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Tuesday, March 11, 2008

The Term Securities Lending Facility

The Fed expands its lending facility:

FOMC Approved Liquidity Actions, but Not, so Far, a Rate Cut, Greg Ip, WSJ Economics Blog: The Federal Open Market Committee met by conference call Monday to approve a new securities lending facility and the extension of swap lines to the European and Swiss central banks, a Fed spokeswoman said.

The Fed said this morning it would lend up to $200 billion in Treasurys to bond dealers in return for collateral such as mortgage backed securities, and make a $30 billion swap line available to the European Central Bank and a $6 billion swap line to the Swiss National bank. The securities lending facility is designed to improve trading conditions in the MBS market. The ECB and SNB will use the swap lines to supply dollar loans to European based banks. ...

The fact the FOMC met yesterday and, at least so far, hasn’t lowered interest rates, suggests that it expects to defer action to the meeting, though it could reconvene at any time before that. Futures markets implicitly trimmed expectations of an intermeeting move following this morning’s announcement, concluding it probably substituted for an intermeeting rate cut. ...

Will this help to remove the fear from financial markets that is causing investment markets to dry up? Perhaps:

Fed Earthquake, by John Jansen: The Federal Reserve has acted to soothe the troubled markets with another massive injection of liquidity on top of what was announced on Friday. In effect they are selling Treasuries to buy spread product. They will even take private label non agency collateral from the dealers. This should provide a massive confidence boost for the spread markets and provide solid reason for some investors to wade back into that market.

The Treasury curve has reacted rather dramatically with the yield on the 2 year note jumping 20 basis points to 1.78 percent. The yield on the 10 year note is back to 3.60 percent and the curve has collapsed to 182 basis points.

But will it last beyond the initial "slap in the face"? Paul Krugman says:

So basically the Fed is going to be swapping Treasuries for dubious securities, in an attempt to give the market a REALLY BIG slap in the face. I understand what they’re doing, and might have done the same in their place.  Still, all I can say is Wheeeee!

Former member of the Federal Reserve staff member Douglas Elmendorf adds:

Taking agency MBS as collateral does not meaningfully increase the risk faced by the federal government. First, the Fed will presumably require a significant "haircut" on the value of the collateral. Second, if the federal government would ultimately prevent a default by Fannie and Freddie anyway, absorbing some of that commitment now does not add to the overall risk. Taking private MBS as collateral does increase risk, unless an adequate haircut is taken, because the government is otherwise unlikely to stand behind the truly private lenders. But the government is hardly pure on this front now: The Federal Home Loan Banks have already lent tens of billions of dollars to private mortgage-lending institutions like Countrywide, so the government has effectively taken some of this risk. More generally, a capable lender of last resort is likely to make money on its lending, because it steps in only when financial markets are sufficiently self-destructing that the feared assets are highly likely to increase in value when panic subsides. We may have reached that point regarding mortgage-backed securities in the U.S. economy.

Without the Fed taking on a "meaningful increase" in risk that provides some insurance to financial markets, I don't believe the "really big slap in the face" will last long-term. But I hope I'm wrong.

    Posted by on Tuesday, March 11, 2008 at 10:39 AM in Economics, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (40)


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