May 2 (Bloomberg) -- The Federal Reserve, seeking to prevent a deeper economic slowdown, took another stab at coaxing banks into lending at lower rates.

The Fed boosted its biweekly Term Auction Facility sales of cash to banks by 50 percent to $75 billion and expanded the collateral it takes from bond dealers through loans of Treasury securities. It also raised the amount of dollars it makes available to the European Central Bank and Swiss National Bank through swap lines to a combined $62 billion from $36 billion.

Borrowing costs for banks have risen as much as 0.38 percentage point in the past six weeks, an increase that blunted the impact of the cash injections that began in December. The strains threatened to further impair mortgage markets, worsening an economy where growth has already stalled.

``The world is awash in liquidity, it just isn't reaching the right financial borrowers,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``Today's action from the central banks is another strong dose of medicine that will help cure what ails the credit markets.''

Fed officials also expanded the collateral they accept under the Term Securities Lending Facility to include AAA rated asset- backed investments. About 95 percent of outstanding student-loan securities are AAA, according to the American Securitization Forum. Democrats in Congress had pushed Chairman Ben S. Bernanke to take student-loan bonds on the central bank's balance sheet.

Focus on Libor

Policy makers and economists have cited the rise in the London interbank offered rate for dollars as evidence of banks' and investors' concerns about lending to counterparts. Eric Rosengren, president of the Boston Fed, said in a speech last month that Libor has ``been elevated since the onset of financial problems'' in July.

A gauge of bank funding costs, the premium on Libor over the overnight indexed swap rate, which is a measure of what traders expect for the Fed's benchmark rate, reached 87 basis points on April 21. That was the highest since the Fed announced the TAF on Dec. 12.

The Libor rate itself fell to 2.77 percent today from 2.78 percent yesterday, putting the spread at 0.77 percentage point.

The Fed created the TAF and two other programs to reverse a decline in liquidity that began last year with the collapse in the market for subprime mortgages. Today's announcement may reduce loan payments for some companies and homeowners with variable-rate mortgages.

`Persistent Liquidity Pressures'

Today's actions were taken ``in view of the persistent liquidity pressures in some term funding markets,'' the Fed said in a statement.

Speculation had risen among Fed watchers this week that the central bank would increase the size of the TAF operations after borrowing costs increased. Some had also anticipated an extension in the term of the loans beyond 28 days.

``It was a relatively conservative measure'' because the duration remains unchanged, Richard Iley, senior economist at BNP Paribas SA in New York, said in an interview with Bloomberg Television. ``Evidence thus far is that these auctions have had very limited impact in bringing down these still-elevated credit spreads. There still remains a tremendous reluctance on the part of financial institutions to lend to one another.''

Today's decision comes two days after the Fed's interest- rate setting Open Market Committee lowered its benchmark rate for a seventh time since September, while signaling it's ready to hold off on further cuts.

`Downside' Risks

In its statement, the Fed removed a previous reference to ``downside'' risks to growth, while noting that past federal funds rate reductions and ``ongoing'' liquidity measures should help spur a recovery in economic growth.

Separately, a Labor Department report today showed employers cut fewer workers than forecast in April, and the unemployment rate unexpectedly dropped to 5 percent.

``They're looking for ways to provide liquidity other than through cutting the federal funds rate,'' said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. With today's actions, ``they're trying to prevent the strains from building up,'' he added.

The TAF, which provides 28-day loans to commercial banks, will sell $75 billion in auctions every two weeks, starting with the May 5 operation, the Fed said in the statement. The decision will increase the amount outstanding under the auctions to $150 billion from $100 billion.

Today's increase may not be the last. Lehman Brothers Holdings Inc. senior economist Drew Matus said he expects another expansion, to a total of $200 billion, over the next two months.

Third Expansion

It's the third increase since the program started in December at $40 billion per month.

The expanded collateral under the TSLF will take effect with the sale to be announced May 7 and settle on May 9, the Fed said. The Fed announced the program in March, auctioning as much as $200 billion in Treasuries. In several of the sales, the Fed has failed to attract enough bids to cover the securities at auction.

The Fed already accepts residential and commercial mortgage- backed securities and agency collateralized mortgage obligations through the TSLF.

``The wider pool of collateral should promote improved financing conditions in a broader range of financial markets,'' the Fed said.

The Bank of England and Bank of Canada, which took part in the original TAF announcement, didn't participate today. The U.K. central bank ``did not see a need'' to participate, while it is ``supportive of the efforts of other central banks in the money markets,'' an official said.

Bear Rescue

In Canada, markets and institutions ``have not been affected in the same way nor to the same extent as elsewhere,'' Philippe Metz, a spokesman for the Ottawa-based central bank, said in an e-mailed statement.

Along with the TAF and TSLF, the Fed in March started direct lending to investment banks at the same rate as to commercial banks, currently a premium of a quarter-point over the benchmark federal funds rate. The central bank also provided $29 billion of financing to secure JPMorgan Chase & Co.'s takeover of Bear Stearns Cos.

Investors have responded, buying a record $45.3 billion of corporate bonds last week and spurring a rebound in the Standard & Poor's 500 stock index from the year's low in March.

Today's decision comes after criticism from Stanford University economist John Taylor, who wrote in a study last month that there is ``no empirical evidence'' the TAF has reduced the premium that banks charge each other to lend cash for three months.

Fed Governor Frederic Mishkin said in a Feb. 15 speech that there was ``some evidence that the TAF may have had significant beneficial effects on financial markets.'' Mishkin included the caveat that ``isolating the impact of the TAF on financial markets is not easy.''

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

Last Updated: May 2, 2008 17:23 EDT