Fed Teams With Central Banks on Credit

December 12, 2007

The Federal Reserve announced Wednesday it was coordinating with other central banks to deal with the global credit crunch. Wall Street rallied after the surprise announcement. In a statement timed to occur before the start of trading in New York, the Fed said it planned to offer $40 billion in emergency funds to banks next week through an auction process.

The Fed said that it was creating a temporary auction facility to make funds available to banks and was also setting up lines of credit with the European Central Bank and the Swiss Central Bank that could be used for additional resources.

The first two auctions of $20 billion each will occur next week on Dec. 17 and Dec. 20.

Wall Street investors applauded the Fed’s latest effort to combat the country’s worst credit crisis in nearly a decade. The Dow Jones industrial average was up by more than 200 points in early trading. A day earlier the Dow had plunged 294 points as investors expressed disappointment with what they saw as a lack of urgency on the part of the central bank for dealing with a credit crunch which threatens to push the country into a recession. The Fed cut a key interest rate on Wednesday but by a smaller quarter-point rather than the bolder half-point move that many investors had hoped for.

Economists looked more favorably on Wednesday’s action, although they cautioned that the Fed’s experiment at finding another way to inject cash into the banking system had not been tested. “Clearly, the Fed is feeling its way in the dark here. Current conditions are unprecedented in modern times,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

Analysts said the use of auctions to try to get more money into the banking system was an acknowledgment that efforts to spur direct loans from the Fed to banks through the Fed’s discount window had not worked as well as hoped because of banks’ fears that investors could become worried if they started utilizing the Fed’s discount window to any large extent.

In its announcement, the Fed said it had reached an agreement with the European Central Bank as well as the Bank of England, the Bank of Canada and the Swiss National Bank to address what it termed “elevated pressures” in credit markets.

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