WASHINGTON — Though the Federal Reserve Board significantly increased the liquidity it plans to pump into the banking system, the central bank's tools for fighting the credit crisis remain the subject of deep skepticism.
A day after investors fled some of the safer securities available, such as debt guaranteed by Fannie Mae and Freddie Mac, the Fed stepped in Friday and said it will boost this month's two term-loan auctions by $20 billion, to $50 billion each. It also took the unusual step of announcing plans to begin term repurchase transactions that could ultimately add another $100 billion into the market.
Despite those efforts, industry observers found few reasons to expect banks to resume lending soon and said the situation has grown more severe than in August, when jitters over delinquent subprime mortgages first sparked the credit crunch.
"It's substantially worse than where we were in August," said Alan Blinder, a former Fed vice chairman who now holds that title at Promontory Interfinancial Network. "The problem is not so much liquidity as the unwillingness of anyone to take any risk. … The deeper problems with our financial system are not going to be fixed by injecting more and more liquidity into the markets."
The Fed said in a statement that it hopes to provide more certainty by continuing the auctions for at least six more months. Previously it had not committed to any sales beyond March 24.
The central bank also promised to increase the size of the auctions further if market conditions continue to weaken.
In a background briefing with reporters Friday, senior Fed staff members declined to say whether a specific event triggered the decision to increase liquidity, though they acknowledged the credit markets have deteriorated markedly in recent days.
The staff members said the Fed will reduce its portfolio in order to manage the risk posed by becoming more entrenched in the credit markets. Nearly two hours after the Fed's announcement, the Federal Reserve Bank of New York said it would sell $10 billion of Treasury bill holdings.
The first auction of the month is slated for today. The most recent sale on Feb. 25 generated 72 bidders with submissions totaling $67.958 billion. The first auction, on Dec. 19, prompted 93 bids worth $61.553 billion.
Though hedge funds and other investors have largely shied away from even the safest debt in recent days, Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial, said the auctions could provide some help to the credit market, because banks are the only institutions eligible to participate.
Though the auctions have received the most attention, observers also found the Fed's actions on repurchase transactions noteworthy. The transactions, which are effectively short-term collateralized loans made to bond dealers, can now be held for as much as 28 days, the Fed said. It also promised more transactions if they are needed by the market.
The repurchase deals "don't provide much liquidity, but they provide a greater degree of comfort that institutions can look to the Fed for a continuous source of liquidity," said Gil Schwartz, a former Fed lawyer who now works in private practice. "You can rely on the certainty that you won't necessarily have to go scrambling for money at the end of the day if the situation gets tight."
Observers said the Fed's move highlights the bind it finds itself in as it tries to do all it can — including substantial cuts to the benchmark interest rate — to encourage lending while minimizing other consequences.
"The problem the Fed faces is they're on the horns of the dilemma," said Keith Leggett, the senior economist at the American Bankers Association.
"If we use our traditional means of monetary policy, the key thing is that's going to lead to further decline in the dollar and is going to build additional inflationary pressure."
