Fed may increase new lending facility to aid markets

WASHINGTON (Reuters) - The Federal Reserve may increase the size of its latest $200 billion lending facility, which staffers stressed was aimed at boosting financial market operations, not helping any particular firm or type of security.

Senior Federal Reserve staff members, who briefed reporters via a telephone conference, said if needed they could quickly scale up the new facility, which allows firms to use mortgage-backed securities as collateral in auctions for Treasury securities.

The Fed's latest action, taken in response to signs that credit markets were at risk of seizing up, gave global financial markets a lift as the Fed joined with central banks around the world to pour cash into stressed markets.

Fed staffers stressed that it was not taking the latest action because it saw a danger of potential insolvencies among U.S. financial firms, but because it thought there was a shortage of liquidity in markets.

Staffers did, however, concede that liquidity issues could escalate into solvency issues if they were not tackled. The Fed wanted to head off that risk.

The Fed staffers said that "haircuts" would be applied to the value of mortgage backed securities that financial firms can use as collateral, but that it was unsure at this stage how severe those might be.

The Fed also said that the private-label mortgage-backed securities (MBS) it would accept as collateral must be AAA-rated and could not be on watch-list for rating downgrade.

If they were placed on a watch-list, they would have to be substituted, they said. They pointed out that possibly $1 trillion-worth of AAA-rated MBS were eligible.

The Fed staff members said that the new lending facility, which it said is similar in construction to an existing so-called Treasury Auction Facility, but with a longer maturity of 28 days, will for the first time lend Treasuries for MBS.

The Fed currently permits use of MBS as backing for liquidity provided through its discount window operations, but does not directly provide securities of part of those actions.

The Fed staffers said it was expected that financial firms will use the Treasuries as a means for raising cash and that in turn will encourage them to resume normal lending business.

The Fed does not want to become directly involved in purchasing MBS, a staff member said. But it does expect that the new lending operation will help bring down risk premiums, and therefore might favorably affect prices for MBS.

(Reporting by Glenn Somerville and Alister Bull)