The US Federal Reserve and other major central banks have started preparing for the damaging collapse of Lehman Brothers. In a statement issued in Washington shortly before midday our time, the Fed revealed that it had been talking to other central banks about a joint approach.

“We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world,” Chairman Bernanke said in the statement.

With Japan, China and South Korea closed for a holiday today, Australia was the first major financial market open for trading with the Lehman collapse impending.

So the Reserve Bank acted on its own to increase liquidity this morning, pumped $1.3 billion in extra funds into the Australian credit markets this morning to make sure any shocks from the impending failure of Lehman Brothers doesn’t cause liquidity problems here. The US Federal Reserve has widened the types of financial securities it will accept as collateral for short term loans as it prepares US markets for the Lehman collapse.

The RBA pumped in the money via the purchase of $1.4 billion worth of semi-government bonds and $700 million of other prime securities via a series of repurchase deals or “repos”. The money market was down an estimated $828 million, so an extra $1.3 billion was pumped into the system, the highest net amount for some months.

The repos were for between four and up to 32 days, indicating the Bank sees any potential liquidity strains extending past this week. Of the total, $1.7 billion was done for 24 or 25 days duration, which pushes the funding out past the end of this month, which is the balance date for a number of leading banks including Westpac, NAB, ANZ and St George.

US stockmarket futures indices were lower around midday Australian time, with the Dow off 293 points, the S&P 500 down 37 points (or around 3.1%) and our market off over 100 points, after it fell again in late morning trading.

In its statement the Fed revealed a significant widening of the eligibility criteria for the types of assets accepted as collateral it accepts for loans to Wall Street bond dealers. It will now accept shares in its primary dealers lending facility, the part of the discount window available to investment banks. That is a significant change and indicates how desperate the authorities are to make sure the system maintains liquidity and isn’t damaged by Lehman’s failure.

Any security of investment grade will be acceptable now, instead of much higher prime triple A rating.

“The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets,” the Fed said.

The statement as issued as reports emerged that the boards of Merrill Lynch and Bank of America had agreed to a $US44 billion mostly share merger that would see Merrill’s basically rescued by the bigger and sounder Bank of America. That’s half what it was worth at the start of the year.

Bank of America has been talking to the authorities about buying part of all of Lehman but when Barclays of the UK withdrew, it switched to Merrill Lynch. It is believed there had been an earlier approach from Merrill management.

Besides the Fed’s moves, there’s talk from Washington and New York of a group of banks negotiating to set up a fund to lend to troubled financial firms. The plan may total at least $50 billion, according to reports on Bloomberg and other outlets.

Collateral for the Term Securities Lending Facility, which auctions loans of Treasury securities to inject cash into the US banking system, will now include all investment- grade debt securities. The size of the TSLF will also increase to $US200 billion from $US175 billion, the Fed said.

And in the week to last Wednesday, US commercial banks large and small were borrowing more than $US23 billion a day from the Fed to keep going. That’s a record.

Peter Fray

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