By Rich Miller and Craig Torres
Oct. 7 (Bloomberg) -- Ben S. Bernanke and his fellow global policy makers may move to unblock markets for loans between banks and commercial paper as their next steps to combat the 14- month credit crisis.
In the U.S., Federal Reserve chief Bernanke yesterday signaled he's preparing measures with Treasury Secretary Henry Paulson to unfreeze markets where loans aren't secured by assets. In Europe, the biggest slide in stocks since 1987 may push governments and central banks to coordinate aid to the region's financial industry and lower interest rates.
``They need to start thinking about more high-powered medicine,'' said Lou Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions.
Stakes are high. The crisis has begun to take its toll on global growth as companies and consumers find it increasingly difficult and costly to borrow money. The world economy has already fallen into its first recession since 2001, according to JPMorgan Chase & Co. economists Bruce Kasman and David Hensley, and things could get worse if the credit freeze persists.
Bernanke is scheduled to speak on the economic outlook from 12:30 p.m. in Washington today. He and Paulson meet with European Central Bank President Jean-Claude Trichet and their other Group of Seven major-nation counterparts Oct. 10 in Washington.
The Fed yesterday said it will double its cash auctions to as much as $900 billion. In a statement, the Fed said it and the Treasury ``are consulting with market participants on ways to provide additional support for term unsecured funding markets.''
Ground Zero
It's those markets that are now ground zero for the crisis. A series of high-profile failures of financial institutions in the U.S. and Europe has made banks wary of trading with each other and sent rates soaring. The three-month London interbank offered rate, or Libor, that banks charge each other for loans was 4.29 percent yesterday, close to the highest since January.
``Libor is the problem and it has been the problem all along,'' said John Roberts, managing director at Barclays Capital Inc., New York. ``If they fix that, they are on their way to fixing a lot of things.''
Rates are also surging in the commercial paper market that many U.S. companies use to finance their day-to-day operations. Yields on overnight U.S. commercial paper jumped 0.94 percentage point to 3.68 percent.
``We are to the point of fearing fear itself,'' Bill Gross, manager of the world's biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., wrote in a note to clients. ``The Federal Reserve must now act as a clearing house'' for banks and ``must also take another bold step: outright purchases of commercial paper.''
Wealth Impact
The worldwide stock market slide yesterday wiped more than $2 trillion off investors' wealth. The Standard & Poor's 500 Stock Index lost as much as 8.3 percent before it closed with a 3.9 percent drop to 1,056.89.
Equity declines were widespread, with Europe's Dow Jones Stoxx 600 Index having its steepest intraday decline since 1987 and emerging markets, until now the locomotives of the world economy, hit particularly hard: exchanges in Russia and Brazil halted trading.
``The Fed's not done yet,'' said former Fed Governor Lawrence Meyer, now vice chairman of Macroeconomic Advisers in St. Louis, Missouri. ``They're going to try to leapfrog ahead and do something even more dramatic.''
The Fed may be constrained in what it can do according to its statutes. All of the U.S. central bank's current programs involve secured loans backed by collateral.
Unsecured Loans
Banks don't use collateral when dealing with each other in the interbank market. In the commercial paper market, $885 billion of the $1.61 trillion outstanding isn't secured by borrower's assets.
Still, Bernanke and his colleagues have shown a knack for stretching the boundaries of their mandate and their statement suggested they could do more in concert with the Treasury. Paulson and Bernanke spoke yesterday and the Treasury chief was also reaching out to Wall Street executives.
One less complicated step would be for central banks to lower rates in concert.
ECB President Trichet signaled last week that he was ready to reduce borrowing costs as regional growth weakens. Traders are betting that the Bank of England will lower rates at a meeting this week, and that the Fed will cut its benchmark by at least half a point at or before an Oct. 28-29 gathering.
`Madness Out There'
``It's madness out there and if this continues you're likely to see a coordinated response from central banks,'' said Dario Perkins, an economist at ABN Amro Holding NV in London, who sees a 50 percent chance of the central banks cutting rates together.
The Reserve Bank of Australia today cut its benchmark interest rate by one percentage point, the most since a recession in 1992, boosting Asian stocks on speculation that counterparts elsewhere will follow it.
At the center of the paralysis in money markets is a tangle of bad mortgages and derivative securities linked to them, and a lack of transparency by financial institutions about what they are really worth. The downfall of Wall Street giants such as Lehman Brothers Holdings Inc. and American International Group Inc. last month raised concern about which firm might fail next.
The source of risk in the market is concern over ``who gets to survive and who doesn't,'' said Richard Berner, co-head of global economics at Morgan Stanley in New York. ``When you are looking at a problem of this magnitude and that is systemic, you don't take any options off the table.''
Commercial Paper
The Fed is already indirectly providing support to the commercial paper market. Its board authorized its Boston branch to provide emergency loans to commercial banks to purchase asset-backed commercial paper from money mutual funds to help them meet shareholder redemptions. Some economists suggested it could do more, though again it might feel limited by its mandate.
Paulson is not so constrained. The $700 billion bank rescue bill passed by Congress last week gives him wide latitude in how he can use the money, including, but not limited to, purchasing bad assets from financial institutions.
The Treasury chief also has the buying power of Fannie Mae and Freddie Mac available to try to shore up the housing market and combat the crisis. The Treasury took over the two mortgage companies last month.
``Bernanke is a student of the depression, and it is not going to happen on his watch,'' said Michael Darda, chief economist at MKM Partners LP. ``The Fed will pull out all the stops until something starts working.''
To contact the reporters on this story: Rich Miller in Washington rmiller28@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net.
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