Wednesday, March 26, 2008

The Fed’s New Alphabet Soup- Vincent Reinhart

First, the mnemonics. On March 14, the Federal Reserve extended access to its discount window to a non-depository, Bear Stearns, for the first time since the 1930s. (The discount window is the Fed’s lending facility, where loans are made at a rate above the federal funds rates and can be secured with a wide variety of collateral.) According to the Federal Reserve Act, lending to such an individual, partnership, or corporation (an IPC) requires the affirmative vote of five of the governors of the Federal Reserve Board. Moreover, the Federal Reserve must attest that there are “unusual and exigent” circumstances and that failure to lend would impair the economy. On March 16, the Fed granted other investment banks access to its lending facility.

On the prior Tuesday, the Fed had introduced a new program called the Term Securities Lending Facility (TSLF), under which it will loan some of the Treasury securities currently on its balance sheet to key financial market participants in return for other securities as collateral. The term of these transactions is 28 days, and the fee paid for the loan of Treasury securities will be set in an auction.

For the past few months, the Fed has been holding regular auctions for depositories of its discount window credit, also for a term of 28 days. This is referred to as the Term Auction Facility (TAF), in which depositories bid for credit. Earlier this month, these auctions were bumped up to total $100 billion per month. To put that sum in perspective, the amount of discount window loans outstanding this month will likely be nine times the previous monthly record from 1919 to the inception of the TAF (see the nearby chart). And if the TAF continues at its recent pace through June of this year, the Federal Reserve will have extended a greater volume of loans over the first eight months of the program than it had cumulatively lent over the prior 90 years.

Last but not least, the Fed also announced that it will loan another $100 billion in the form of 28-day term repurchase (RP) agreements. RPs are the bread-and-butter of a central bank’s open market operations. In the typical RP, the Fed lends money to its dealer counterparties for a fixed term, taking collateral in the form of Treasury securities or the debt and mortgage-backed securities of the government-sponsored lenders, Freddie Mac and Fannie Mae.

If we tally up all these new programs, the Federal Reserve appears willing to commit almost one-half of its balance sheet, around $400 billion, to promote the renewed health of financial markets. Given its open-ended invitation for investment banks to follow the Bear Stearns route and tap the Fed’s discount window, it may wind up committing even more.

-The Fed’s New Alphabet Soup

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