28 Days Later

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.

Update History:
  • 11-Mar-2008, 1:30 p.m. EST: Added update re Yves Smith and Barry Ritholz comments on collateral quality.

15 Responses to “28 Days Later”

  1. Brian W writes:

    It seems that the long term result of this is that 1) there will be non-payment of borrowed equity and 2) taxpayers ultimately will end up with the bill and 3) this is no better than the current mess with multi-leveraged instruments, except for the ultimate (tax)payer can feel the pain quicker!

    Let me get this straight: You have a financial industry that has painted itself into a corner, leveraging so far that there is no hope of them working their own way out.

    Financial houses are drowning in bad debt, so you add even more pool more water (ie credit)to the financial pool, because they (the financial industry) are soooo good at using that same water to fix their own problems? Hmmm….

  2. Rob S writes:


    Given your statmenet re: TSLF as an inefficient cash infusion, what I’m not clear on is its ultimate impact on the money supply. Does this mechanism just have built in sterilization (unlike the TAF with that separate announcement redeeming cash) and that’s why the Fed introduced this? If not, it’s hard to escape the conclusion that this is the next round of the Big Risk Shift to the public.

  3. jh writes:

    “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.”

    I think this is the key to the debt/equity question in the case of both TAF and TSLF.

    Both programs are sterilized (TAF via sales of treasuries; TSLF via lending of treasuries), so there is no effect on the monetary base, or on broader money supply.

    Both programs effectively increase the size of government credit funded by the private sector, and reduce the size of private credit funded by the private sector. In each case, part of the monetary base (government credit) is used to fund private credit (collateral) rather than public credit (treasuries).

    In both programs, government credit (treasuries) previously funded by other government credit (monetary base) is now funded by the private sector, so there is a net increase in the float of government credit funded by the private sector. There is a corresponding net increase in the float of private credit funded by the public sector.

    The systemic monetary effect for both programs is really the same. While money is supplied by TAF, it is withdrawn by the sterilization sale of treasuries. The banking system ends up with the same total balances at the Fed. The distribution of balances among banks at that point is just different. Treasuries are supplied by the TSLF. This affects neither the level nor the distribution of balances among banks.

    In that sense, neither program is a net cash infusion for the private sector. Both programs reduce credit risk for the private sector because part of the monetary base is used to intermediate an equivalent amount of private sector credit. The TAF changes the distribution of bank reserves but not the total amount; the TSLF changes neither.

  4. eh writes:

    While it may be true that some of the ABX indices are or can be misleading, I think it is fair to say that the securities that may now be used as collateral are “illiquid” for a reason, i.e. reasonable risk aversion. And I’m wondering: What will happen when these decline in value? Does the Fed do margin calls? Will they be willing to force an ‘event’, or insolvency, on some borrower when this is what TSLF has been designed to (at least) delay?

  5. ponzi writes:

    I crap in a bucket and try to sell it. Amazingly nobody wants to buy it. I need some money fast and somebody is willing to lend me boatloads of money using the bucket of crap as collateral (it *is* worth something after all I guess). The interest rate of the loan is lower than the going rate. The lender is willing to do this over and over again. Is the lender here losing out?

    Who is losing out when the Fed does what it did today? Nobody? Tax payers?

    Ponzi Q. Globalization

  6. PD Quig writes:


    The losers were those of us short this ‘market.’ Anybody convinced it’s time to go long?

    That’s what I thought.

  7. In 1942 New York City instituted rent control as a temporary wartime measure. It’s still has it. Temporary? As the Mogambu Guru would say, “Hahahahaha”.

  8. Great comments, and more questions than answers.

    A few points regarding the effects of TAF/TSLF on the quantity and distribution of reserves. We know only from Fed practice that TAF is a “sterilized” intervention. The Fed might have chosen, and might in the future choose, to auction funds via TAF without countervailing open-market operations. So far, TAF has been pretty much sterilized. As such, it has not affected the total availability of reserves, but, as jh says, it has affected their distribution, as banks long illiquid securities and short reserves got relief. Effectively, reserve-rich banks are lending to reserve-poor banks with the Fed serving as an intermediary and assuming the credit risk.

    TSLF is sterilized intervention by construction. No extra action is required by the Fed to keep the monetary base constant. However, it does affect the distribution of cash between firms, in the same way that TAF does, although an extra step is required. Firms that are cash-poor and long iffy securities are lent Treasuries that they then post as collateral to raise cash. Just like TAF, TSLF is a means of facilitating lending between private-sector firms by having the Fed assume the credit risk. It’s just structured slightly differently, and covers primary brokers rather than depository institutions.

  9. tom a taxpayer writes:

    Let me try to clear up the confusion about this pea called TSLF. You see on the table before me are three shells. I take the TSLF pea and place under the shell on my left (your right).

    I place my left hand on the left shell (your right), and my right hand on the right shell (your left).

    I switch the left shell with the right shell. Keep track of where the pea is (it’s worth $200 billion).

    Now, I switch the left shell with the middle shell (your middle). Then I switch the middle shell with the right shell (your left).

    Now I switch the left and right shell, then move the right shell between the left and middle shell, then move the middle to the left, and the right between the left and middle, then move the middle to the far left, and then switch the right and left shells.

    Now under which shell is the $200 billion TSLF pea?

    I turn over the left shell. No $200 billion TSLF pea.

    I turn over the right shell. No $200 billion TSLF pea.

    I turn over the middle shell. No $200 billion TSLF pea.

    I hope this clears up the confusion about the TSLF.

