U.S. Federal Reserve Chairman Ben Bernanke said Tuesday the world's most powerful central bank may extend securities dealers' access to direct loans from the Fed into 2009 as long as emergency conditions "continue to prevail."
Bernanke, speaking Tuesday in Arlington, Virginia, at the FDIC Forum on Mortgage Lending for Low/Moderate Income Households, said "the Federal Reserve is strongly committed" to financial stability and is "considering several options, including extending the duration of our facilities for primary dealers beyond year-end."
Further, Bernanke also said the Fed would "take a leading role" in any liquidation process for a failing investment bank.
The Fed, and other U.S. Government institutions, as well as other major central banks, are in the midst of dealing with the aftereffects of the end of the housing boom in the U.S., which led to a surge in mortgage foreclosures and related asset-back defaults.
Bloomberg News reports that the Fed is increasing its so-called Term Auction Facility (TAF) by 50% to $75 billion. The reason? The program, which makes emergency loans to banks saddled with asset-backed securities (ABS) such as collateralized debt obligations (CDOs), is busted. That's because the TAF is designed to lower borrowing costs but it has accomplished the opposite.
This comes in response to criticism from a Stanford University economist, John Taylor, who wrote in a study last month that there is "no empirical evidence" the TAF has reduced the premium that banks charge each other to lend cash for three months. In fact, last month's TAF auctions were 2.82% and 2.87% -- above the then-2.5% rate on direct loans through the Fed's discount window. This "seeming anomaly" of the higher rate may have resulted from banks' willingness to pay a premium to avoid the stigma of borrowing from the Fed's discount-window.
This means that despite all the happy talk on Wall Street, we are not out of the woods by any stretch of the imagination. As I pointed out here, investment banks and hedge funds borrow $32 for every dollar of capital. If they owned just those dodgy securities, a mere 6% drop in the $6.1 trillion market for CDOs would wipe out their $340 billion worth of capital.
The U.S. Federal Reserve Friday announced an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, starting with the auction on May 5.
The action brings the amounts outstanding under the TAF to $150 billion, the Fed said.
In addition, the Fed also authorized further increases in its existing temporary reciprocal currency arrangements with the European Central Bank and the Swiss National Bank. The arrangements will now provide dollars in amounts of up to $50 billion and $12 billion to the ECB and the SNB, respectively, representing increases of $20 billion and $6 billion. The Federal Open Market Committee (FOMC) extended the term of these reciprocal currency arrangements through January 30, 2009.
Furthermore, the Fed also authorized an expansion of the collateral that can be pledged in the Federal Reserve's Schedule 2 Term Securities Lending Facility (TSLF) auctions. Primary dealers can now pledge AAA/Aaa-rated asset-backed securities, in addition to already eligible residential- and commercial mortgage backed securities and agency collateralized mortgage obligations, beginning with the TSLF auction on May 7, 2008.
The ever-incisive FT columnist Martin Wolf offers a stark and sober analysis of the United States' current financial and economic predicament, but it's an analysis well-worth reviewing, if one has the time.
A synopsis is provided here, but first, full warning: read the analysis when you're feeling well and in a good mood, not during other times.
The compelling question following the Fed's action, in conjunction with the world's other, major central banks, is whether it will work. Will it be enough to get the U.S. economy moving again?
And as is so often the case in economics, the answer depends on three unknown factors, a pair of economists told BloggingStocks Tuesday. (In an initial review, the market appeared to signal its approval of the Fed's action, with investors sending the Dow 300 points higher to 12,156 in late Tuesday afternoon trading. )
New Fed tool: TSLF
First, the Fed's new Term Securities Lending Facility should convince bank dealers that liquidity should not be an issue, economist David H. Wang said Tuesday. "No bank or bond dealer should fear that they won't be able to find financing. That should improve bond market liquidity," Wang said. In addition, the Fed's willingness to swap U.S. Treasuries for mortgage-backed securities (MBS) should restore some trust -- but by no means total trust -- to the MBS market and help market participants price these securities, he said. The Fed's accepting private mortgage debt collateral speaks directly to where the market is stressed the most, Wang said. However, if MBS's are not pricing and trading, that would indicate continued concerns about liquidity, he said.
The dollar plunged to a new record-low of $1.5463 versus the euro Friday, in a global-wide greenback sell-off, before recovering at mid-day after the U.S. Federal Reserve took two actions to pump more money into the beleaguered U.S. banking system.
Prior to the Fed's liquidity-enhancing actions, the currency markets drove the dollar down on speculation that the Fed would again lower benchmark, short-term interest rates by 75 basis points at its policy meeting on March 18 in an attempt to stimulate a U.S. economy that shows increasing signs of contraction. Those recession fears grew in the currency market and in the stock market after the U.S. Labor Department announced Friday that the U.S. economy lost 63,000 jobs in February 2008 -- the nation's largest drop in payrolls since March 2003.
