Fed Lends $20B To Banks To Ease Crunch

Treasury Secretary Henry Paulson takes questions during a town meeting about housing in Kansas City, Mo., Tuesday, Dec. 18, 2007.
AP Photo/Orlin Wagner
The Federal Reserve is providing $20 billion in loans to banks as part of an unprecedented auction process to ease a global credit crisis and make sure financial institutions can keep lending to their customers.

The central bank on Wednesday announced banks' use of a new auction facility that was created to encourage banks to seek cash directly from the Fed to help them overcome credit problems.

The Fed announced that the interest rate on the short-term loans will be 4.65 percent, which is slightly less than the 4.75 percent the Fed charges banks on emergency loans through its "discount" window. Banks have been reluctant to use the Fed's discount window because of the fear that investors will believe they are having trouble getting funds in a normal manner.

The Fed received bids from banks for $61.6 billion worth of loans, an indication the Fed had been successful in achieving its goal of encouraging banks to use the new auction facility.

In its announcement of the auction results, there were 93 bids for the emergency loans. Each bank could submit up to two bids. The auction for the loans was conducted on Monday, and the results released on Wednesday.

A second auction will be conducted on Thursday, offering banks another chance to get a slice of another $20 billion in loans. The Fed said it would conduct two more auctions in January and then assess whether the process was worth continuing.

The Fed announced last week that it was creating an auction facility that would give cash-strapped banks a new way to get short-term loans from the central bank to help them over the credit hump. A global credit crisis has made banks reluctant to lend to each other, which can crimp lending to individuals and businesses.

The smooth flow of credit is the econony's life blood. It permits people to finance big-ticket purchases, such as homes and cars, and helps businesses to expand their operations and hire workers.

The Fed's actions are part of a global response in which other central banks also are taking steps to curb the credit crisis.

The European Central Bank on Tuesday opened its credit tap wide, pumping a record amount of cash - more than $500 billion - into markets to keep banks from Finland to France flush with the cash they need to operate.

The move, along with another liquidity infusion by the Bank of England, was aimed at keeping jittery markets calm amid a credit squeeze. It appeared to calm stock markets.

In the United States, the Fed also has been slicing its most important interest rate, called the federal funds rate, to help deal with the tight credit situation. The Fed has lowered this rate three times this year. It most recent rate cut on Dec. 11 dropped the rate down to 4.25, a two-year low. The funds rate is the rate banks charge each other on overnight loans. It affects a wide range of interest rates charged to people and businesses, making it the Fed's main tool for influencing U.S. economic activity.

The credit problems and a severe housing slump are raising the odds that the country could fall into a recession. Financial companies have taken multibillion-dollar hits because of bad mortgage loans. The situation has caused turbulence on Wall Street.