ibnlive » Business

Mar 17, 2008 at 12:53pm IST

US Fed Reserve cuts discount rate

Washington: The US central bank on Sunday cut its lending rate to banks by a quarter of a percentage point and established a new lending facility to make short-term loans to banks in a dramatic bid to boost liquidity in an economy hit hard by defaults on home mortgages and a tightening credit market.

The Federal Reserve approved the move unanimously in an emergency weekend meeting, immediately decreasing the so-called discount rate from 3.5 per cent to 3.25 per cent.

It also announced the creation of a lending facility to make short-term loans to financial institutions designed to "improve the ability of primary dealers to provide financing to participants in securitisation markets."

CREDIT CRISIS: US Fed Reserve approved the cut in lending rates at an emergency weekend meeting.

The new lending organization will make loans from Monday and will last for at least six months. It also approved the sale of ailing investment bank Bear Stearns to bank JPMorgan Chase.

JPMorgan Chase agreed to buy investment firm Bear Stearns for just $2 per share after bailing out the company days earlier, the companies announced on Sunday. The Fed said the decisions were "designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth."

"These steps will provide financial institutions with greater assurance of access to funds," Federal Reserve Chairman Ben Bernanke said after the announcement.

The board's action came ahead of its next regularly scheduled meeting on Tuesday, at which analysts expect a cut in its benchmark interest rate of up to 1 percentage point.

The Bear Stearns deal came after a shortage of cash forced the investment firm to seek short-term financing from the Federal Reserve through JPMorgan Chase Friday, after clients pulled $17 billion from Bear Stearns over two days.

The company has been a major holder of bonds backed by risky sub-prime mortgage loans to borrowers with poor credit and the collapse of two of its funds helped spark the collapse of the sector and the economic downturn.

The move sent Bear Stearns shares to their lowest ever Friday and sparked fears it could go out of business. It lost 47 percent of its value, or $27 to close at $30 per share.

The deal announced on Sunday will be backed by up to $30 billion in financing from the Federal Reserve, which said it had approved the merger. The value of the deal is less than a 10th of the firm's worth last week, Bloomberg said.

"The past week has been an incredibly difficult time for Bear Stearns. This transaction represents the best outcome for all of our constituencies based upon the current circumstances," Alan Schwartz, president and chief executive of Bear Stearns, said in a statement.

Investors will receive 0.05473 shares of JPMorgan Chase stock for every share of Bear Stearns stock under the deal. Both companies' boards approved the arrangement and it is expected to be completed by the end of the second quarter.

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