However, the dollar recovered somewhat after the Fed, in a surprise move, took two actions to boost banking system liquidity. The Fed increased by $20 billion total the size of its next two Term Auction Facility auctions, known as TAF, to $100 billion, or $50 billion for each auction, to be held on March 10 and March 24.
Second, in an even-more surprising move, the Fed announced the start of new "28-day repurchase transactions" totaling another $100 billion. Further, the Fed said for the new 28-day loans, banks will be able to post as collateral U.S. Treasuries, agency debt, or agency mortgage-backed securities -- which are eligible as collateral in conventional open market operations.
The decision represents an increase of $20 billion from the amounts that were announced for these auctions on February 29. The Federal Reserve will increase these auction sizes further if conditions warrant, the Fed added.
Also, the Fed said in order "to provide increased certainty to market participants, the Federal Reserve will continue to conduct TAF auctions for at least the next six months unless evolving market conditions clearly indicate that such auctions are no longer necessary." Economic Analysis: Friday's decision indicates the Fed believes banks need more short-term liquidity, given continued tight credit conditions and concerns about subprime loan and related asset quality.
The U.S. Federal Reserve will conduct two auctions of 28-day credit through its Term Auction Facility in March, the Fed announced Friday, in a statement.
The Fed said it will offer $30 billion in an auction on March 10, 2008 and $30 billion in an auction two weeks later, on March 24, 2008.
The Fed also reiterated its support for the term auction facility policy. The Fed said: "The Federal Reserve intends to conduct biweekly TAF auctions for as long as necessary to address elevated pressures in short-term funding markets. Decisions regarding auctions in April will be announced by Friday, March 28."
With home foreclosures expected to increase in 2008 as the second wave of variable interest rate mortgages reset, an influential member of Congress is expected to introduce legislation that would enable the Federal Housing Administration to buy at-risk loans, enabling them to be refinanced and preventing homeowners from being foreclosed upon, The Financial Times reported Wednesday.
U.S. Congressman Barney Frank, D-Massachusetts and chairman of the House Financial Services Committee, is floating a $15 billion initiative that would authorize the FHA to buy as many as 1 million at-risk mortgages, The FT reported. Some loans, such as those for investment properties and vacation homes, would not be eligible for the program.
The overlooked FHA
Overlooked during the "Roaring 1990s" economic expansion and this decade's housing boom, the Federal Housing Administration is a Depression-era agency that insures loans made to borrowers with poor credit.
More than half the collateral backing cash advances made by the U.S. Federal Reserve to U.S. banks is in the form of loans, not securities, the Federal Reserve Bank of New York told The Financial Times.
Economists and analysts had speculated that banks would post only complex housing-related securities -- including mortgage-backed securities -- that they could not refinance elsewhere.
That has not been the case. The Federal Reserve Bank of New York told FT that since the credit crisis began, banks had continued to provide a wide variety of assets as collateral -- including U.S. Treasuries, other government and agency-backed securities, and private-label mortgage-backed securities.
The U.S. Federal Reserve said that despite inflation concerns, "relatively low" interest rates may be needed "for some time," the central bank announced Wednesday in the minutes from its most-recent meeting. At the same time, however, the Fed raised its inflation projections for 2008.
"Several participants noted that the risks of a downturn in the economy were significant,'' the Fed said in minutes of the January 9 and 21 conference calls and the January 29-30 policy meeting last month. "Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending.''
Last week, in Congressional testimony U.S. Federal Reserve Chairman Ben Bernanke indicated that the Fed will lower rates further if financial conditions and the availability of credit deteriorate.
Also in the minutes, the Fed termed the inflation statistics since the end of the year, "disappointing." The Fed now expects 2008 core inflation of 2.0-2.2%, up from the previous 1.7-1.9% estimate.
Further, the Fed lowered its 2008 U.S. GDP outlook to 1.3-2.0% from the earlier 1.8-2.5%.
The Fed may have to lower interest rates again because previous cuts have failed to lower borrowing costs for many corporations and households, Bloomberg News reported Wednesday.
Despite 125 basis points of rate reductions by the Fed over a nine day span in January 2008, companies are paying more to borrow now than before the cuts, data compiled by Merrill Lynch (NYSE: MER) indicated, Bloomberg News reported.
Further, banks have been forced to abandon loan sales, student loan enterprises have had to postpone auctions, and even major municipalities have had to increase the interest rate they offer on bonds to attract investors reluctant to take on additional debt instruments amid subprime asset defaults and constrained credit market conditions. Economist David H. Wang told BloggingStocks Wednesday in a normal market the Fed's rate cuts would have lowered short-term borrowing costs and enhanced liquidity. It has not happened, which all but guarantees another rate cut by the Fed on March 18.
