Fed may extend Wall Street lending

By Patrick Rucker

ARLINGTON, Virginia (Reuters) - Federal Reserve Chairman Ben Bernanke said on Tuesday the U.S. central bank may keep an emergency lending facility for big Wall Street firms open longer than it initially intended, a signal the Fed is fearful of shutting down a vital backstop.

Credit costs have been driven higher and U.S. economic growth also has been hurt by market turmoil, Bernanke said at a forum sponsored by the Federal Deposit Insurance Corp.

"We are currently monitoring developments in financial markets closely and considering several options, including extending the duration of our facilities for primary dealers beyond year-end, should the current unusual and exigent circumstances continue to prevail in dealer funding markets," Bernanke said.

Remarks by Bernanke and Treasury Secretary Henry Paulson, who spoke at the same conference, calmed financial markets, which had been rattled this week by the possibility that government-sponsored mortgage finance providers Fannie Mae and Freddie Mac would be forced to raise substantial new capital.

Wall Street stocks soared, prices of short-term U.S. Treasury debt securities eased and the dollar posted gains.

"The last thing he wants to do is walk away and see a dealer collapse," Anton Schutz, portfolio manager at Mendon Capital Advisors in Rochester, New York, said of Bernanke. "It's all about safety and soundness," he added.

Paulson contributed to market optimism by saying that flatter sales of existing homes in recent months implied some stabilizing in home-buying demand.

STILL UNDER STRAIN

The Fed set up the so-called Primary Dealer Credit Facility, or PDCF, in March as part of its effort to facilitate the purchase of ailing investment bank Bear Stearns by JPMorgan Chase & Co. It said at the time the PDCF would continue for at least six months.

The lending program allows primary dealers -- the biggest firms that deal directly with the Fed -- to borrow directly from the Fed at the discount rate, currently 2.25 percent.

The Fed's action came after weeks of turbulence in financial markets had raised fears a credit crisis stemming from rising mortgage defaults was spiraling out of control.

Borrowing at the primary dealer facility averaged as high as $38 billion a day in March and early April, but eased to $1.7 billion a day in the week ended July 2.

Bernanke said, though, that markets were still strained.

One indicator of banks' willingness to lend to one another, the gap between the three-month London interbank offered rate, or Libor, and three-month overnight index swaps, was at its widest in over two months on Tuesday.

Bernanke said the Fed, working with other regulators at home and abroad, "has redoubled its efforts to strengthen the capital positions, liquidity reserves, and risk-management practices" of financial institutions it supervises.