The US Federal Reserve must be very worried, so worried that it has just thrown a lifeline to the entire US financial system.

It’s Sunday in the US and the central bank has just unveiled two measures designed to keep the US and the global financial systems from taking an almighty hit.

It seems the failure of investment bank Bear Stearns, which was crippled by a rapid loss of liquidity, has forced the Fed to up the ante in its battle to keep global financial systems stable. Now the Fed has moved to establish a credit facility for securitisation markets, which basically covers the entire US economy.

Besides approving the JP Morgan purchase of Bear Stearns for a derisory $US2 a share (Bear Stearns shares were $US70 a week ago), the Fed said in a statement that it was establishing this new facility:

…  to improve the ability of primary dealers to provide financing to participants in securitization markets.

This facility will be available for business on Monday, March 17.

It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities.

The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.

The discount rate was also cut today from 3.50% to 3.25%.

Securitisation of debt is at the heart of the current crisis which was triggered by subprime mortgage failures. Car loans, property loans, corporate debt and credit card debts have all been securitized to generate new capital by selling to investors in the US and around the world.

The new facility is an attempt to make sure there’s enough money and confidence for home lending to continue, credit card purchases to be maintained and for the myriad other examples of credit to continue being created.

What the Fed is doing is providing a credit line from it to the US markets through its 20 primary dealers (big commercial and investment banks) to enable them to continue doing deals and generating credit. This is a signal to the market that money will be there to support the system continuously, not just through auctions and repurchase agreements.

The Australian market was off 128 points, or nearly 2.5% at midday. Trading went on as the Fed’s announcements and the sale of Bear Stearns were reported to the markets.

Japan’s Nikkei, the other major market trading at midday Sydney time, was off 3%, while the US dollar had fallen to around 97 yen, a 12 year low. The US dollar was trading around 1.5786 to the euro.

Peter Fray

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