Fed acts to ensure cash flow of non-financial firms

Fed acts to ensure cash flow of non-financial firms

WASHINGTON: Opening a new front in an all-out war against the global credit crunch, the United States government announced yesterday a radical plan to buy massive amounts of short-term debts.

The new initiative is necessary, United States Federal Reserve chairman Ben Bernanke warned yesterday, as the financial crisis has not only darkened the country’s current economic performance but could also prolong the pain.

The Fed chief’s more gloomy assessment appeared to open the door wider to an interest rate cut on or before the central bank’s next meeting on Oct 28, to brace the wobbly economy.

Mr Bernanke said the Fed will ‘need to consider’ whether its current stance of holding rates steady ‘remains appropriate’ given the fallout from the worst financial crisis in decades.

The Fed’s latest move, invoking 1930s Depression-era power, will buy ‘commercial paper’, short-term IOUs that many companies rely on to finance their day-to-day operations, such as purchasing supplies or making payrolls.

This will benefit tens of thousands of non-financial companies whose life blood - its cash flow - has been frozen by the financial crisis.

The news gave a mild fillip to European markets after piecemeal efforts announced earlier yesterday by central banks from Australia to Iceland to shore up their economies could not sustain investors’ confidence.

US stocks, however, were lower as the early pop fizzled out. At 1.30am Singapore time, the Dow Jones Industrial Average fell 250.25 points to 9,705.25.

In Europe, confusion reigned.

Threatened with national bankruptcy, Iceland adopted sweeping powers over its banks as its currency went into freefall. It also sought a ¥4 billion (S$8 billion) loan from Russia.

In Britain, bank shares slumped on a report leaked from secret talks that the government was asked by major banks for an injection of public money to help them recapitalise.

In France, President Nicolas Sarkozy said his government was prepared to help its banks by acquiring a stake in their capital if necessary. He also called on Japan and other Group of Eight (G8) countries to hold an emergency summit to deal with the financial crisis.

The International Monetary Fund made a similar call, urging central banks yesterday to provide direct support to the banking system, saying some US$657 billion (S$963 billion) will be needed in the next several years.

It now expects worldwide credit losses to reach US$1.4 trillion, up from last month’s forecast of US$1.3 trillion.

European Union (EU) finance ministers agreed to guarantee bank deposits of up to ¥50,000, against ¥20,000 under current rules, across the 27 European Union countries, according to Reuters.

Of the raft of measures announced yesterday, analysts said the Federal Reserve’s was the most significant.

This is because the US$99.4 billion daily market for commercial paper has virtually dried up - a key reason why the US economy is faltering. Unable to borrow money freely or forced to pay a high cost to borrow, employers are cutting jobs and reducing capital investments.

Commercial paper is a way for companies to borrow money for short periods, typically ranging from overnight to less than a week. But most investors have become too jittery to buy paper for longer than overnight or a couple days. That has made it increasingly difficult and expensive for companies to raise money to fund their operations.

Under the new plan, the Fed will provide a ‘backstop’ that would give companies a new place to get cash.

With this move, the US central bank is now lending to non-financial businesses in addition to commercial banks and investment firms.

ASSOCIATED PRESS, REUTERS, NEW YORK TIMES, BLOOMBERG NEWS

Source : Straits Times - 08 Oct 2008

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