Wednesday, March 19, 2008

The Fed crosses into new territory

The Fed broke new ground this week in trying to avert a financial collapse. First, it took direct exposure to Bear Stearns' assets worth $30 bn- people would be justified in viewing this as quasi-nationalisation.

Secondly, it created two new faciliies allowing it to act as lender of last resort to non-bank financial institutions- in this instance, primary dealers. John Berry of Bloomberg describes these:

Aside from helping in the sale of Bear Stearns, the extraordinary actions the Fed took included creation of a term securities lending facility on March 11 and a primary dealer credit facility on March 16.

Both involved the group of 19 securities dealers known as primary dealers — companies that have qualified to participate as counterparts in the New York Federal Reserve Bank’s daily open market operations used to keep the federal funds rate close to the FOMC’s chosen target. Bear Stearns was on the list until its abrupt sale.

Under the first facility, the dealers will bid at weekly auctions beginning March 27 to obtain 28-day loans of Treasury securities in exchange for certain other collateral such as mortgage-backed securities insured by Fannie Mae and Freddie Mac. There will be separate auctions for exchange of Treasuries for AAA/Aaa-rated private label mortgage-backed securities that are not on review for downgrade.

The point is to take some of the pressure off the stressed mortgage-backed securities market. The other facility began yesterday to give primary dealers access to overnight credit from the Fed in exchange for collateral such as mortgage-backed securities, municipal securities and investment grade corporate securities. Normally, only financial institutions can borrow directly from the Fed.

No comments: