Fed announces two auctions for banks to bid for loans

The move aims to ease a credit crunch that’s made loans harder to obtain.

WASHINGTON (AP) — The Federal Reserve announced Wednesday a novel approach to injecting money into the banking system as it struggles to combat a severe credit crunch that threatens to drag the country into a recession.

The announcement helped dispel the sour mood on Wall Street, where investors had pushed the Dow Jones industrial average down by 294 points Tuesday out of disappointment with what was seen as a timid interest rate cut. After Wednesday’s announcement, stocks recouped a part of the previous day’s losses, with the Dow finishing up 41 points.

The Fed said it would conduct two auctions next week where banks can bid for up to $40 billion in loans, money that they will have to bolster their own reserves. It marked the Fed’s biggest concentrated effort to inject liquidity into the banking system since the Sept. 11, 2001, terrorist attacks.

The hope is that the extra funds will spur increased lending on the part of the banks and combat a serious credit crunch that has made loans harder to obtain for many businesses and consumers.

The Fed linked the new auction process to an announcement that it was extending a line of credit in dollars to the European Central Bank and the national bank of Switzerland so that those institutions could better deal with credit problems in Europe. The Fed said it was also coordinating with the central banks of England and Canada.

The efforts seek to restore market confidence that Federal Reserve Chairman Ben Bernanke and his colleagues at the Fed and the monetary authorities in other countries were doing enough to deal with the spreading global credit crisis.

Private analysts expressed approval of the Fed’s efforts, saying they marked a much better response after what they viewed as a botched rate cut announcement Tuesday. The rate cut was widely seen as not bold enough in light of the serious problems facing the economy.

“They are trying to help hard-pressed banks raise much-needed cash. The banking system is under severe pressure because the banks don’t want to lend to each other,” said Mark Zandi, chief economist at Moody’s Economy.com.

The Fed is trying the auction program as an experiment to provide another avenue for providing loans to banks because banks have shied away from borrowing from the Fed’s discount window because of the stigma that can be linked to banks that make frequent use of it.

“This is a creative way to try to get more cash into the system without marking anyone as being in trouble,” Zandi said.

The Fed’s new program will begin with two auctions next week and another two in January. The first auction for up to $20 billion will occur Monday, followed by a Dec. 20 auction for another $20 billion.