WASHINGTON — The Federal Reserve Board’s plan to boost liquidity through international auctions was widely viewed Wednesday as a creative alternative to discount window borrowing.
Still, no one — not in the industry nor at the central bank — is sure it will work. With $40 billion expected to be auctioned this month, the issue is whether the plan will inspire enough confidence to kick-start lending.
Wachovia Corp. chairman and chief executive Ken Thompson said the Fed is on the right track.
“Banks are still fearful of each other, and everybody is worried about counterparty risk, and people are hoarding their balance sheets,” Mr. Thompson said Wednesday. “This will help that. I think that is exactly what needs to happen because, more than lowering rates in the economy, just having the banking system liquefy will make a huge difference.” Mr. Thompson made his comments at a conference held by Goldman Sachs in New York.
Gil Schwartz, a former Fed lawyer who now works in private practice, echoed those concerns.
“There’s a reluctance by banks to lend because of the uncertainty with what’s happening in their portfolios,” he said. “Can you restore a degree of confidence in banks that there will always be enough liquidity out there so you can go ahead and lend? The problem is one of concern that you don’t know what the value of your portfolio is so you’re concerned about capital.”
Industry representatives had been hoping the central bank would cut the discount rate more aggressively than it did the federal funds rate at its meeting Tuesday in order to spur banks to use the window.
“I expected 25 basis points on the fed funds but hoped for more on the discount rate,” Mr. Thompson said.
But the Fed considered and rejected the idea, fearful that it would make it harder to control the volume of reserves, a senior central bank official told reporters Wednesday.
Instead, it came up with an unprecedented plan it believes will sidestep several issues, including the traditional stigma attached to use of the discount window.
“There is no reason to believe there would be a stigma associated with the use of this facility,” the official said of the planned auctions.
An auction also could at least in theory release liquidity at a discount to the fed funds rate without significantly interfering with the kind of risk-pricing information that central banks get from interbank and other market rates.
The Fed is planning two auctions — on Dec. 17 and Dec. 20 — at each of which it will accept bids on $20 billion worth of term funds. Bids will be capped at 10% of the auction size, and loans from the first auction would mature on Jan. 17 but those from the second would be due Jan. 31. The Fed plans two additional sales, Jan. 14 and 28, though the size of these auctions has not been decided.
Former comptroller of the currency Eugene Ludwig lauded the plan as a sign that the Fed is working “to break the logjam in the credit markets.” But he said it alone would not solve the liquidity crisis.
“It’s going to take a cocktail of medicines to knock out every strain of this infection,” said Mr. Ludwig, who now heads Promontory Financial Group. “There’s no single drug that is going to cure it. It’s time for the federal government to step up with a more vigorous solution.”
A series of cuts in the fed funds and discount rates have failed so far to stabilize markets and free up liquidity, and a separate plan by the Treasury Department to aid ailing structured investment vehicles and help homeowners facing higher mortgage costs has been harshly criticized.
But the Fed’s move could prove enticing to banks because it would let them borrow from the central bank while avoiding the discount window, where loans carry a higher rate and an inference that the borrower is troubled.
“There is still a stigma attached to borrowing at the discount window,” said Greg McBride, the senior financial analyst at Bankrate.com. “That’s why you see the Fed reaching into the toolbag to pull something out.”
It also reflects the international nature of the crisis, analysts said.
The plan calls for currency swaps with the European Central Bank and the Swiss National Bank. This would give the ECB power to provide up to $20 billion and the SNB to issue $4 billion in U.S. currency, a move of particular importance as the dollar’s value declines. Many observers saw the provision as further recognition that financial problems have spread beyond the U.S. market.
