The Central Banks are Beginning to Show More of the Weapons at Their Disposal

It is clear from the actions being taken that the central banks are very concerned about liquidity issues. Before yesterday’s rate cut the Fed was content to control money by periodically injecting cash into the markets and lowering rates. Looks like more medicine is needed. Text in bold is my emphasis. From Bloomberg:

The Federal Reserve, European Central Bank and three other central banks moved in concert to alleviate a credit squeeze threatening global economic growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks.

The Fed said in a statement it will make up to $24 billion available to the ECB and Swiss National Bank to increase the supply of dollars in Europe. The Fed also plans four auctions, including two this month that will add as much as $40 billion, to increase cash in the U.S.

Central bankers took the action after interest-rate reductions in the U.S., U.K. and Canada failed to allay concerns that banks will reduce lending, sending the U.S. into recession and hobbling growth abroad. Borrowing costs have climbed as mounting losses on securities linked to subprime mortgages caused lenders to conserve cash.

``This is shock and awe,'' said Fred Goodwin, a fixed- income strategist at Lehman Brothers Holdings Inc. in London. ``The fact that it's coordinated means they have joined together in the war to attack the problem, which is that banks don't trust each other.''

The Bank of England increased the size of reserves it will auction in money market operations and widened the range of collateral it will accept on three month loans. . . . .

. . . . . The measures are ``designed to address elevated pressures in short-term funding markets,'' the Fed said in a statement in Washington. The U.S. central bank said it's considering setting up a permanent arrangement to provide funds to banks through so- called ``term auction facility'' operations.

Fed Vice Chairman Donald Kohn and other officials have expressed frustration that banks haven't made more use of direct loans from the U.S. central bank. Policy makers reduced the so- called discount rate to half a percentage point more than the benchmark rate in an effort to stimulate use of the resource.

By providing funds to banks through auctions, ``the Fed decides how much liquidity it wants to offer,'' instead of waiting for lenders to borrow at the discount rate, said Alina Anishchanka, a currency strategist at UBS AG in London.

The world's major central banks have been struggling to restore liquidity since the market for assets backed by U.S. subprime mortgages collapsed because of rising foreclosures. In August, the Fed was forced to cut its discount rate and join the European Central Bank and Bank of Japan in pumping billions of dollars into the banking system.

The Fed has since lowered its benchmark rate three times, and was joined last week by the Bank of England and the Bank of Canada. The ECB has shelved planned rate increases. . . . .

. . . . ``It's an important policy response to the deterioration in credit-market conditions that we've experienced in recent months,'' said Neil MacKinnon, a former U.K. Treasury official who is chief economist at London-based hedge fund ECU Group. ``It's a coordinated effort and that's important; it suggests the central banks are ready to provide liquidity on demand.''

The first U.S. auction of 28-day funds, will be $20 billion on Dec. 17. The second auction will provide up to $20 billion, taking place Dec. 20. The central bank plans two more auctions, Jan. 14 and Jan. 28, with possible additional operations thereafter, the Fed said.

All ``generally sound'' institutions can participate in the operations, the Fed said. The ``wide variety'' of collateral used for discount-rate loans will also be accepted for the term- auction facility, the statement said.

``By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could when the unsecured interbank markets are under stress,'' the Fed statement said.

In addition, the Federal Open Market Committee authorized ``temporary reciprocal currency arrangements,'' or swap lines, for up to six months, with the ECB of as much as $20 billion and $4 billion to the SNB ``for use in their jurisdictions.''

Some investors expected a larger reduction of a half-point to stave off a recession. The Fed's board also reduced the discount rate, covering direct loans to banks, by a quarter point to 4.75 percent, half of what many economists predicted.