I haven't time to write properly, I am caught between a million things. But when I woke up to 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. So, when I step into the blogosphere to read comments like "solid first step", I feel compelled to spew some first impressions.

  1. If you think (as I believe most Fed policymakers do) that the goal of monetary policy in reacting to the current financial crisis is to make it go away, this plan is brilliant.

  2. Under traditional discount window borrowing, the best the Fed could do is offer funds at a "penalty" or "premium" and hope that banks borrow, despite a longstanding market perception that direct borrowing from the Fed is a sign of weakness. Now, the Fed has turned the tables. It will set precisely how much money it will lend ($40B just in the next cople of weeks!), and let banks bid on how much they are willing to pay for the use of that money. The scale of this program is immense. Typically direct borrowings from the Fed are under $1B. It was a big deal in August when in a clearly orchestrated and coordinated move, 4 big banks were persuaded to temporarily borrow $2B total, in an attempt to diminish the "stigma". This is the Federal Reserve saying, "No more pussyfooting around. You will borrow, and not $1 or $2 billion, but $40B, now!"

  3. I agree with several commentators (Felix Salmon, Calculated Risk) that the Bair/Paulson Plan, whatever it is, is not a bailout. But this, this is a bailout,. Nearly all government bailouts take the form of subsidized loans, extending credit at low rates to counterparties or against collateral for which the market would have demanded a high premium. That is precisely what the TAF will do. The Fed's press release claims, of course, that loans will only be available to "sound" banks, and that they will be "fully collateralized". But no one who can get the same deal from private markets will use this facility. The need for the program arises because private markets are skeptical about the soundness of counterparties and the quality of the assets they have to offer as collateral. The Fed hints at this when it mentions the "wide variety of collateral" that can be used to secure loans. You can bet that whatever it is private lenders are eschewing will be pledged as collateral to the Fed under TAF. The Fed is going to bear private risk that the market refuses to. That is a bailout.

  4. The rate at which funds are lent could turn out to be be an interesting number, but probably won't. This rate will be bounded within a narrow range. It can't go much lower than the expected Federal Funds rate over the term of the loan (there would otherwise be an arbitrage for very creditworthy banks — borrow TAF, lend Federal Funds). Presuming consistent standards for collateral and creditworthiness, it can't go higher than the ordinary discount rate (since banks would just go to the discount window directly rather than bid in an overpriced TAF program). In theory, the TAF rate could tell us something about the state of the credit markets. If it is close to the Federal Funds rate, it would mean that few parties are experiencing problems borrowing cash against their assets, while if the TAF rate were near the discount rate, that would signal credit market, um, turbulence. But interpretation of this number is going to be made complicated by the scale of monies being offered. To lend 40B cash fast, the Fed may well have to offer the money at near the Federal Funds rate, because the particpation of very creditworthy banks will be required to get rid of the dough. But less creditworthy banks will be participating as well, and, in a single-price auction, these banks will enjoy the low interest rates effectively set by large-bank bidding. So, it is likely that the TAF rate will be very close to the expected Federal Funds rate, but that noncreditworthy borrowers pledging iffy collateral will gain the capacity to borrow at that rate. The effective discount window "penalty" will drop to about zero, even though the formal discount premium will stay at 50 bps.

There's much more to say about all this. (Systemic implications? will it be effective against the crisis? what's the role and meaning of the "global coordination" aspect to all this? etc., etc.) I have a meeting. Very blogospherically, I'm going to hit send and go without even a proofread. Please forgive my enthusiasm, and any errors that might come with.

Update: Of great significance to the workings of the international financial system... I'm Steve! A couple of very fine bloggers have linked to this post, referring to me as Randy. [Both fixed now! Thanks!] I include my middle name in my punditizing to distinguish myself from a more famous Steve Waldman who most emphatically is not me! Also, my last name has just one 'n', and I should not be confused with the much smarter and better looking Robert Waldmann, who is blessed with two letters 'n'. Finally, I'd like to clarify a bit that my "enthusiasm" for the TAF plan, and my suggestion that it is "brilliant", should be understood in very narrow terms. From the perspective of policymakers whose goal is to put out a fire while minimizing changes the existing structure, I do think the TAF is a stroke of brilliance, although it may lead to some hard choices down the line (more later). But I want to emphasize, that perspective is not my own. I believe that capital markets and the global financial system are in quite urgent need of reform. I don't support palliative measures unless attached to credible reasons to believe that they will put us on a path to change, rather than extend a quite awful status quo. So I don't "like" the Term Auction Facility. But I do admire its cleverness.

Update 2: Note Felix Salmon's comments (with the help of Alea's jck) on discount window collateral.

Update History:
  • 12-Dec-2007, 6:32 p.m. EST: Added two "update" paragraphs, moved scare-quotes from discount window to penalty, where they belong.
  • 12-Dec-2007, 7:25 p.m. EST: I've messed around with some wording and misspellings in the updates.
  • 12-Dec-2007, 11:10 p.m. EST: Added "Both fixed now. Thanks!" to the first update. Also, added a missing "the", and replaced an extra "the" with a "to".
Steve Randy Waldman — Wednesday December 12, 2007 at 1:09pm permalink
jck (mail) (www):
Hi Steve, hope you are well.
"what's the role and meaning of the "global coordination" aspect to all this?"
US banks or SIVs aren't the only one in need of $ liquidity, hence the "global coordination" where foreign will have a bite at "TAF".I still think all of this as a lot to do with the new capital requirements which requires a capital charge for [unused] stanby facilities.
EU banks have been slashing counterparty lines like there is no tomorrow.We are far from subprime it's a sideshow at this point.Fed action doesn't address the problem.The ECB put $130 bn in the system in august, did that help? You know the answer.
12.12.2007 4:04pm
Steve Randy Waldman (mail) (www):
jck -- Good points. I've been reading your posts on credit line scarcity and Basel II feedback effects with great interest.

I hadn't given much thought to the difficulties associated with getting dollar liquidity "injected" into to non-US financial systems, and I'm still having a hard time thinking it through (on the one hand, foreign CBs can't just print dollars and buying them with domestic currency might increase dollar scarcity and domestic inflation, on the other hand a desire for dollars to lend would be a great excuse for CBs to fight dollar depreciation without appearing to be explicitly targeting the currency). The swap arrangements announced today clearly make it easy for FCBs to lend dollars without expanding the domestic money supply or rattling FX markets. It does introduce some extra FX risk to CB balance sheets, but that's probably marginal.

I'm not sure I'll have much great insight on the international dimension of today's announcement, but I suspect that you will. I look forward to reading more.
12.12.2007 6:13pm
Mark Thoma (mail) (www):

Apologies - I fixed the name. I'm not sure where I got confused as I know better.

12.12.2007 7:00pm
Measure for Measure (mail):
One obvious alternative would be to go back to the (recent) days when the discount rate was set below the Fed Funds rate.

In those circumstances, there's little stigma in borrowing at the discount window, at least for a day.
12.13.2007 5:28pm
Robert Waldmann (mail) (www):
Thanks for the link. However, I am not better looking than you are. The photo on my site is not ugly because it was taken by a brillianto photographer. I really look like a mud skipper
12.14.2007 4:18am
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