US Fed prepares to replenish war chest

By Stephen Foley
Sunday 23 October 2011 01:26

Having already pumped $300m (£151m) of extra money into the US financial system, the Federal Reserve is making extraordinary contingency plans in case the credit crisis persists for so long that its own reserves dwindle.

The US central bank is in talks with the Treasury and politicians on Capitol Hill about measures that could buttress its ability to act as lender of last resort. In doing so, it is hoping to answer the nagging fear on Wall Street that the Fed may run out of ammunition to pursue what have so far been roundly applauded efforts to keep the credit markets moving.

While the Fed could lend money to banks without dipping into its reserves, and continue doing so even if reserves run out, this is in effect printing money, and officials fear the inflationary consequences of doing so.

For this reason, officials confirmed yesterday that the Fed is considering ways to replenish its stockpile of US Treasury bonds, which has dwindled from $792bn last July to $487bn last week. Since the credit crisis hit, the Fed has come up with a raft of innovative schemes for lending to the financial markets. In particular, it has begun taking as collateral mortgage-backed securities, which banks have been reluctant to trade while their value has been plummeting alongside the housing market.

One option is for the Fed to take the unprecedented step of issuing debt, which it would then lend on into the credit markets. Another plan is to ask the US Treasury to issue more debt which the Fed could put to work.

Another option would be for the Fed to start paying interest on any excess deposits that US banks have at the central bank. That would set a floor for the interbank lending rate.

Separately yesterday, leading banks promised tougher voluntary standards in an attempt to forestall calls for tighter supervision. The Institute of International Finance, which represents more than 375 banks worldwide, also called for reviews both of current accounting rules which force them to mark assets to market, and of credit agencies.

Josef Ackermann, the chief executive of Deutsche Bank who chairs the IIF, said: "Many firms need to improve their risk management, liquidity management and conduit underwriting approaches significantly." The IIF report came before G7 meetings that are scheduled to discuss financial regulation.

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