Wednesday, July 30, 2008

Expansion of the Feds Emergency Liquidity

The basic premise of the TAF (Term Auction Facility) has been discussed here before, where the Federal Reserve Bank issues short term bonds to banks at low interest rates, which they use to back higher interest loans or investments—all in a borrow-low and lend-high carry trade principle. Two other related programs have been the PDCF (Primary Dealer Credit Facility) and the TSLF (Term Securities Lending Facility) for investment banks.

TAFs began in September 2007 with the onset of the credit freeze, and had expanded steadily to $75 billion by March, and now recently have expanded by another $25 billion with 84-day cycles. TSLFs were made available on March 11, 2008 after the fall of Bear Stearns, which offers $200 billion of liquidity; they are available to "primary dealers," are offered weekly, and have a 28-day maturity, where treasury securities are borrowed with mortgage-backed securities as collateral. Like TSLFs, PDCFs are available to primary dealers, but have overnight terms, with outstanding loans in the $15-30 billion dollar range.

A "primary dealer" is an investment bank with access to the Fed's discount window; the link has the list of them. Bottom line, banks and investment banks have expansive lines of credit through the Federal Reserve Bank.

The news today is the expansion of TAFs by another $25 Billion, and the extension of TSLFs and PDCFs from mid-September 2008 to January 2009.

With these emergency lending systems enacted by the Fed, the U.S. taxpayer accepts the risk when banks default on their capital base due to the origination of bad loans. By my math, the amount at stake is somewhere between $300-400 billion, with seemingly little resistance by the Fed to expand this amount as is convenient.

Speaking of which, the other major financial event is the bailout of the GSEs and troubled mortgages, now tied together in the same bill and moving briskly through the house and senate. Material details will be reported once it gets to the White House and is signed in to law, which could be any day now.

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