Tight Credit Market

Credit Card Debt: New Collateral for Fed Loans?

We are staying tuned for whatever new solutions the Federal Reserve may offer to ease the tension on the tight US and European credit card market. And we did not have to wait long. On May, 2, the Fed announced its determination to increase the amount of its cash auctions, or the size of credit it can issue to banks, and to allow banks to use student loans, car loans and credit card debt as collateral for its loans.

The Federal Reserve took the measures citing the never receding liquidity pressure in credit markets in the USA and Europe whose banks are also holders of dollar loans in the mortgage sector.

Before these actions were announced the Fed had again lowered its Target rate down to 2% which lead to the reduction of the prime rate to 5%. As it appears, however, when it comes to credit cards, the interest relief is not as significant as it was expected.

Credit rates switching practiced by most card issuing companies has prevented customers from taking advantage of the lowered variable APRs because now they can only get a fixed APR set by the issuer independently from the Fed.

No wonder, banks have to find a way to pay back loans they borrowed from the Federal Reserve and the defaults on credit cards force them to act in the way that affects responsible cardholders.

Fortunately, Fed is determined to meet the needs of financial institutions hurt by the credit crisis and comes up with two solutions to the problem of tight credit market.

The solutions come as lending facilities, and the first of them, the Term Securities Lending Facility, expands the type of collateral banks use to back up Fed loans. Up to this day, banks could only use mortgage to secure the Fed loan but now it has been added by student, car loans and credit card debt.

Together with the Fed's decision to lend as much as $200 billion to 20 different banks and the expanded collateral, the second lending facility, the Term Auction Facility, is very likely to ease things on the credit market.

Through the Term Auction Facility the Fed increases the amount of credit it can give to banks, and $75 billion was set as the amount per auction, up from the previous $50. So, banks can now get greater Fed loans and have more chances to obtain them through the expanded collateral approved by the Federal Open Market Committee.

It is in the Fed's interest to ease tight credit conditions and fight the liquidity pressures through offering more and easier credit to banks. The Federal Reserve has got to get back its credit, so it helps financial institutions get recovered from the bad credit losses and subprime loans, especially in the mortgage sector.