The head of the world's largest bond fund said the Fed needs to take additional steps to calm markets and instill confidence.

Bill Gross, managing director and co-chief investment officer at PIMCO, said the Federal Reserve must act as a clearing house for institutional transactions, buy commercial paper and cut the Fed funds rate to 1.00%.

"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 wrote in his monthly letter on PIMCO's website.

Gross uses the example of a McDonald's drive-thru to illustrate the problems in the intrabank market.

"At one window you order and pay, at the other - 20 feet ahead - you pick up your lunch. What if you thought that after paying at the first window, your 1000 calorie sandwich might not be waiting for you a few seconds later. You might not pay; business as usual might not take place. That is what is happening in the credit markets," he said.

Gross said the Federal Reserve needs to act as an intermediary in order to stem the "McFear".

In the rest of his letter, Gross touches on the causes of the crisis and looks ahead to a post-credit crunch future.

"How this came to be is obvious in retrospect: too much exuberant leverage, not enough regulation; too strong a belief in asset-based prosperity, too little common sense that prices could go down as well as up; excessive 'me first' greed, too little concern for the burden of future generations; a political morass unworthy of our Founding Fathers," Gross wrote.

Gross said he anticipates a "lengthy recession but not depression" in the United States. It will result in record deficits and a rise in longer-dated bond yields. As capitalism changes, he said, it will need to balance private incentive and government oversight.

"The benevolent fist of government will now join hands with Adam Smith in a most visible manner," Gross wrote.

By Adam Button and edited by Nancy Girgis
©CEP News Ltd. 2008