When the TAF program was first announced, it was billed as a temporary facility. The announcement was in December, and some suggested it was intended to help banks meet end-of-year balance sheet needs. Four auctions were announced, two auctions of 20B in December, and two January auctions for an amounts that has not yet determined. An important question at the time was what would happen 28 days later, when loans made via two December auctions expired. Would the amounts of the January auctions be the same as the December auctions, effectively rolling over the TAF loans (not necessarily to individual borrowers, but to the consolidated banking system)? Would the January loans be smaller, indicating a gradual phase-out consistent the temporary nature of the program? Or would the loans be expanded, suggesting an ongoing intervention of indeterminate scale? Since then, the size of the program has more than doubled, and the Fed has announced explicitly that it intends to continue the program "for as long as necessary to address elevated pressures in short-term funding markets".
In the past few days, the Fed has announced two new programs, and again, we are left to wonder what happens 28 days later. This weekend, I argued that since the Fed cannot retire loans made via TAF and its repo program without adding to those "elevated pressures", the loans should be considered an equity infusion, because they'll be repaid at the convenience of the borrower rather than on a schedule agreed with the lender. Does the same argument apply to the new Term Securities Lending Facility (TSLF)? On face, it's harder to view TSLF as an equity infusion, since the Fed is giving no one any cash. (In fact, the Fed will withdraw some cash as interest.). Eyes unprotected by green shades will glaze over at descriptions of a kind of asset swap, where some obscure assets are "pledged" to the Fed while other boring securities are lent to firms.
But to firms holding illiquid securities that the Fed is accepting as collateral, the program is equivalent to a not-so-efficient cash infusion, because the Treasuries the Fed is lending are liquid and can be converted to cash easily in private markets. From a cash-strapped firm's perspective, borrowing a treasury, then borrowing cash against that Treasury in ordinary repo markets, is equivalent to borrowing cash directly from the Fed, except that there'll be an extra middleman to pay. So, this new facility might well be a form of equity, if the Fed is willing to roll it over indefinitely and require payment only at the convenience of borrowers. We'll have to wait and see what happens, 28 days later.
As a sidenote on the debt vs equity question, Yves Smith points out that S&P and Moody's have not cut the AAA ratings of many securities that no longer meet their usual guidelines for that rating. TSLF specifically allows the pledging of "non-agency AAA/Aaa-rated private-label residential MBS" as collateral. (Only Treasuries, agencies, and agency MBS can be pledged for the Fed's repo program. Non AAA debt can be accepted as TAF collateral, at the discretion of the Fed and at reduced valuations. Fed discount window guidelines apply.) To the extent Fed loans (in cash or securities) are genuinely overcollateralized, they are more "debt-like", as equity is "risk capital" and the Fed bears little risk of nonrepayment. To the extent that the true value of the collateral is less than the value of the loans, either initially or due to decay over time without new collateral being posted, the facilities appear more like equity.
Update: Yves Smith and Barry Ritholtz both question the quality of TSLF collateral. Barry Ritholtz also tries to quantify the proportion of AAA MBS whose ratings might be questionable, but his analysis is based on the ABX indices, which jck at Alea warns us may not be a fair sample.
- 11-Mar-2008, 1:30 p.m. EST: Added update re Yves Smith and Barry Ritholz comments on collateral quality.
|Steve Randy Waldman — Tuesday March 11, 2008 at 12:50pm||permalink|