We know that the Fed has pretty low standards when it comes to the collateral it will accept. But that doesn't really matter, since the Fed is mainly relying on getting its money back from the banks it's lending money to: the collateral remains on the bank's balance sheet, not on the Fed's. And that's a problem for the banks, says John Dizard:
The discount window, the no-longer-purposely-unattractive alternative means for banks to obtain liquidity, does not provide the necessary relief because the credit risk for the loans or bonds discounted there remains with the discounters. You can get cash from the Fed, if you are a bank, but you effectively retain the risk on your balance sheet. That means that under the capital guidelines, you have not solved your fundamental problem.
So if a bank wants to get an illiquid CDO off its balance sheet, where can it turn? The markets certainly don't seem to be interested in such paper right now. How about the European Central Bank?
Let's say a subsidiary (not a branch) of a U.S. bank, bank holding company, or dealer operating in Europe has a CDO (collateralised debt obligation) or two, with which it would be willing to part.
The ECB could buy them, freeing up the subsidiary's balance sheet for some much needed market making. Obviously this works just as well for a European bank with dollar paper.
Interesting idea – although I have to admit I'm not holding my breath for this to happen. I have no doubt that the ECB could, were it so inclined, get into the buying-CDOs business. But I'm also pretty sure that it won't. The ECB has no particular expertise in valuing such paper, and if it entered the market it might well find itself holding the worst of the worst issues.
Every once in a blue moon it can make sense for central banks to start buying up securities directly, but this is not one of those times. Central banks are lenders of last resort; they shouldn't be bag-holders of last resort as well.
Update: It turns out that investors bought $63 billion of CDOs in the third quarter, over and above any purchases they made in the secondary market. Looks like there is market demand for CDOs after all, if the price is right.