Fed's Direct Loans to Banks Climb to Record Level (Update2)

By Christopher Anstey and Steve Matthews

May 15 (Bloomberg) -- The Federal Reserve's direct loans of cash to commercial banks climbed to the highest level on record in the past week as money-losing lenders increasingly turn to the central bank for funds.

Funds provided through the so-called discount window for banks rose by $2.8 billion to a daily average of $14.4 billion in the week to May 14, the central bank said today in Washington. Separately, the Fed's loans to Wall Street bond dealers rose by $75 million to $16.6 billion.

Policy makers have increased the attractiveness of direct loans as they seek to alleviate the impact of the credit crunch. Fed Chairman Ben S. Bernanke said two days ago that while markets have improved, they remain ``far from normal,'' adding that the central bank is prepared to increase its twice monthly auctions of funds to banks.

``The Fed is providing an extraordinary amount of liquidity through various mechanisms,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. While ``credit markets are showing signs of improvement'' there is ``a long way to go,'' he said.

Fed officials have reduced the cost of direct loans to a quarter-point above the benchmark overnight lending rate between banks. In March, they extended the term of the loans to commercial banks to 90 days. The discount rate is now 2.25 percent, compared with the three-month London Interbank Offered Rate for the dollar of 2.72 percent.

`Good Sign'

``The fact that banks are willing to take advantage of it may be a good sign for the market,'' said Louis Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. ``They're willing to take advantage of cheap money and'' lend it on to customers, he said.

Bernanke today urged banks to raise more capital to help limit damage to the economy. Banks and securities companies have raised about $244 billion of capital since July, after writedowns and credit losses in excess of $333 billion.

Fed policy makers in March created the Primary Dealer Credit Facility to offer direct loans to the 20 brokers that trade Treasury securities directly with the New York Fed. The resource allows Wall Street banks to borrow money at the discount rate overnight.

As of May 14, there was $14.5 billion of loans outstanding in the primary-dealer program, while commercial banks had $13.4 billion of discount-window loans, the Fed reported.

Bear Stearns

The central bank doesn't disclose who is borrowing from the discount window or other facilities. Bear Stearns Cos. had borrowed $32.5 billion from the Fed as of March 21, according to a JPMorgan Chase & Co. regulatory filing on April 11. The Fed provided $29 billion of financing to secure JPMorgan's takeover of the investment bank in March.

Bank of America Corp. Chief Executive Officer Kenneth Lewis urged policy makers today to choose between bailing out Wall Street investment banks or letting the ``hotbeds of risky financial innovation'' fail as the market dictates.

``I understand the argument for opening up the Fed's discount window to investment banks in this environment,'' Lewis said in a speech today at New York University's Stern School of Business. ``But I'd also say that providing a public backstop to an inherently risky business that is not required to backstop itself is a tough sell for taxpayers.''

Fed holdings of U.S. Treasury securities fell $22.3 billion for a daily average of $520.1 billion. The central bank had about $713 billion of Treasuries two months ago.

Net Miss

There was one net miss, on May 14, the Fed said. A net miss occurs when the actual reserve level in the banking system diverges from the Fed's projections for a day by $2 billion or more. If the level is outside expectations, the federal funds rate can deviate from target.

The central bank also reported that the M2 measure of money supply rose by $1.1 billion in the week ended May 5. That left M2 growing at an annual rate of 6.7 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.

The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds.

During the latest reporting week, M1 fell by $7 billion. Over the past 52 weeks, M1 declined 0.1 percent. The Fed no longer publishes figures for M3.

To contact the reporter on this story: Chris Anstey at canstey@bloomberg.net

Last Updated: May 15, 2008 18:04 EDT

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