Fed Injects $620b, Will Now Pay Interest On Reserves, Which Will Better Control Rates

In an effort to buy some time for teetering credit markets awaiting the $700b Treasury MBS purchase proposal to be approved by Congress, the Fed has added about $620b in liquidity to the system and also increased its short-term Term Auction Facility, which enables banks to get 28 or 84 day loans. This comes after stock markets dropped the most since 1997, the FDIC has brokered two deals in as many days to save WAMU and Wachovia, European governments have rescued four banks in two days, and 3Mo LIBOR (a key short-term borrowing rate) is spiking drastically. According to Bloomberg:

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed’s emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The Bank of England and the ECB will each double the size of their dollar swap facilities with the Fed to as much as $80 billion and $240 billion, respectively. The Swiss National Bank and the Bank of Japan will also double their dollar swap lines, while the central banks in Australia, Norway, Sweden, Denmark and Canada tripled theirs. All the banks extended their facilities until the end of April 2009.

The Fed is also increasing the size of its three 84-day TAF sales to $75 billion apiece, from $25 billion. That means the Fed will make a total of $225 billion available in 84-day loans. The central bank will keep the sales of 28-day credit at $75 billion.

In addition, the Fed will hold two special TAF sales in November totaling $150 billion so banks can have funding available for one or two weeks over year-end. The exact timing and terms will be determined later, the Fed said. The TAF program began in December, totaling $40 billion.

Additionally, the $700b rescue package that Congress is expected to finalize by Wednesday will give the Fed the ability to pay interest on overnight reserves that financial institutions hold with the Fed, which makes it easier for the Fed to inject liquidity without changing rates.

Paying interest on reserves puts a “floor” under the traded overnight rate, which would allow a central bank “to provide liquidity during times of stress” without affecting the rate, New York Fed economists said in a paper last month.