Thursday March 27, 1:42 pm ET By Richard Leong and Krista Hughes
NEW YORK/FRANKFURT (Reuters) - The U.S. Federal Reserve prepared to pump $75 billion into frozen credit markets following moves by European central banks on Thursday to help lenders who scrambled to meet quarter-end funding needs.
The Fed was ready to exchange billions in low-risk U.S. government bonds for underperforming mortgage investments from primary dealers as part of steps announced this month to help them raise capital and to encourage broader lending.
Banks are clamoring for extra cash to meet capital requirements ahead of Monday's quarterly book closing, reducing their willingness to lend and adding to strains in crisis-hit markets.
"We are getting distortion from quarter-end, and banks are still reticent to lend," said William Knapp, investment strategist at MainStay Investments in New York.
London interbank rates reflected banks' unwillingness to part with cash. Three-month sterling LIBOR funds edged above 6 percent, the highest since late December, while overnight dollar LIBOR rates jumped to 3.07750 percent, the highest since the Fed cut rates by 75 basis points on March 18.
Traders and analysts said extra funds from central banks would be welcomed given fresh tensions on markets.
"The need for liquidity is becoming particularly acute into month-end, quarter-end," said Richard McGuire, fixed income strategist at RBC Capital Markets in London.
The Bank of England lent 13.62 billion pounds ($27.33 billion) at its regular one-week money market operation, up from prior week's 10.93 billion. Banks bid for almost three times that much, showing the intense demand for cash.
The Swiss National Bank also offered three-month funds to the market and the European Central Bank said it was ready to provide funds to bring down rates.
MONEY RATES STILL RISING
This reluctance has led to bottlenecks in the credit market with some firms able to raise capital more easily than others.
For example, U.S. commercial paper market contracted for a fourth consecutive week. The outstanding amount of asset-backed commercial paper, which had been a key funding source for the U.S. mortgage market, fell $2.6 billion, but the amount of unsecured paper issued by financial companies increased by $2.2 billion in the week to Wednesday, according to the Fed.
In other areas of the U.S. credit market, risk premiums on credit default and interest rate swaps climbed as the stock market weakened.
U.S. primary dealers, which do business directly from the Fed, will bid later Thursday on $75 billion of Treasury securities in an auction from the Fed's Term Securities Lending Facility.
TSLF differs from other newly created lending programs from the Fed. Rather than obtaining loans from the Fed, winning bidders at the TSLF auction will likely have to get funding from each other and the open market, according to analysts.
Increased lending activity among primary dealers and banks will hopefully unleash more funding to consumers and other parts of the economy hurt by the current global credit crunch.
At the moment, banks and primary dealers have clung to the financing from Fed and other central banks, restricting credit and pushing up lending rates.
