Fed taking mortgages as collateral in $200B Treasury auction

In a new program intended to ease the credit crunch, the Federal Reserve today announced it will lend $200 billion in Treasury securities to banks and investment firms, allowing them to pledge mortgage-backed securities as collateral.

The Fed said the move to provide more liquidity was a reaction to strains on financial markets, and is being made in concert with similar, but smaller, injections of temporary funding through the European Central Bank, the Bank of England, the Swiss National Bank, and the Bank of Canada.

The Fed will auction off Treasury securities on a weekly basis, and the dealers who buy them will have 28 days to settle up. The new Treasury auctions are similar to short-term cash loans the Fed began making in December through an auction process.

The Fed announced Friday that it was increasing the amount of those 28-day term auctions from $60 billion a month to $100 billion a month for as long as needed, and is also initiating $100 billion in 28-day term repurchase agreements with mortgage-backed securities accepted as collateral.

There were 82 bidders Friday in the first of two cash auctions scheduled for March, with the Fed loaning $50 billion at an average rate of 2.8 percent. That's 20 basis points lower than the current 3 percent target for the federal funds rate, the rate banks charge each other to loan money overnight.

The latest steps to provide liquidity to financial markets have also raised speculation that members of the Federal Reserve's Open Market Committee will be under less pressure to lower short-term interest rates again when they meet March 18.

The committee has cut the target for the federal funds overnight rate five times since September, from 5.25 percent to 3 percent.

Treasury Secretary Henry Paulson noted in a speech this month that the Fed's short-term interest-rate cuts have also brought down the London Interbank Offered Rate, or LIBOR, which many adjustable-rate mortgages are indexed to. Paulson said that with the reduction in LIBOR, the monthly payment on a $200,000 ARM loan will increase by $70 a month when the introductory interest rate expires, instead of $300 in December.

Source - Inman News