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Steve Randy Waldman on the new Fed plan
Here (hat tip to Mark Thoma):
I am caught between a million things. But when I woke up the the Federal Reserve's press release about the TAF, my jaw dropped. It was one of those moments when the world shook, everything was the same, but everything had changed...this plan is brilliant.
I'm a bit more blase than that, but I did think it worth a blog post. The core innovation is that the Fed announces a quantity of funds to be auctioned, and the market sets the price. That is in contrast to the Fed targeting the Federal Funds rate; price-quantity equivalence results do not hold when credit rationing is present. It's like forcing a certain amount of discount window borrowing. This means that new funds will get to banks, and to banks with credit problems, it will be interesting to see at what price.
The skeptical Jim Lowe, over at Mark Thoma's, says:
The primary problem facing credit markets is not lack of liquidity but rather a combination of capital inadequacy and fears of credit/counterparty risk. I don't see how another liquidity injection addresses these problems.
In response, the Fed seems to be promising to "hold the bag" on the collateral offered by the soon-to-be borrowing banks. Could this be a collateral pledge disguised as a liquidity injection? Or is the main goal simply to reroute liquidity injections away from the main banks and toward the troubled cases?
Here is Greg Ip as well.
Addendum: Comment #1 gives what is apparently the Fed's schedule for evaluating collateral, mortgages appear to receive very favorable treatment.
Posted by Tyler Cowen on December 12, 2007 at 04:18 PM in Economics | Permalink
Comments
DealBreaker is linking to the Fed's discount schedule for collateral. Disclaimer: The linked list is effective dated 9/22/06. The MBS and CMO values are of particular interest, I think.
Posted by: Bernard Guerrero at Dec 12, 2007 4:56:12 PM
short term funding markets have seized up for a number of reasons - mainly because banks don't trust each other - but this is being aggravated by year end balance sheet "window dressing". Commercial Banks and Investment Banks have different year ends, I-Banks close the books on 11/30. This allows them to provide a "service" to their clients, the Commercial Banks, by renting them their balance sheet in late December. Commercial Banks offload assets onto I-Banks, in exchange for a nice fee, so that the Commercial Banks balance sheets and capital ratios look all prettied up. The transactions are unwound early in the new year. This year, as mentioned, banks are unwilling to lend to each other like before. And because I Banks balance sheets are themselves stretched thin, they are not able to help out the Commercial Banks in the usual way. Thus, the Fed is providing term based liquidity to help get through closing of Commercial Banks fiscal years.
Posted by: joe at Dec 12, 2007 7:16:27 PM
His name is "Steve Waldman" (with one n) rather than "Randy Waldmann".
Grep Ip also has a FAQ at Everything You Want to Know About Today’s Fed Move But Didn’t Know Who to Ask.
If this new TAF unfreezes bank lending, then presumably the Libor spread will diminish. This matters since things like student loans and especially ARM mortgages are often tied to Libor rather than the Fed funds target rate. Cuts in the Fed rate have been ineffective because Libor remained stubbornly high. It's not clear that this will be truly effective in forestalling the wave of foreclosures from ARM resets over the next year (goodbye subprime mortgage crisis, hello even-scarier prime mortgage crisis), but it can't hurt.
The Fed will be taking junk as collateral on very generous terms. A huge bailout.
Posted by: at Dec 12, 2007 8:58:43 PM
Peter Eavis in Fortune: Why the Fed bailout might not work
Posted by: at Dec 12, 2007 10:10:41 PM
I found the above comment by Joe to be interesting, and would like to understand it a little better for a project i'm working on. Joe, if you're checking back on the comments, would you be so kind as to email me? the email address attached to your post does not function
Posted by: Hugo at Dec 12, 2007 10:47:17 PM
I too think that Joe's comment was pretty interesting. Isn't that illegal though? I could have sworn that something similar happened with Enron. They sold tanker ships to a bank and promised to by them back later at a price higher: A loan by any other name. If commercial banks sell assets to investment banks with an understanding to repurchase, even if its tacit, is it a loan? Its not illegal to make a loan like that, but illegal to hide the fact that you have a liability from your investors.
