USA: More Initiatives from the Fed
As a response to the liquidity problems for Bear Stearns, which this weekend led to a takeover from JP Morgan Chase, the Fed announced two new initiatives yesterday.
- Primary Dealer Credit Facility. In a new lending facility called Primary Dealer Credit Facility, primary dealers can now obtain overnight funding in exchange for a wide range of collateral including investment- grade corporate securities, municipal securities, MBS and ABS for which a price is available. Primary dealers have until now not had direct access to borrowing from the Fed through the discount window or TAF auctions, as these facilities only cover depository institutions and not investment banks. The rate on the lending facility is the discount rate (primary credit) and it will remain in function for a minimum of six months. It will be extended if necessary.
- Cut the discount rate (primary credit) from 3.5% to 3.25%. The Fed has thus narrowed the spread between the discount rate and the Fed funds rate to 25bp. This spread was originally 100bp but was cut to 50bp in August last year.
Late last week the financial crisis took yet another turn as the US investment bank Bear Stearns came into liquidity problems and had to get funding from the Fed through JPMorgan Chase. Since Bear Stearns is not a commercial bank it cannot obtain funding through the discount window or on TAF auctions. It can, however, participate in the security lending facilities which the Fed expanded last week, but the new auction does not take place until 27 March. As speculation of Bear Stearns' liquidity problems was floating in the market it led to a kind of “bank run” on Bear Stearns, and within a short time period it could not get funding (see Bear Stearns press release of 14 March). A loan facility through JPMorgan Chase could not stop the problems which over the weekend led to a full takeover of Bear Sterns from JPMorgan Chase. With the new facility, the Fed aims to secure direct funding to investment banks that cannot use the discount window or TAF auctions to get funding.
Outlook and assessment: The developments last week and over the weekend increase the scope of the crisis. They also illustrate how unpredictable the crisis is, as these events happened only three days after market sentiment was improving on the Fed's latest initiative, when it expanded the Security Lending program (see our Flash comment: - Global: Coordinated central bank action). The development is a cause for concern as the probability of a full credit crunch with severe damage on the economy is rising rapidly, in our view. On Tuesday, the Fed meets for its regular meeting and it increasingly points to a full one percentage point cut. If the market prices it fully going into the meeting, we also think the Fed will deliver it. This will take the Fed funds rate to 2%
Danske Bank
http://www.danskebank.com/danskeresearch
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