Fed Weighs Increasing Term Auction Facility Yet Again

When the Fed’s innovation, the Term Auction Facility, which is in effect an improved discount window, was implemented last December, its size was $40 billion, which was considered extraordinary, a sign of how desperation conditions in the money markets were. Now that several increased put the facility is $100 billion, the banking community and the press treat the idea that it might need to be enlarged yet again as something comparatively routine, rather than a sign that banks are still under serious stress despite concerted measures by central banks,

Yet again, the Fed is acting out the cliche, “if all you have is a hammer, every problem looks like a nail.” Central banks know how to deal with liquidity crises; the TAF and its other facilities are well suited for that sort of problem. But fundamentally, the financial services industry is suffering from a solvency problem. Too many of the assets on its balance sheets contain loans to borrowers who lack the ability (and in some cases the desire) to make good on their debts. Forcing interest rates into negative real interest rate territory will only help a portion of the underwater borrowers. In addition, a distortion this severe is almost guaranteed to produce more misallocation of capital, which is not good for the US in the long term. And if the Fed miraculously manages to keep asset values from falling further, it is merely delaying the day of reckoning, and Japan is the poster child of the results of such a Phyrric victory.

From Bloomberg:

Federal Reserve Chairman Ben S. Bernanke may need to step up his effort to unfreeze bank funding markets as a surge in borrowing costs blunts the impact of the cash auctions the central bank introduced in December.

The cost of obtaining funds for three months has risen by 0.33 percentage point since the Federal Open Market Committee’s last meeting on March 18. The jump may force homeowners with variable-rate mortgages and some companies to pay more on their loans at a time when economic growth is faltering…..

“There’s clearly a need for the Fed to do more,” said Charles Lieberman, a former New York Fed economist who’s now chief investment officer of Advisors Capital Management LLC in Paramus, New Jersey. “The underlying problem” is that banks and other investors are “still nervous” about lending to each other, he said…..

Investors’ focus may instead shift to the Fed’s attempt to stem the surge in bank funding costs that began in August, when the subprime-mortgage market’s collapse spurred concern about losses at financial firms.

The three-month London Interbank Offered Rate for dollars has climbed to 2.87 percent from 2.54 percent on March 18.

Increases in Libor and other rates are “a pretty clear indication that liquidity remains an issue or that term liquidity remains scarce,” said Dean Maki, chief U.S. economist at Barclays in New York and a former Fed researcher. “The Fed’s made pretty clear they’re going to continue to attack those problems as needed.”

The TAF is one of several Fed initiatives to unblock credit markets, along with direct loans to investment banks and $29 billion of financing to secure JPMorgan Chase & Co.’s takeover of Bear Stearns Cos. Investors have responded, buying a record $45.3 billion of corporate bonds last week and spurring an 11 percent rally in the Standard & Poor’s 500 stock index from the year’s low last month…

Another gauge of bank funding costs, the premium on Libor over the overnight indexed swap rate, a measure of what traders expect for the Fed’s benchmark rate, reached 87 basis points on April 21. That was the highest since the Fed announced the TAF on Dec. 12.

Bigger TAF operations would probably slow or reverse the increase in borrowing costs, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. …

Fed Governor Kevin Warsh, San Francisco Fed President Janet Yellen and three other district-bank presidents voiced concerns about rising prices this month.

“Federal Reserve officials view themselves as about done with policy easing,” said Vincent Reinhart, who was the Fed’s chief monetary-policy strategist from 2001 until September 2007. “They probably want to signal that the easing cycle is over, at least for a while.”

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  1. Anonymous

    Just get dollars and save yourself, these asshats are going to bring this whole country to it’s knees trying to bail out these insolvent banks.

  2. Richard Kline

    The Fed is keeping much of the commercial banking industry in the US alive via the life-support of the TAF. Not only are they rolling over the first $40B every 28 days, thay look to be more than doubling that. We will soon be hearing, I expect, that the term period will be lengthened to three months or even a year, as in UK; the Fed can choose any duration it wants at this point.

    This policy isn’t entirely crackbrained, sorta-kinda. If I were to hazard a guess, the idea behind papering over a commercial-side solvency crisis in this way is to put a floor under the debt and inter-bank credit markets while the equity value of the commercials falls to attractive levels. Once the substantial private capital we all know is sitting on the sidelines at present [not quite, it’s sitting in RMB bearing deposits more like] sees that the Fed has and will keep the commercials from going under in formal terms, the notion is that this private money will buy up cheap equity in the life-supported commercials and gradually recapitalize them ‘privately,’ over the next six-twelve months to kick around a number.

    This is a desperate undertaking, but in the circumstances what are the options? Nationalization would be better and cleaner, to me, but the Fed does not currently have the authority, and it is not conceivable that they will get that authority out of the doofus last dayz of the Dubya II Administration, to say nothing of the present do-nothing, good-for-nothing Congress (to dust off an applicable and time tested phrase). If, and I say if, there is no major financial down cycle in the US over the next six months, this desperate expedient may have a chance to succeed: wait out private capital until they see that the worst is over and the price is right to buy big banks chunk by hunk on the cheap. I very much doubt that this scenario for the next six months applies as we have yet to see the full impact of any asset class depreciation except subprime re enter the financial system fully (even LBO loans aren’t being written down/off to the same level of the problem), nor have consumer spending and unemployment decline pressures been priced into _anything_. We aren’t going to get a hard landing to me, we’re going to get a third story fall if we’re lucky. So the Fed’s second-story climb-down scenario does not seem the likely one.

    I’m not going to call the Fed-Treasury crazy for what they are doing. But I rather wish they were doing something else. Sitting in a stinking pool with ones fingers in ones ears is not a mid-term policy, let alone a long-term one. [Yeah, that’s a mixed metaphor, but hey one does what one can when opining in real time. : ) ]

  3. tmjfsn

    It just dawned on me that the reason the banks won’t lend to each other is because they take a look at their own books say “Oh God, if they’re in the same shape as us…”

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