Term Securities Lending Facility

[ClydeR]

Hey Gan, you usually know a lot about economics matters. I was wondering if you understand the "Term Securities Lending Facility." I've read about ten articles about it, and none of them make sense to me. I usually assume that if a financial transaction is too complicated to explain in simple terms, then it's either very risky or very shady.

The Federal Reserve's press release describes (http://www.federalreserve.gov/newsevents/press/monetary/20080311a.htm) it thusly--


The Federal Reserve announced today an expansion of its securities lending program. Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The TSLF 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. As is the case with the current securities lending program, securities will be made available through an auction process. Auctions will be held on a weekly basis, beginning on March 27, 2008. The Federal Reserve will consult with primary dealers on technical design features of the TSLF.

In addition, the Federal Open Market Committee has authorized increases in its existing temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB, respectively, representing increases of $10 billion and $2 billion. The FOMC extended the term of these swap lines through September 30, 2008.

The actions announced today supplement the measures announced by the Federal Reserve on Friday to boost the size of the Term Auction Facility to $100 billion and to undertake a series of term repurchase transactions that will cumulate to $100 billion.

Does that mean the Federal Reserve is trading good Treasury bonds for risky mortgage backed bonds so that the Federal Reserve, and not private investors, will lose money from those investments? I read one article, but I don't remember where now, that said there was something fishy about the way the feds were deciding whether or not a bond was AAA or Aaa rated. If the Federal Reserve loses money on an investment, is there really any money lost?

[Valthissa]

I was curious about the new program as well.

details here:

http://www.newyorkfed.org/markets/tslf_faq.html

it does not appear to be either risky or shady.

C/Valth

[Atlanteax]

Well, the gist of it to me is that the Fed is accepting AAA rated MBS in addition to what they usually accept... which enables Banks to move the ILLIQUID assets off their sheets, and thus freeing up cash to either lend out or to invest elsewhere.

My thought is that the Fed Reserve does not *expect* to take a loss on these securities... it is just that no banking institutions are eager to buy them, so the Fed is stepping in as a buyer. I'd say that if there's a loss, there's theortically no loss, as it essentially involves printed money.

Obviously contributed in a huge way to the DOW gaining 400 points.

[Daniel]

They are increasing the money supply.

[Gan]

Hey Gan, you usually know a lot about economics matters. I was wondering if you understand the "Term Securities Lending Facility." I've read about ten articles about it, and none of them make sense to me. I usually assume that if a financial transaction is too complicated to explain in simple terms, then it's either very risky or very shady.

Does that mean the Federal Reserve is trading good Treasury bonds for risky mortgage backed bonds so that the Federal Reserve, and not private investors, will lose money from those investments?
You're correct in the exchange but incorrect in losing money since these will eventually be auctioned off to the highest bidder.

I read one article, but I don't remember where now, that said there was something fishy about the way the feds were deciding whether or not a bond was AAA or Aaa rated.
I know that the typical rating entities - Moody/S&P/Fitch usually provide the ratings of most bonds, so the Fed isnt acting as a referee rater in as much as they are attempting to find a baseline (IMO). I do know that the malfeasance in rating bonds can get an institution into trouble if they knowingly rate a bond higher than its actual risk - see the latest probe of CountryWide.


If the Federal Reserve loses money on an investment, is there really any money lost? I dont think it can be described as simply as money lost - since the Federal Reserve is not necessarily a profit vehicle. The only money it makes is on the rates it charges banks to borrow from it in order to support its operating costs. Think of it as the economy 'losing' that money (see dollar devaluation).


Sorry for the late response, I've been out sick today and away from the computer. I've tried to answer your questions as best I can with two caveats in mind: 1) I'm not a banking/finance guy, so after a while all the little vehicles that banks use to move money around to take advantage of fluctuations in interest rates gets a little confusing; and 2) I have a head full of cold/flu drugs, so I might not sound too coherent.

As Daniel said, they [The Federal Reserve] are increasing the money supply, this is just another vehicle with a specific target in mind. Its specifically a banking and finance tool that is used to guide the economy. It involves how loans are offered in terms of being used as collateral and how that collateral is used in the securitized market between lenders and how they loan each other money. I view it as a catalyst that the Federal Reserve is implementing to spur increased lending activity between banks and investors in the short run. Because the natural reaction to a liquidity crunch is that banks tend to hoarde money. The critique is that we're just replacing a short run liquidity problem for a long run liquidity problem.


Here's a decent article in the Economist that sheds a little light on the subject.
http://www.economist.com/daily/news/displaystory.cfm?story_id=10837381&top_story=1

And a better one on cnn.money
http://money.cnn.com/2008/03/11/news/economy/Fed_lending.ap/index.htm?postversion=2008031109


WASHINGTON (AP) -- The Federal Reserve on Tuesday announced it is ramping up efforts to provide more relief in the spreading credit crisis, saying it will make up to $200 billion in cash available to cash-strapped financial institutions.

The Fed said it will lend the money to financial institutions for a term of 28 days, rather than overnight. The action is being coordinated with central banks in other countries to try to provide help in a global credit crises that threatens to push the U.S. economy into its first recession since 2001 if it hasn't already.

"Pressures in some of these markets have recently increased again," the Fed said in a statement. "We all continue to work together and will take appropriate steps to address those liquidity pressures." The other banks involved are the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank.

In addition, the Fed has authorized increases in existing programs called "swap lines" with the European Central Bank and the Swiss National Bank
"These arrangements will now provide dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB respectively," the Fed said, extending the term of these swap lines through Sept. 30.

The new lending initiative "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," the Fed said. Its announcement said that securities will be made available through an auction process on a weekly basis beginning March 27.

The new program, called the Term Securities Lending Facility (TSLF), is geared to provide primary dealers -- big investment firms that trade directly with the Fed -- with short-term loans. They would pledge other securities -- including federal agency debt, federal agency residential-mortgage-backed securities -- as collateral for the loans.

The loans would be made available through an auction process. Auctions will be held on a weekly basis, beginning on March 27, 2008.

The Fed since December has been making short-term loans available to banks through a new auction facility. It has provided $160 billion available to squeezed banks in hopes it will help them to continue lending to individuals and companies.

Last week, the Fed announced that it would increase the amount of loans it plans to make available to banks this month to $100 billion. At the same time, it said it would make another $100 billion available to a broad range of financial players through a series of separate transactions.

The Fed has been working to pump billions of dollars into the banking system to aid an economy rocked by the subprime mortgage crisis and the severe tightening of credit.

A meltdown in the housing and credit markets has made banks and other financial institutions reluctant to lend to each other, causing a cash crunch. Financial companies wracked up multibillion-dollar losses as investments in mortgage-backed securities soured with the housing market's bust. Problems first started in the market for subprime mortgages-- those made to people with blemished credit histories. However, troubles have spread to other areas.

The picture worsened just after the Fed's announcement Friday, when the Labor Department released a report showing employers slashed another 63,000 jobs in February, the most in five years. http://i.cdn.turner.com/money/images/bug.gif (http://money.cnn.com/2008/03/11/news/economy/Fed_lending.ap/index.htm?postversion=2008031109#TOP)

I highlighted something unique in red in that the use of the auction process was one of the things that Greenspan initiated back in the mid/late 80's to help the US climb out of that recession and housing bust with all of the S&L failures. Greenspan talked about it at length in the middle of his book.

[Daniel]

Essentially what they are doing is offering cash for non liquid asset in banks. The auctions are basically whatever banks will offer in their non liquid assets for the money which will value the securities.