PIMCO urges Fed to jump-start commercial paper market

NEW YORK (Reuters) - Bill Gross, head of the world's largest bond fund, on Monday urged the U.S. Federal Reserve to take more dramatic steps to jump-start paralyzed credit markets, including direct purchases of commercial paper.

"A systemic delevering likely requires a systemic solution, which moves beyond cyclical interest rate cuts, liquidity provisions, or even the purchase of subprime mortgage-backed bonds," Gross, chief investment officer at Pacific Investment Management Co, wrote in his October letter to investors released Monday afternoon.

Gross, who oversees more than $812 billion in assets at Pimco, said the Fed must make the bold step of outright purchasing of commercial paper.

Furthermore, the Fed must now act as a "clearing house," guaranteeing that institutional transactions are cleared and counterparty obligations are honored, Gross said. That is because credit markets are based on trust and when there is no trust, just as is the case now, markets can freeze up, he noted.

Interest rate cuts are also in order, Gross said.

"They should also cut interest rates to 1 percent, because we are experiencing asset deflation, and the threat of headline inflation is long past," Gross said.

The Dow Jones industrials .DJI settled Monday below 10,000 -- the first time since October 2004 -- down 369.88 points.