Fed will support securities market directly

The US Federal Reserve Bank will start backing primary securities dealers as well as banks through its discount in another attempt to stave off a general financial collapse, it announced yesterday.

As the Fed put the final touches to its $30 billion support facility for Bear Stearns, it was also preparing to allow primary dealers to borrow overnight from its discount window, using any investment-grade securities, including mortgage-backed and asset-backed securities (MBS and ABS), as collateral. The window will stay open for at least the next six months, the Fed said, citing a provision in US law that allows it to support "any individual, partnership or corporation" with discount loans under "unusual or exigent circumstances", if the Fed is satisfied that the borrowers could not obtain adequate credit elsewhere.

The Fed also cut its primary credit rate by 25 basis points to 3.25%, and announced that it would lend at that rate to depository banks for up to 90 days - the previous maximum was 30 days. The same rate will apply to the new scheme, although its loans will be overnight only.

The news marks yet another relaxation of its lending criteria by a Federal Reserve now faced with the threat of the largest US financial crisis since the Great Depression. Last week's announcement of a $200 billion capital injection in the form of 28-day loans secured against agency or AAA-rated MBS was dramatic enough, but still failed to procure a sustained recovery. This latest scheme relaxes the minimum collateral quality still further - now any investment-grade security, not merely AAA-grade, will be accepted - and comes alongside another cut in lending rates and the decision to support the JP Morgan takeover of Bear Stearns, as well as the widespread expectation of a further 100bp cut in headline lending rates to 2% later this week.

It also extends the Fed's obligations beyond the reach of its regulatory powers: the Fed only has the authority to regulate commercial banks, not investment banks (which is why last week's rescue loans to Bear Stearns had to be channelled through JP Morgan), but the new lending scheme will put the Fed into the position of supporting an industry it cannot control.

Meanwhile, this morning the Bank of England offered an exceptional £5 billion three-day repo, saying it was "in response to conditions in the short-term money markets this morning". The offer was oversubscribed, with £23.6 billion in bids received.

See also: JP Morgan buys Bear Stearns after receiving Fed guarantee
Fed bails out Bear Stearns
Central banks act again to preserve liquidity
Banks relied too much on ratings, supervisors say