Fed Opens Cash Spigot to Overseas Credit Markets

The Federal Reserve threw open its coffers to strained overseas credit markets, taking further steps to stem the global financial crisis.

The U.S. central bank said Monday it would provide unlimited dollars to the European Central Bank, Bank of England and Swiss National Bank, allowing them to relieve pressure on commercial banks across their regions. Dollars have become elusive in recent weeks as short-term money markets around the world deteriorate. Domestic and foreign banks largely have been frozen out of loans beyond a day as institutions hoard resources amid concerns about the health of trading partners.

The U.S. previously had extended $620 billion in currency swaps with foreign central banks, which provide the funds in exchange for collateral from commercial banks. Removing the limits should provide assurance for foreign commercial banks in the affected regions to get funds to support their dollar-denominated investments. The Fed authorized the swap lines through April.

"This is big stuff, as bold a move as I could imagine," said Ray Stone of Stone & McCarthy Research Associates.

European banks have increased their dollar-denominated investments, such as U.S. mortgage securities, by $499 billion since 2000, according to the Bank for International Settlements

The Fed and ECB have steadily expanded their swap line since opening it in December. Last month, the ECB and Bank of England began auctioning dollars daily. Those overnight funds helped to overcome a time-zone hurdle that left European banks scrambling for dollars when U.S. markets were closed.

Monday's move permits European central banks to lend as many dollars as banks request, for terms of a week, a month, or 84 days. The scaling up from piecemeal actions to limitless supplies should ease tensions in dollar-denominated interbank lending markets.

"The central banks here are providing a market that simply doesn't exist any more in the private sector," said Julian Callow, European economist with Barclays Capital in London. "Particularly for European banks, which have been so dependent on U.S. dollar funding, I think it's very important."

The U.S. central bank received authority this month to start paying interest in reserves that commercial banks deposit at the Fed, offering vastly more room to expand its liquidity facilities during the financial crisis.

The announcement came early Monday morning from the four participating central banks and the Bank of Japan, which is considering similar measures. Last Wednesday, six central banks -- including the four from Monday's action along with central banks in Canada and Sweden -- jointly announced a half-percentage-point cut in interest rates.

Before the Fed's announcement, European central banks had to dole out their dollars in relatively small amounts. At the ECB's most recent auction of 84-day dollar funds, for example, 70 banks bid $88.6 billion for the $20 billion on offer.

There were signs Monday that the move, in concert with European governments' sweeping bailout plans, had begun taming interbank tensions. London interbank offered rates, or Libor -- which are meant to be benchmarks for the rates at which banks lend to each other in dollars -- fell, with the three-month rate dropping to 4.7525% from 4.81875% on Friday.