The FED Liquidity Facilities – A Comment

The liquidity facilities created by the Federal Reserve since December 2007 is providing pockets of liquidity in different parts of the financial system. In this sense, these facilities are unclogging the US financial system in different stances.

These facilities are now entitled to give any type of collateral for the FED. So let’s say that the banks give the FED their ‘junk (or CDOs) collaterals’. In exchange the banks receive from the Federal Reserve an amount that is part of the ‘borrowed required reserves’ as a way to offset their losses from the CDOs. The whole process has been proved to be efficient because the total amount of required reserves has not changed since the first auction promoted by the FED. According to the Federal Reserve, these facilities are permanent suggesting that the banking bailout will continue as long as the financial system is at risk. It is a bailout because the collaterals offered by commercial banks (CDOs?) have been posting significant losses. The Federal Reserve is basically transferring - through the TAF - the future losses that commercial banks would have to report in their balance sheets to the lender of last resort, the Central Bank of the United States. Second, the financial contagion experimented during the 1990s emerging markets crisis is also present in the current scenario. In turn, countries that did not carry CDOs, or had small exposure to the US financial system, are also being affected.

The absence of significant regulation on the synthetics as well as on the ‘monolines’ companies that started to provide insurance for these synthetics made the whole process prone to deep financial crisis. Second, that financial crisis stemming from bad regulation is possibly worse than the 2001 Argentina ‘default’.

The imbalances displayed by the United States twin deficits are not new. Few were those that argued that China could finance such system forever. The so-called Bretton Woods II may now come to an end. So what can we expect from the future? A new Bretton Woods? Under what terms? Would Latin countries join?

In what follows we took from the Federal Reserve website a summary of the liquidities facilities created by the Federal Reserve.

1. Under the Term Auction Facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized. Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). It was first introduced on December 2007.

2. The Federal Reserve Primary Dealer Credit Facility (PDCF) is an overnight loan facility that provides funding to primary dealers in exchange for a specified range of eligible collateral in accordance with the program terms and conditions. All terms and conditions are subject to change. It was established in March 2008. Also established in March 2008.

3. The Term Securities Lending Facility (TSLF) is a weekly loan facility that promotes liquidity in Treasury and other collateral markets and thus fosters the functioning of financial markets more generally. The program offers Treasury securities held by the System Open Market Account (SOMA) for loan over a one-month term against other program-eligible general collateral. Securities loans are awarded to primary dealers based on a competitive single-price auction. The TSLF is a 28-day facility that will offer Treasury general collateral (GC) to the Federal Reserve Bank of New York’s primary dealers in exchange for other program-eligible collateral. It is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. It was established in March 2008.

4. The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility is a lending facility that provides funding to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions. The program is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally. It was first created in September 2008.

5. The Federal Reserve created the Commercial Paper Funding Facility (CPFF) to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby contribute to greater availability of credit for businesses and households. Under the CPFF, the Federal Reserve Bank of New York will finance the purchase of highly rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers. It was established in October 2008.

6. The Money Market Investor Funding Facility (MMIFF), authorized by the Board under Section 13(3) of the Federal Reserve Act, will support a private-sector initiative designed to provide liquidity to U.S. money market investors. Under the MMIFF, the New York Fed will provide senior secured funding to a series of special purpose vehicles to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. It was established in October 2008.

7. The Term Asset-Backed Securities Loan Facility (TALF) is a funding facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by loans of various types to consumers and businesses of all sizes. Under the TALF, the Federal Reserve Bank of New York (FRBNY) will lend up to $200 billion on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. The FRBNY will lend an amount equal to the market value of the ABS less a haircut and will be secured at all times by the ABS. The U.S. Treasury Department--under the Troubled Assets Relief Program (TARP) of the Emergency Economic Stabilization Act of 2008--will provide $20 billion of credit protection to the FRBNY in connection with the TALF.