"We're definitely going to need another shot [interest rate cut]," Wang said. "The only question now is whether the Fed goes 25 basis points or 50. Credit market conditions are way too constrained. It's one thing to have a bond deal on a young company deferred or priced differently on risk factors, but this business of Sallie Mae's auctions failing to generating interest is just a ridiculous situation, frankly. It shows just how irrational the market has become, short-term."
As the saying goes, what if you invited everyone to a party and no one showed up?
That's a little like how the U.S. Federal Reserve feels right now. The Fed has lowered benchmark, short-term interest rates substantially - - including 125 basis points of reduction in January 2008 alone - - but so far, banks, stung by subprime losses, have been reluctant to ramp-up lending, CNBC.com reported Monday.
Patience advised
Still, economist David H. Wang took issue with those arguing that the Fed's rate cuts and ongoing term auction facility that haven't worked or weren't needed.
Concerning rate cuts, Wang told BloggingStocks Monday that the banking sector had to work through "a period of loan fright" - - an irrational fear of risk - - that is, in his view, the additive inverse of "the total neglect of risk" that characterized the earlier housing boom.
"Banks need some time to improve their balance sheets. Some may accomplish this through job cuts and by operational cut-back. Many will accomplish this through curtailed lending and tighter lending standards, at least for a short period of time," Wang said. "But in time, lending to businesses and individuals will resume its normal pace."
'Gradualism' vs. shock therapy
Second, the Fed's term auction facility - - which U.S. Federal Reserve Chairman Ben Bernanke has said will remain in operation "for as long as necessary" - - is working. "The term auction facility is doing exactly what it's supposed to do... it's providing short-term loans to banks who need it, who don't want to borrow from the discount window and who can't get the money from other banks who are afraid to lend," Wang said. "And in the process, bank operations are maintained, even as they slowly and gradually digest subprime defaults and related asset write-offs."
And that last point may be the key to understanding the outlook for a resumption of normal lending conditions, he said. Given the size of likely, problematic subprime loans - - some have put the figure at $500 billion - - and the preference for gradualism, it may be two quarters or more before normal lending conditions resume. Further, the correct place to look for the start of increased lending is not the stock market's level, but commercial activity: orders for new equipment, business expansion plans, and job growth / new hiring announcements.
And while some economists argue that it would be better if the financial services sector wrote-off problem loans quicker - - i.e. 'the sooner the better for economy,' Wang does not agree.
"Shock therapy may have worked in Poland's transition from a communist centrally-planned economy to a free-market economy but we're dealing with a magnitude difference in money here," Wang said with chuckle. "The Fed's goal here is to enable banks to gradually work the bad loans out the system, while maintaining the conditions for sustainable economic growth and not causing runaway inflation. And so far, that strategy is working, in my interpretation."
The U.S. economy could be growing faster before the inauguration of the new U.S. president. Bloomberg News reported Monday.
The forecast is based on the rise in the 5-year U.S. Treasury yield from its lowest level relative to the 2- and 10-year notes since 2001. The last two times that occurred, during the 1990 and 2001 recessions, the economy started to expand within nine months.
Famous last words
Economist David H. Wang agreed that the indicator has accurately predicted previous recoveries. "It's been an accurate indicator, famous last words," Wang told BloggingStocks Monday.
However, Wang cautioned that the nation's public officials, corporate America and individuals can't overlook, or neglect to prepare for, what's in-between.
FT columnist and economist Martin Wolf astutely observes that in the rush to evaluate whether the U.S. Federal Reserve's monetary policy easing and the U.S. Congress' $150 billion stimulus plan will work, we need to decide what 'will work' means.
Using the Fed's definition, Wolf says, the monetary/fiscal policy will have been judged a success if policymakers have eliminated any risk of a collapse into a Japanese-style deflation. (In the late 1980s, Japan fell into a decade-long deflation period after the collapse of a real estate boom and related asset prices.) Conversely, Wolf notes, Congressional officials, particularly those up for re-election, may not view the stimulus policy as a success unless the U.S. economy is growing at a healthy rate, at/above 3% GDP growth.
'Will work' bar too low?
The above, of course, leads to the natural question of "Is the 'will work' bar too low?" Economist David H. Wang says no.
The 
The ever-incisive FT columnist
The U.S. Federal Reserve will conduct two auctions of 28-day credit through its Term Auction Facility in March, the Fed announced Friday, 
More than half the collateral backing cash advances made by the U.S. Federal Reserve to U.S. banks is in the form of loans, not securities, the Federal Reserve Bank of New York 
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