Fed ready to boost credit auction size

THE FEDERAL Reserve stands ready to increase the size of its credit auctions beyond the current level of $150 billion (€97 billion) a month if required to combat stress in the money markets, its chairman said yesterday.

Ben Bernanke's pledge came in a speech in which he welcomed "some improvement in financing markets" but warned that "conditions in financial markets are still far from normal".

The Fed chairman defended its support of a rescue takeover of Bear Stearns, saying that if it had gone bankrupt it could have triggered a "much broader liquidity crisis" and a fire sale of assets.

But he said the US central bank would scale down its extensive liquidity support operations when markets normalised. He also warned that regulators would have to ensure that financial institutions did not run increased liquidity risks in the future based on the assumption that the Fed would always step in when markets were stressed.

Mr Bernanke said the credit crisis had overturned the assumption that primary dealers - many of them investment banks - could safely rely on short-term secured funding.

Supervisors would have to require that future liquidity planning "take into account the possibility of a sudden loss of substantial amounts of secured financing". This could lead to banks being forced to fund themselves with more expensive longer-term debt, which would reduce the incentive to gear up with high ratios of debt relative to equity.

Mr Bernanke said the Fed's emergency facility that lends money directly to primary dealers "seems to have bolstered confidence". Conditions in the Treasury repossession market - which he said had become "very strained around mid-March" - have "improved substantially".

Liquidity was better in a number of markets, he said, with lower spreads on some mortgage-backed securities and corporate bonds. But a number of secondary markets for securities "remain moribund".

He said Libor/OIS spreads - a measure of tension in the interbank money market - have "receded" but "remain abnormally high". Funding pressures were also evident in recent Fed credit auctions, he said.

Fed officials say that increasing the size of the credit auctions relative to other liquidity operations could help the Fed deal with ongoing liquidity demands while preparing an exit strategy. - (Financial Times service)