The Federal Reserve is working with the US Treasury on plans for a move into unsecured lending in the hope that this extreme step could help revive credit markets. As well as unsecured lending to banks, the plan could see the Fed directly purchasing commercial paper or funding a special purpose vehicle set up to do this. Any unsecured lending would be a radical departure for the Fed, which has never made unsecured loans. The step would enable the Fed to address directly two key financial system problems: the freezing of the term interbank money market, which covers all but overnight borrowing, and the rapid contraction of the commercial paper market. As the Fed doubts it has the legal mandate to make unsecured loans on which there is a likelihood of some loss, it needs the Treasury to guarantee losses on the loans, probably under new powers granted by Congress last week with the passage of the $700bn Paulson plan. However, it is awkward for the Treasury to support a big unsecured lending programme when the core of its pitch to Congress was the plan to purchase troubled mortgage-related assets. It is possible that the US authorities will be unable to reach agreement. But the urgency of the situation – and the fact that the Fed referred to unsecured lending in a Monday press release – suggests it will happen.

This entry was posted by Gwen Robinson on Tuesday, October 7th, 2008 at 5:44 and is filed under Capital markets. Tagged with federal reserve. Edit this entry.