Posted by: Sam at Dec 12, 2007 11:18:11 PM
Tyler, regarding the supposed favorable treatment provided mortgages in that schedule, it all depends on the quality of the Fed's collateral valuations. The haircuts on mortgages in that schedule are applied to market value, not outstanding principal balance. If the Fed gets the market value right -- not an easy thing, admittedly -- the haircuts aren't obviously favorable.
Posted by: anon at Dec 13, 2007 5:44:10 AM
It's a little like promising that all the funds from the state lottery will go to schools. The schools wind up with whatever the political agreement is, and the lottery funds just displace the allocation they would have gotten from general funds.
In particular, adding to the money supply this way just displaces the equivalent amount of government debt buyback in meeting the Fed's target.
What's different is the point of injection has to start as a bank, rather than being distrubuted throughout the economy.
Posted by: Ron Hardin at Dec 13, 2007 7:26:14 AM
I have put to Martin Wolf at FT for comment the view that the effect and probably the function of the process being established is to re-start the pricing of assets (auction method) in much the same way as done by the RTC during the Savings & Loan debacle.
This will be a "synthetic market" in that the buyers have no true "demand" for the assets to be purchased (collateral); nor do they have a "need" to deploy idle capital. But, it can initiate the pricing mechanisms.
Posted by: R. Richard Schweitzer at Dec 13, 2007 10:55:01 AM
Hugo, unfortunately I'm not the one to talk to about this issue. I highly recommend contacting Brad Hintz at Sanford Bernstein if you'd like more info. He's the former Treasurer of Morgan Stanley and the CFO of Lehman Brothers
Posted by: joe at Dec 13, 2007 11:45:37 AM
Full credit here goes to Brad Hintz. This is just a few paragraphs from a piece he put out the day before the TAF was announced.
The reason that funding tightens at calendar year-end is that as December 31 approaches, commercial banks begin to reduce their discretionary lending activities in order to "window dress" their balance sheets for year end. And as this large funding source disappears, the cost of funding over that short period near December 31 rises rapidly. For the fixed income divisions of the institutional brokerage firms, because their year end is November 301, this presents an earnings opportunity. The US brokerage firms increase their balance sheets and purchase assets that have been shed as part of this year-end window dressing by the commercial banks and provide funding at highly attractive rates2 through financing trades.
This bit of Wall Street trivia is important because the 2007 year end is going be much, MUCH more 'exciting' than normal because major commercial banks around the world, which have suffered losses in Q3 2007, are now in challenging capital positions. To shore up their Tier 1 capital ratios and to appear both liquid and financially strong when they print their 2007 year-end balance sheets, the only available solution is to reduce discretionary loans and shed assets prior to year end.
However, for brokerage firms, the funding and liquidity challenges of August have not been forgotten. Commercial paper issuers have reduced the tenure of their maturities and a significant portion of the brokers' balance sheets have become less liquid as conditions have worsened in the structured product and MBS marketplace. As such, it appears that the Street is attempting to remain very liquid at year end in the face of much more attentive rating agencies and very concerned counterparties. Morgan Stanley has publicly stated that it "is husbanding" liquidity. So this year, the major capital markets brokers appear to be passing on the opportunity to peak their balance sheet.
Posted by: joe at Dec 13, 2007 11:52:30 AM
I'd ask the same thing as this guy off Minyanville:
I'll tell ya, between the coordinated agendas, discount window collateral changes, invisible hands, superfund conduits, sub-prime bailout plans and now, the biggest act of international economic cooperation since the 9/11 terrorist attacks, you can't help but wonder what the heck the Fed sees that the markets, 5% off their highs, have yet to price in?
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