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By Richard Leong and Lynn Adler
NEW YORK, March 5 (Reuters) - Banks scrambled to raise cash this week after U.S. mortgage finance agency Fannie Mae abruptly slashed the number of financial institutions that hold its funds, market sources said on Friday.
The move forced banks dropped by Fannie Mae FNM.N to liquidate Treasuries and other short-term securities and borrow in the open market so they could return money Fannie Mae had with them, they said. This caused an increase in short-term interest rates across key U.S. loan markets since Wednesday.
The banks had helped to manage Fannie Mae's cash by lending it to each other in the federal funds market.
There has been market speculation on just how much these banks have to raise to comply with the Fannie Mae decision, with guesses as high as $100 billion.
Fannie Mae has declined to comment on the matter.
At the end of 2009, Fannie Mae reported it held about $69 billion in cash and cash equivalent instruments. Of that amount, nearly $54 billion took the form of fed funds and repurchase agreements.
Fannie Mae's portfolio summary for January showed it was ramping up its cash holdings to handle $127 billion of seriously delinquent loan buyouts starting in March. For more, see [ID:nN01110241]
The cash scramble on Wednesday and Thursday led to a spike in overnight interest rates on federal funds and repurchase markets to their highest levels since December.
It is unclear why Fannie Mae made the sudden move to reduce the number of banks holding its cash.
Nearly all the financial institutions cut by Fannie Mae were foreign banks, market sources said.
"Fed funds have increased from around the 13 basis-point level to the 19 basis-point level on the perception that this provides less liquidity for the marketplace," said Walter Schmidt, structured product strategies manager at FTN Financial in Chicago.
"When fed funds are this low a few basis points is a big percentage move," he said.
A U.S. Treasury spokesperson declined to comment on the matter, but noted that it was Fannie Mae's decision.
Freddie Mac, the second largest U.S. home funding provider, has not acted similarly.
The company in a Feb. 24 regulatory filing with the Securities and Exchange Commission said it held no federal funds or other unsecured lending at the end of 2009 or the prior year.
"We have not made any recent changes to, or announcements on, the way Freddie Mac participates in the fed funds market," Freddie Mac spokesman Michael Cosgrove said.
The Federal Housing Financing Agency, which regulates Fannie Mae and Freddie Mac, declined to comment.
Additional reporting by David Lawder in Washington