Jersey State Investment Council, told the FT. "You need to activate the Tarp quickly, and you also need a robust central bank response to the dysfunctionality of the commercial and municipal paper markets."

The US Treasury could as early as Monday take the first big step towards the implementation of its $700 billion plan to buy troubled assets from ailing financial companies by outlining the guidelines for the selection of a handful of private asset managers to run the programme.

After securing congressional approval for the rescue plan on Friday afternoon, Hank Paulson, Treasury secretary, vowed to "move rapidly to implement the new authorities, but also methodically" and insisted that "transparency" would be important throughout the process.

The core of the Treasury plan -- a reverse-auction mechanism for the acquisition of the troubled assets from a range of financial institutions -- will not function until next month at the earliest.

Over the weekend, Treasury officials have been working on the release early this week of criteria for the hiring of several large asset management groups that will be charged with managing the portfolio of assets purchased by the government.

The groups will be expected to turn round their applications quickly so the Treasury can start evaluating the proposals by the end of the week.

Asset purchases by the Treasury will focus on securities backed by home mortgages. The Treasury was also granted the power to purchase other assets if it deemed it necessary.

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