Oct. 2 (Bloomberg) -- Commercial banks and bond dealers borrowed $348.2 billion from the Federal Reserve as of yesterday, an increase of 60 percent from the prior week amid a worsening credit freeze.

Loans to commercial banks through the traditional discount window rose about $10 billion to $49.5 billion as of yesterday, the Fed said in a weekly report today. The total surpassed the previous record after the 2001 terrorist attacks.

Borrowing by securities firms totaled $146.6 billion, up from $105.7 billion. Under a new emergency program announced Sept. 19, banks borrowed $152.1 billion as of yesterday to buy commercial paper from money-market mutual funds, more than double a week ago.

The report reflects the Fed's expansion of credit and emergency-lending programs to halt a yearlong credit crisis that pushed interest rates on three-month dollar loans today to a nine-month high as short-term corporate borrowing fell by the most ever.

``The financial system is on a lifeline,'' said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. ``The Fed will have to maintain this expansion of its balance sheet for quite some time.''

A provision in the $700 billion financial-rescue legislation being considered by Congress would let the Fed pay interest on bank reserves it holds, making it easier for the central bank to manage short-term interest rates while pumping funds into the banking system.

Government Stake

AIG, the largest U.S. insurer, drew down $61.2 billion on its $85 billion credit line from the Fed, up from $44.6 billion as of Sept. 24, the central bank said. The Fed agreed Sept. 16 to rescue AIG with the loan in return for an 80 percent stake for the U.S. government.

As of last week, the Fed combined lending through the Primary Dealer Credit Facility, which serves 18 securities firms, and began in March with new programs special to three of them: Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co.

On Sept. 21, the Fed allowed the U.S. broker-dealer units of Goldman Sachs, Morgan Stanley and Merrill to pledge a broader range of collateral and have their London broker-dealer units borrow. The action coincided with the Fed's agreement to let Goldman Sachs and Morgan Stanley convert to commercial banks, putting the two remaining major investment banks under stricter regulation and giving them access to more-favorable Fed loans.

Merrill agreed Sept. 15 to be bought by Bank of America Corp., while the Fed allowed Lehman Brothers Holdings Inc. to fail the same day.

Daily Lending

Average daily lending to bond dealers in the seven days through yesterday rose $59.5 billion to $147.7 billion, the Fed said.

The Fed separately has lent $149 billion to commercial banks through the Term Auction Facility, an emergency program begun in December. The program will be expanded to $450 billion, the Fed said this week.

The central bank said on Sept. 14 it will accept equities as collateral from securities firms under the PDCF. Citigroup Inc. and nine other large banks said they would use the program starting that week as they created a $70 billion lending program.

Today's report, providing statistics as of Oct. 1, doesn't identify borrowers.

The report reflects part of the Treasury Department's plan, begun last month, to sell government securities to expand the Fed's balance sheet. The sales added a daily average of $266.1 billion of Treasuries to the Fed's coffers in the past week.

Credit Crisis

Fed holdings of U.S. Treasury securities rose $55 million to a daily average of $476.6 billion in the past week. The central bank had about $791 billion of Treasuries at the start of the credit crisis in August 2007.

Last month, the Fed said it would extend emergency loans to banks to purchase asset-backed commercial paper from money funds after a record exodus of investors from the mutual funds, long considered to be among the safest investments. Average loans in the past week totaled $122.1 billion a day.

Prime money-market funds held about $230 billion in asset- backed commercial paper that banks could buy with Fed funds, senior Fed staff officials said last month.

The subprime-mortgage collapse has led to $588 billion of writedowns and losses at major financial institutions since the start of 2007.

The three-month London Interbank Offered Rate in dollars was 4.21 percent today, a nine-month high. Commercial banks can take out up to 90-day loans from the Fed at 2.25 percent. Primary dealers pay the same rate for overnight loans. The AIG loan accrues interest at three-month Libor plus 8.5 percentage points.

Half-Point Cut

In 2001, the discount rate was a half-point below the Fed's benchmark federal funds rate. In 2003, the Fed reset the discount rate at 1 percentage point above federal funds. The Fed reduced the spread to a half point in August 2007 and to a quarter point in March 2008. Traders expect a half-point cut in the federal funds rate this month, to 1.5 percent.

In March, the Fed agreed to loan $29 billion against a pool of securities to facilitate Bear Stearns Cos.'s sale to JPMorgan Chase & Co., taking the portfolio onto the central bank's balance sheet. The Fed expects the latest quarterly revaluation of the portfolio to be in the Oct. 23 release of the Fed's balance sheet, New York Fed spokesman Andrew Williams said.

The Fed also reported that the M2 money supply rose by $165.5 billion in the week ended Sept. 22. That left M2 growing at an annual rate of 5.8 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.

The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds.

During the latest reporting week, M1 rose by $60.9 billion. Over the past 52 weeks, M1 increased 2.6 percent. The Fed no longer publishes figures for M3.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: October 2, 2008 17:48 EDT