Monday, February 23, 2009
The Fed balance sheet is growing again; bank credit is up $76.9 billion for the week ending on Feb. 18 to $1.91 trillion, while reserve balances grew another $85.6 billion to $688.9 billion. The balance sheet is set to expand (much) further; the Fed is expected to announce the start date of its new Term Asset-Backed Securities Loan Facility (TALF) soon. The program is massive - up to $1 trillion - and could help consumer ABS markets, but questions still remain.
The chart illustrates the asset side of the Fed's balance sheet, including its credit easing policy measures - Commercial Paper Funding Facility (CPFF), its various non-commercial bank loans (Maiden Lane, Maiden Lane II, and Maiden Lane III), and listed under "securities held outright, the mortgage backed security purchase program (MBS), for example.
Over the last week, bank credit grew mainly due to the following: (1) a new $55.69 billion of the NY Fed's MBS purchase settled on balance, and (2) the Fed increased its Term Auction Facility (TAF) lending another $34.7 billion.
The Fed is purchasing MBS on a weekly basis, but the securities only settle on balance at a lag. To date, another $71.6 billion in MBS have already been purchased by the NY Fed that have not yet settled on balance. As for the TAF, the Fed still has 3 auctions scheduled through March 23 2009 for another $450 billion in lending. Unless the Fed wants to wind down this program (highly unlikely), which currently holds a 23% share of total bank credit extended by the FEd, further auctions will likely be scheduled soon.
TALF will raise Reserve bank credit by up to $1 trillion, or more than 50% of its current total.
The TALF program is expected to get underway soon - the NY Fed has been uploading a lot of technical information regarding the program. The TALF plan is simple. The NY Fed will lend to eligible borrowers (the requirements are much broader than the commercial banking system) at a fixed or floating interest rate against eligible collateral of various consumer and small business asset-backed securities (ABS).
The collateral eligible for the TALF loan includes the highest rated ABS backed by auto loans, credit card loans, student loans, and small business loans. Depending on what type of security is used as collateral, the Fed will lend up to 95% of the collateralized assets (haircut amounts range from 5%-16%). If the security is downgraded after the Fed assumes it as collateral, the Fed takes the hit. If the borrower defaults on the loan, the Fed sells off the ABS collateral.
The TALF program was extended - from $200 billion to $1 trillion - as part of the government's Financial Stability Plan . It is not certain exactly how effective will be the TALF on the ABS markets. For one thing, there is some question as to the incentives of the program: whether or not the haircut (5%-16%) plus interest payments will be sufficient to attract participants to the program. Another Fed program, the Money Market Investor Funding Facility, did not attract any eligible participants to borrow under the program (its lending on the Fed's balance sheet remains at $0).
Other questions remain. Here is an excerpt from the NY Times last week:
For one thing, the Fed will make loans against only triple-A rated securities, not lower-rated bonds, which are first to suffer losses when borrowers default on loans. That will not help banks sell junior bonds, which many investors have shunned because of fears that losses would rise as the economy worsened, said Thomas H. Atteberry, a partner at First Pacific Advisors, an investment firm based in Los Angeles.
“It’s probably a step forward but it may only be a baby step forward,” said Mr. Atteberry, who does not plan to use the TALF.
Jerry Marlatt, a partner at the law firm of Clifford Chance who specializes in securitization, said that lenders using the TALF would be willing to retain more of the risk associated with loans on their own books to get deals done. That should help ensure that lenders make better-quality loans in the future, because they will be liable for most of the losses.
Simon Johnson, an economics professor at the Massachusetts Institute of Technology and a former chief economist at the International Monetary Fund, said many people might take a dim view of the TALF program because it provided government subsidies to investors like hedge funds. Investors who borrow from the Fed could enjoy annual returns of 20 percent or more. “The TALF,” he said, “raises a lot of questions.”