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US, European central banks step up credit crisis battle

Business Materials 2 May 2008 22:27 (UTC +04:00)

The US Federal Reserve and key European central banks on Friday announced a fresh offensive against a global credit crisis that has gridlocked lending and slowed the world economy.

"In view of the persistent liquidity pressures in some term funding markets, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing an expansion of their liquidity measures," the central banks said in separate statements, the AFP reported.

The Fed and leading European banks have worked in concert several times, pouring billions of dollars into the financial system since the credit crisis erupted in August amid rising defaults on US subprime, or high-risk, mortgages.

The worst US housing slump in decades and tightening credit as mortgage-backed securities plunged in value have had a domino effect on financial markets. Embattled banks have written down billions of dollars in assets and made them reluctant to risk lending.

An aggressive series of Fed interest rate cuts, slashing 3.25 percentage points off its base federal funds by Thursday since September in a bid to ease the credit squeeze, has not lowered mortgage rates.

Home foreclosures have spiked as borrowers with adjustable mortgages, often linked to the London interbank (LIBOR) rate, face higher rates as the loan resets from tantalizingly low entry rates.

"Since many floating rate mortgages in the US are tied to LIBOR, the Fed certainly is making an attempt to have the recent rate cuts feed through to these mortgage holders," said Andrew Busch, analyst at BMO Capital Markets.

A move of this kind had been expected to address the credit crunch, said Joel Naroff of Naroff Economic Advisers.

"They're trying to address every aspect of the problem," he said. "The problem is no longer are rates low enough, it's that there's got to be enough liquidity in the system for banks to start lending again."

John Lonski, economist at Moody's credit rating agency, agreed.

"The relatively high level of LIBOR" and its disconnection from Treasury bond rates "suggest that the banks still encounter funding pressures," he said.

"There is no evidence that the Fed rate cuts since summer and other extraordinary attempts to enhance liquidity have lowered mortgage rates."

The three measures announced by the central banks Friday expanded their efforts to tackle the credit crisis; two of them directly affect the US financial system.

The Fed raised the amount of monthly lending available to banks by 50 billion dollars to 150 billion under the so-called Term Auction Facility, beginning Monday.

The US central bank also expanded the type of assets that can be used as collateral to obtain its loans.

The Fed said it would now accept AAA/Aaa-rated asset-backed securities beginning Wednesday, in addition to the already eligible mortgage-backed securities and agency mortgage-backed securities.

"The wider pool of collateral should promote improved financing conditions in a broader range of financial markets," the Fed said.

To boost overall liquidity, the Fed, ECB and SNB said they would increase the amount of dollars they offered in their money market auctions.

The Fed increased its swap agreement with the ECB by 20 billion dollars to 50 billion dollars, and doubled that with the SNB to 12 billion.

Both European central banks said they would continue to provide dollar liquidity as long as required by market conditions.

Meanwhile, the Bank of England sat out the coordinated central bank move.

"We have not been seeing evidence that the London market is short of dollars, and so we did not see a need for the bank to participate," a BoE spokesman said.

The British central bank is "supportive of the efforts of other central banks in the money markets," he said.

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