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To keep credit flowing, Fed extends $40-billion to banks

WASHINGTON - Banks squeezed by a global credit crisis have a new way to get their hands on cash so they can keep making loans to individuals and businesses.

The Federal Reserve, under pressure to take more aggressive action, unveiled a plan Wednesday designed to bring banks and their borrowers relief by offering $40-billion in emergency funds to banks next week through an auction process. Also, central banks in Europe and North America agreed to increase the amount of money they could lend to banks and to make it more readily available in an effort to ease the credit squeeze.

Fed officials said the move was an effort to improve financial markets, not a response to problems at any individual bank. Financial markets initially soared on the announcement but relinquished most of their gains by day's end. The Dow rose 41.13, or 0.31 percent, to 13,473.90, after rising as much as 271.75 in early trading. The Standard & Poor's 500 index rose 8.94, or 0.61 percent, to 1,486.59, and the Nasdaq composite index rose 18.79, or 0.71 percent, to 2,671.14.

Some questions and answers about what the Fed is doing:

Why is the Fed taking this action?

The credit crisis has unhinged Wall Street and threatens to hurt the U.S. economy, which is fighting to avoid a recession.

Why are banks having problems?

A meltdown in the housing and credit markets has made banks and other financial institutions reluctant to lend to each other, causing a cash crunch. During the credit crunch, many banks have been hoarding cash - not wanting to lend or borrow from others banks. That makes it harder and more expensive for individuals and businesses to obtain credit from banks to finance all sorts of things, such as homes, cars, school and small-business ventures.

How does the Fed's plan help?

At the heart of the Fed's plan is the creation of a new temporary facility to provide banks with at least $40-billion in emergency loans. The Fed is trying to shore up the finances of the banking system.

How will that help individuals and businesses?

If banks have adequate cash on hand, they may be more likely to make loans to people and businesses that need them. The free flow of credit is the economy's lifeblood. It allows people to make big-ticket purchases and businesses to build and expand.

How does the core of the plan work?

The Fed's facility will lend $40-billion in emergency funds to banks through two auctions next week: Monday and Thursday. Banks needing cash and that are judged to be in "generally sound financial condition" by their local Federal Reserve bank can participate in the auction. Banks place bids to get a slice of the money.

The loans are expected to be at rates lower than the 4.75 percent the Fed currently charges banks for direct loans through its discount window. To secure the short-term, 28-day loans, banks can pledge a broad variety of collateral. It is the same type of collateral - such as corporate bonds, real estate loans, agricultural loans and collateralized mortgage obligations - allowed if the bank borrowed through the discount window.

Two more auctions are scheduled on Jan. 14 and Jan. 28.

What else is in the Fed plan?

The Fed also set up lines of credit with the European Central Bank and the Swiss National Bank that could be used for additional resources. It said that this temporary arrangement would supply up to $20-billion in reserves to the Europeans' central bank and up to $4-billion to the Swiss central bank.

The Fed's announcement Wednesday was part of a globally coordinated response involving the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank.

[Last modified December 13, 2007, 01:37:36]