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Term Auction Facility Increased to $900 Billion, With No Apparent Success

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The increase in the size of the Term Auction Facility, from $150 billion a month ($75 billion per two 28 day auction) as of its last auction to $900 billion today (with an interim plan to go to $450 billion that was blown past in this announcement) is an admission that the banking system is not functioning. The size of the TAF, a single facility, now exceeds that of the Fed’s entire recent balance sheet size.

As we noted in previous posts, these liquidity measures have become counterproductive. Citing FT Alphaville:

Liquidity is being thrown at the system, but it’s just making things worse.

By pumping in more money central banks aren’t addressing the fundamental concerns of the banks at all. Going cold turkey is a very unpleasant thing, but the solution isn’t more drugs, even if they alleviate short term pain.

In assuming they can rely on central bank money market operations – which will be expanded (as is the case) when the going gets tough – banks are naturally avoiding lending to each other.:

Persisting in a failed course of action is a sign of desperation.
From Bloomberg:

The Federal Reserve will double its auctions of cash to banks to as much as $900 billion and is considering further steps to unfreeze short-term lending markets as the credit crunch deepens.

“The Federal Reserve stands ready to take additional measures as necessary to foster liquid money-market conditions,” the central bank said in a statement released in Washington today. Fed and Treasury officials are “consulting with market participants on ways to provide additional support for term unsecured funding markets,” the statement said.

Today’s steps follow a hoarding of cash by banks that sent the premium on the three-month London interbank offered rate over the Fed’s benchmark interest rate to a record. Industrial companies are also finding it harder to raise cash after the market for commercial paper shrank to a three-year low as investors flee even borrowers with few links to mortgages.

“It is pretty much all out war,” said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd., New York. “They are pulling out all the stops to try and get borrowers and lenders to meet and do transactions once again.”

Implementing part of last week’s emergency legislation to shore up the financial industry, the Fed said today it will begin paying interest on the cash reserves banks hold at the central bank. The step should give Fed officials greater power to inject cash into banks without interfering with their benchmark interest rate, which stands at 2 percent.

Fed Chairman Ben S. Bernanke’s speech on the economic outlook tomorrow in Washington should give an indication of whether U.S. central bankers are prepared to cut the main rate before the next meeting Oct. 28-29, Rupkey said.

As part of today’s steps, the Fed will increase its auctions under the 28-day and 84-day Term Auction Facility operations to $150 billion each. The two forward TAF auctions in November will be increased to $150 billion each, the Fed said.

Note that the 84 day auction is a new feature, presumably created when the TAF went to $450 billion as of late September (although no auctions were conducted at that level; the first auction was today). Also, I am surprised at the Fed using 84 day auctions. Its statutory authority limited it to extending 28 day loans. Was a new provision slipped into the 451 page bailout bill?

The article also mentioned the Fed’s new authority, granted with the rescue bill, to pay interest on bank reserves.

John Jansen tells us that, per our comment at the top, that central bank liquidity measures had become counterproductive, the efforts to increase liquidity are not thawing out the money markets:

The money markets have frozen solid again. My favorite correspondent on that market reports that participants are following the advice of Polonius and are refraining from borrowing or lending. The Federal Reserve announcement earlier today of a gigantic increase in the size of the TAF program has not broken the logjam or sweetened the mood.The gentleman with whom I speak on this topic suggests that if we have a few more days of this inactivity and illiquidity, then the direness of the situation will leave the Fed will it will be force to guarantee Libor deposits and commercial paper.

He also remarks that we are at the point of self fulfilling prophecy. On that point he references the S and P downgrade of Royal Bank Scotland this morning.

This makes perfect sense, In the 1930s, it was the withdrawal of deposits by understandably frightened customers, spooked by bank failures, that neutered the Fed’s efforts to increase money supply by expanding the monetary base. Banks in the US (and any country running a significant current account deficit) are dependent on wholesale market funds, and that has frozen with the fear of bank failures. Just as the Fed was unable to reflate until 1934, after the FDIC was created in 1933, so to it make take a guarantee of Libor and commercial paper to get liquidity moving.

But will such a guarantee be credible? Those markets are large relative to GDP, but the answer, at least for commericial paper, is yes due to its historically low default rate. Commercial paper outstandings as of last week were $1.6 trillion, versus a US GDP of $14 trillion. However, pre Lehman, there were remarkably few commercial paper defaults, fewer than 10 in the last decade. Guaranteeing CP on an interim basis (a year?) would have been a far more direct way to go about this than throwing more money at the TAF

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23 comments

  1. BuzzP

    The Treasury – Sept is normally a flat month (no significant increase/decrease in Treas debt) – this Sept the increase was ~$380B plus another ~$123B Wed & Thurs last week since end of Sept (Fri figures released later today) – that gives Fed ~$500B

  2. BuzzP

    add’l info – and all in two weeks

    09/17/08 debt – $ 9,647B
    10/02/08 debt – $10,149B

    that’s the ~$500B I mentioned

  3. Max

    buzzp, thanks. Stupid me, I forgot that the blackhole that is our federal budget provides an unlimited source of “safe and sound” AAA securities for the Fed’s “balance sheet”.

    Does this strike anyone as absurd? It does me.

  4. buzzp

    Yves – as for the 84-day auctions, Treasury has been using “Cash Management Bills” to raise funds – many are longer than 28-day

    9/18 – 76-day
    9/19 – 45-day
    9/19 – 59-day (that’s 2 terms in 1 day)
    9/25 – 34-day
    9/26 – 101-day
    etc

    It seems that Paulson approved his plan before Congress voted….

  5. Anonymous

    Twenty years ago, printing that much money would have proven a bit difficult.

