WASHINGTON - The Federal Reserve, struggling to ease a severe nationwide credit crunch, announced a novel approach yesterday to injecting money into the banking system.
The Fed said it would conduct two auctions next week at which banks can bid for up to $40 billion in government loans. The winning banks then will have that money available 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 money will spur increased lending by the banks - thus combating a serious credit crunch that has made loans harder to obtain for many businesses and consumers. Without borrowed money, most businesses cannot buy new equipment and expand their plants, and consumers often delay or scrap plans to make major purchases.
The credit crisis began last spring in the housing market with a rising number of defaults, especially on subprime mortgages - loans to homeowners with poor credit histories. It spread into the overall credit market, with banks increasingly reluctant to make loans of any kind, even to creditworthy corporations and individuals.
Yesterday's Fed announcement initially lifted spirits on Wall Street, with the Dow Jones industrial average up more than 200 points in early trading. However, stocks could not hold on to those gains as investors worried that the Fed's auction plan would not be enough to deal with the worsening credit crunch.
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 those institutions could better deal with credit problems in Europe.
The Fed said it also was coordinating with the central banks of England and Canada.
"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 in West Chester, Pa.
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 take place Monday, followed by a second auction next Thursday for another $20 billion.
The Fed said that all banks judged to be in generally sound financial condition by their Fed regional bank would be eligible to participate in the auctions for funds.
The Fed said the new auction process should "help promote the efficient dissemination of liquidity" when other lines of credit were "under stress."