  10. EUROLANDER writes:

    Thanks to Steve and JH (= afsb?) for their enlightening comments. Many analists talk about these injections of funds from the CBs but few seem to understant them as you do. From them I gather that the Fed is acting as a lender of last resort, but lending treasuries instead of cash (reserves), and accepting “first-class” MBS as collateral. If these collateral proves good, they will reverse the move in the future. If not, they will be faced with two options: issue a margin call, which may lead to a default, or look the other way round. and keep rolling the loan over. If they do the latter, they still may get away with it if the loan taker is able to pay the interests on the loan. If they fail, the Fed will end up with collateral of little value, and it will be the Treasury (= the taxpayers) who will pay the ultimate price, since the Fed gives the most part of their profits back to the Treasury.

    We can therefore conclude that both the government and the Fed will have a keen interest in not letting these financial institutions fail. They have also the means: inflation. Through inflation the burden of the losses will be switched from the government to the dollar-denominated-assets holders, many of them foreigners. So what will they do?

  11. afsb writes:

    From Stephen Hawking’s 1988 book A Brief History of Time:

    “A well-known scientist (some say it was Bertrand Russell) once gave a public lecture on astronomy. He described how the earth orbits around the sun and how the sun, in turn, orbits around the center of a vast collection of stars called our galaxy. At the end of the lecture, a little old lady at the back of the room got up and said: “What you have told us is rubbish. The world is really a flat plate supported on the back of a giant tortoise.” The scientist gave a superior smile before replying, “What is the tortoise standing on?” “You’re very clever, young man, very clever,” said the old lady. “But it’s turtles all the way down!”

    And it’s balance sheets all the way down :)

    (afsb and JH)

  12. Henry writes:

    Consider the Fed as an asset/”liability” balance sheet.

    In this pursuit, I end up asking the question: “WHICH is the Special Purpose Vehicle, the Treasury, or the Fed?”

    Which one is expendable, disposable, to be sent off with whatever debt burdens the new econ system wants to shed?

    #1 clue derives from “WHO holds the gold?”

    IF the gold is there in Ft. Knox (or West Point), it officially belongs to the Fed, via certificates for the physical storage in Treasury facilities. This confusing arrangement, of course, leaves room for much fiddling, doesn’t it? Certificates can be conveniently canceled, but, I’m guessing, won’t be. 1933 was about something, and we’ll find out, soon enough.

    BUT — that “$11 Billion” of gold (at $42, right?) on the Fed asset side is now worth about $250 billion. AND, the Fed gains (or is balanced out favorably, at least) every time its other actions devalue the Treasuries it holds vs. gold.

    The Fed has one special advantage over other asset/liability institutions. Its “liabilities” — FRNs, 800 billion of them — cannot be turned in for its assets. DAMN! How do I get a deal like that?

    So — if the Treasury goes down in deficit flames, the Fed can flush its losses on Treasury debt along with its own funny green papers, and call it a wash. Yeah, right. Most of the J6Ps would be none the wiser.

    But, does it still have an Ace in the Hole? Yes, (current value) about 250 billion of ’em, enough to start over another banking system, on whatever terms of reality/illusion the public demands, to get ’em het up into trusting a “banking” system again. (Put the gold “on display” in the bank windows, as the 1800s banks did. Amazing, to my view, how USAmericans could get fooled, and re-fooled, about every 10 years, by another round of reserveless banking.)

    In other words, right now, they are offering no more Reality than people demand of banking.

    At the collapse of one Wonderland banking regime, they’ll put fingers in the wind, and see just how solid the next one needs to be. And then they’ll stretch the gold leaf over whatever canvas they decide to paint the new system onto…

  13. groucho writes:

    #1 clue derives from “WHO holds the gold?”

    Today’s “gold” is(and has been) energy since Nixon defaulted on the BW1 system. The 70’s saw the emergence of BW2 with oil being the true reserve value.

    The US was able to tie the dollar to oil through the quid pro quo with the Saudis. The dollars value was tied into oil through a formula of price plus % of surplus recycled through western MCBs.

    The Iraq war is about continuing that game for as long as possible. Unfortunately, Asia decided to give up on communism. Now we are moving into RESOURCE WARS. If the US is smart, it will put together a “manhattan solar energy plan”; and try and get in front of this conflict.

    Let’s see what happens after the election. Maybe we’ll get lucky and someone with half a brain will get in.

  14. Steve:

    The addition of a bunch of new drive-up windows at the Fed today,March 13, 2008, with bright red neon “WNL-YNS” (We no look-You no say)signs blinking on and off, has decreased the long TAF lines. In case you’re planning to make a run for the drive-up windows this afternoon let me first warn you that the Fed hasn’t had time to print up application forms. So take a sheet of 81/2 x 11 paper, cut it in half length wise, and put in the following information: Company name and address, the amount you want in either cash, or AAA Treasuries, and the amount of “securities” you’re delivering (your call on this number), and whatever you do, don’t sign or date the bottom line until you’re in front of the teller. So you drive up, hand your application to the teller, he/she says “Sign and date”, you do so while also handing over your bundles of “securities”, and he/she hands you the amount you’ve requested while he/she throws your bundles into a big old dusty cardboard box on the floor, unexamined. I will also caution you that you will see a lot of smoke, and will smell a lot of burning rubber as you approach your WNL-YNS window. Don’t be alarmed. This is only the residue left behind as those in front of you have exited their windows in their AAA Unlimited Top Fuel Dragsters. I suggest you might consider trading in your Prius for the same on your way over. Who knows when the Fed might change their mind, and lock the exit gates?

    Best of luck and Best regards,


  15. Michael writes:

    Does anyone know who Steve Randy Waldman IS? I’m trying to figure out what he does besides blogging and running the amazingly non-transparent mchange.com and associated consulting stuff. Thoughts? Background? Context on his writing?