Fed Takes Steps On Global Credit Crunch

A sale pending bank owned home is seen in Tujunga, Calif., Wednesday, Nov. 28, 2007. Hit by a severe credit crunch, existing home sales fell for the eighth straight month with median home prices dropping by a record amount.
AP Photo/Damian Dovarganes
The Federal Reserve announced Wednesday it is coordinating with other central banks to deal with the global credit crunch.

The central bank 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.

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.

"This is going to allow cash-strapped banks more freedom to lend money to both businesses and consumers, thereby easing or at least bringing some relief to the credit markets," CBS News MoneyWatch correspondent Alexis Cristoforous told CBSNews.com.

The Fed said that commercial banks would be able to bid at auction for funds that would be drawn from the Temporary Auction Facility. The money would be intended to help cash-strapped banks raise money needed to keep making loans to businesses and consumers.

The action represented another step by the Fed to deal with a serious credit crunch stemming from the tightening of bank lending standards in the wake of multibillion dollar losses from a rising tide of defaults on mortgage loans.

"What you have here is a backstop," Art Hogan, chief market analyst of Jefferies and Company, told CBS News' Mara Rubin. "You have an additional $40 billion in the credit system as available liquidity that doesn't necessarily have to be used, but at least you know it's there and psychologically, sometimes that is all you need to get the credit system working again.

"This, on top of yesterday's move, which cut both the federal funds rate and the discount rate by a quarter point each, should buy the major banks some much needed time to get their financial house in order," says Cristoforous.

That quarter-point rate cut disappointed Wall Street, which pushed the Dow Jones industrial average down by 294 points. Investors had hoped for a bolder response to the growing housing and mortgage crisis in the United States.

The Fed said all banks judged to be in generally sound financial condition by their Fed regional bank would be eligible to participate in the auctions for funds.

The first auction of $20 billion was scheduled for next Monday, followed by another auction of $20 billion on Dec. 20. The third and fourth auctions will be on Jan. 14 and 28.

The Fed said that the new auction process should "help promote the efficient dissemination of liquidity" when other lines of credit were "under stress."

The experience gained from the four scheduled auctions would be "helpful in assessing the potential usefulness" of this new process to provide funds to U.S. banks, the central bank said.

It said that the temporary swap arrangements being set up would provide up to $20 billion in reserves for the European Central Bank and up to $4 billion for the Swiss National Bank. The reserves would be available for a period of up to six months.

Since the global credit crunch hit with force in August, other central banks as well as the Federal Reserve have been injecting massive amounts of money into the banking system in an effort to keep credit flowing.

However, those efforts have only been partially successful. Many businesses and consumers report rising trouble in obtaining loans as banks become more fearful about extending credit in the wake of a surge in bad loans stemming from the U.S. housing crisis.

The Fed's move comes "at a time when there is a concern things are getting worse not better," said Hogan.