    But nowadays, we have computers and can make any imaginary number into “real” money! Wheeeeeee

  6. Anonymous

    This is reality friends.

    1. The Bush Cheney crimes in office have been so numerous, they will never allow elections to held.

    2. Martial law will be declared and all media silence.

    3. A private army of soldiers will be created by Paulson to enslave the masses.

    This is not fantasy. Welcome to Bush-World forever.

  7. Anonymous

    With no consumer spending and more like consumer withdrawal, no support is in place for a bottom and the spiral downward accelerates.

    Can anyone quote the LIBOR?

  8. S

    Yves,

    FDR was able to reflate by devaluing the dollar. Here we have the exact opposite occuring. The dollar is strengthening. it would makes sense to try and innoculate the foreign central banks from losses suck domestic capital in and then devalue the dollar. Good for everyone but savers seeing we have next to none. bernanke doesn’t seem to get that by leaning into the wind he thinks he can artifically increase asset prices. One has to wonder when it is time to short the dollar against anything viable. The only problem right now is there isn;t anything. Why then isn;t gold in the thousands?
    __________________________________
    By late 1923, the German government required 1,783 printing presses, running around the clock, to print money.

    Germans wheeled shopping carts filled with literally trillions of marks to pay for a single loaf of bread. Employees asked to be paid their wages each morning so that they could shop at noon before merchants posted the afternoon price rises.

    The New York Times ran a story on October 30, 1923, datelined Berlin, which told the tale of an American who went into a restaurant and handed the waiter a dollar, asking for “all the food an American dollar will buy.” The waiter recovered from his astonishment and began to serve the guest.

    “Soup, several meat dishes, fruit and coffee were served. While the guest was smoking his cigar the waiter brought another plate of soup, and later another meat dish.

    ” ‘What does this mean?’” the astonished and satisfied guest asked.

    “The waiter bowed politely and replied: ‘The dollar has gone up again.’”
    Source: Gordon Craig, “Germany 1866-1945″]

  9. S

    The US is trying to hold the rest of the world hostage via the dollar. The US is faced with one outcome: loss of dollar hegemony. How they game whether or not to go nuclear seems the question?

  10. Anonymous

    “Also, I am surprised at the Fed using 84 day auctions. Its statutory authority limited it to extending 28 day loans’
    Whether legal or not has that stopped this crew.

  11. Anonymous

    The Federal Reserve’s first fifteen years were a period of relative prosperity, but the crash of 1929 ushered in a decade of global financial instability and economic depression. Subsequent scholarship, notably the classic monetary history by Milton Friedman and Anna J. Schwartz (1963), argued that the Federal Reserve’s failure to stabilize the money supply was an important cause of the Great Depression. That view today commands considerable support among economists, although I note that the sources of the Federal Reserve’s policy errors during the Depression went much deeper than a failure to understand the role of money in the economy or the lack of reliable monetary statistics. Policymakers of the 1930s observed the correlates of the monetary contraction, such as deflation and bank failures. However, they questioned not only their own capacity to reverse those developments but also the desirability of doing so. Their hesitancy to act reflected the prevailing view that some purging of the excesses of the 1920s, painful though it might be, was both necessary and inevitable.

    Remarks by Chairman Ben S. Bernanke
    At the Fourth ECB Central Banking Conference, Frankfurt, Germany
    November 10, 2006

    Thanks Ben

  12. ubetchaiam

    “It seems that Paulson approved his plan before Congress voted….”; Yves can you elaborate in a column about this please?

  13. doc holiday

    Long Term Capital Management, founded in 1994, was a hedge fund that remarkably generated 40% annual returns in its first 2 years. Its hubris soon grew to epic proportions – Taleb compares LTCM’s strategies to “picking up pennies in front of a steamroller”. They generated many small gains balanced against the unlikely chance of a large loss. In 1998, the steamroller won:

    “During the summer of 1998, a combination of large events, triggered by a Russian financial crisis, took place that lay outside [LTCM’s} models. It was a Black Swan. LTCM went bust and almost took down the entire financial system with it, as the exposures were massive. Since their models ruled out the possibility of large deviations, they allowed themselves to take a monstrous amount of risk.”

  14. Midwest Product

    09/17/08 debt – $ 9,647B
    10/02/08 debt – $10,149B

    Friday’s debt numbers have been released:
    10/03/08 debt – $10,186B

    Throw another $37B on the pile.

  15. Francois

    If guaranteeing LIBOR/CP would be a better solution to unfreeze the credit markets, the question is:
    Would BB have the kahunas to turn off the TAF spigot while moving to a CP guarantee?

    Is it even doable at this point?

  16. SlimCarlos

    >> the direness of the situation will leave the Fed will it will be force to guarantee Libor deposits and commercial paper.

    This is a great idea. It will be abused, but with one stroke things would start moving again.

  17. joe

    Above at 2;31,

    s said:

    “”By late 1923, the German government required 1,783 printing presses, running around the clock, to print money.”"

    I could be wrong, but it has always been my understanding that both the bank and the printing presses were privately owned, and thus had nothing to do with the government doing anything, except, like today, letting it happen.

  18. Don

    Guaranteeing Libor & CP would be continuation of the same, would it not, except with the added twist that life support is extended to corporations.

    Add to that the extended guarantees for money market funds and bank deposits up to $250,000, isn't it not the case that the gamble is all the greater that our generous global benefactors remain generous?

  19. wintermute

    The moment has already passed when the Fed could guarantee commercial paper and expect only small losses. The 10 failures in 10 years occurred during benign market conditions riding the infamous Greenspan bubble.

    The economic downturn will crater many unsafe corporations, such as GM, with huge commercial paper losses. Additionally whole cities and states are going to require federal bailouts now…

Comments are closed.