Friday, February 27, 2009

The Fed is shifting focus

It's been three months since the Fed announced its Term Asset-Backed Securities Loan Facility (TALF), and over two weeks since the Treasury announced its Financial Stability Plan, under which the size of the TALF was increased to $1 trillion. The size of the Fed balance sheet peaked at $2.3 trilliion on the week ending December 17, 2008, and has since then decreased by $354 billion (on 2/25/09).

The Fed is shifting focus. It awaits the start of its TALF program, where the Fed will lend against a wider range of collateral to a much broader base of firms (any U.S. company with eligible collateral can participate in TALF). Furthermore, the only programs that have increased in size are those to purchase directly alternative assets (MBS or CDOs, for example).

The table lists the Fed's assets and liabilities since the peak of its bank credit activity on December 17, 2008. It appears to me that the Fed has changed its tune away from traditional lending and toward direct purchase of assets, increasing only those programs that buy assets directly.

The top line, Reserve Bank Credit, is all credit extended to the commercial banking system and primary dealers; it has fallen by $353 billion since two months ago. The Fed's traditional method of targeting bank reserves is through the buying and selling of securities, and accepting a rather narrow range of collateral that was updated in 2006 (you can see the collateral that the Fed accepts for the TAF and discount window here).

The chart to the right comes from the Fed's new website; it lists the collateral pledged for $1.5 trillion in lending as of the middle of December. As you can see, the list is rather vague. It doesn't list what these assets are worth now (current market value), and the ABS accepted is probably not the bad stuff that firms are currently writing down.

Overall, I presume that the traditional lending programs have probably become less attractive, as the assets that banks want to get off their balance sheets (collateral) cannot be done under current programs. And furthermore, only banks can borrow in these programs.

So the Fed is gearing up for TALF - Repo loans have been unwound. Originally, the Fed started beefing up its Repo arrangements with primary dealers, as the collateral accepted under a Repo (primary dealer collateral, see here) is slightly wider than the collateral accepted by traditional open market operations (buying and selling Treasuries). I take this reduction in repo lending as a sign that the Fed has announced or introduced new programs - TALF (assets backed by consumer credit and small business loans) or MBS purchase - that either purchase the illiquid assets directly or will be accepted as collateral, making the back-door approach, repos, unnecessary.

The Fed has increased its holdings of CDO's and MBS via direc purchase from AIG and its subsidiaries and from the open market (in the case of MBS). On the open market, the Fed purchased $160 billion in MBS, but only $68.5 billion is showing on balance. That's almost $100b in assets that the Fed owns - nontraditional assets, I might add - that have yet to settle on balance.

To me, the Fed is moving away from traditional liquidity measures - extending bank credit in exchange for narrowly-defined collateral or a slightly extended version (Term Securities Lending Facility and the PDCF), and toward direct purchase of less-liquid assets, or accepting a wider range of collateral linked to consumer and small-business ABS for loans available to any U.S. firm that holds the collateral (TALF).

Rebecca Wilder


  1. Great sleuthing Rebecca.

    Marc Faber foretold all of this back in 2008 mocking that Bernanke would become a "used car salesman".

    What would the Fed Res balance sheet look like if Bernanke's accounting dept. had to mark assets to market prices?

    With any other company, Bernanke would get fired for gross incompetence.

  2. Dutiful dissection – Au Fait

    A yo yo. The Central Bank fruitlessly exchanges the rating agencies crème de la crème

    Banks buy their liquidity instead of following the old fashion practice of storing their liquidity. They pay for what they already own. In a world of interest bearing checking accounts there are leakages. The Hicksian Cross doesn’t balance. The liquidity preference curve is a false doctrine.

    Now the FED is unwinding it’s “elastic currency”. It is pushing seasonal mal-adjustments. It ignores the fallacious real bills doctrine. You don’t drain reserves when unemployment is breaking records. Bernanke didn’t learn from 9/07 nor 9/08.

    Excess reserves are a victim of the yield curve. Obama’s trillions made the “tax” rebate unattractive. And statistical “true ups” are big and late.


    And down we go.

  3. Charging a fee instead of paying interest on excess reserve balances would help a lot. Marking mortgages to market against principal and interest write-downs would not be too bad, as long as it grows the middle class. That would be more efficient than cram-downs in bankruptcy court, of which there would be more if the regulatory and legislative write-down authorization isn't done. How much are we paying for term-asset loans from the Fed compared to just letting the banks do their usual thing?