Tuesday, the stock market roared ahead as it collectively cheered Fed Chairman Ben Bernanke’s latest attempt to loosen the squeeze of the credit crunch. Bernanke had hinted at an expanded loan facility to banks to the tune of $100 billion, but this morning the Fed announced that it will lend up to $200 billion of Treasury securities under its new "Term Securities Lending Facility."
Treasuries have long been known as the safest of all securities with their implied backing by the U.S. Government, and the recent flight to safety only increased demand. The banks will be able to use the increasingly risky mortgage-backed securities, generally issued by Fannie Mae (FNM) or Freddie Mac (FRE), as collateral on the loaned Treasuries. Furthermore, instead of the normal overnight loan structure, these loans will be available for 28 days. The clear goal is to ease the strain on the economy by making more funds available to lubricate the credit markets.
The implementation of the “Term Securities Lending Facility” greatly diminishes the likelihood of a three quarter point rate cut at next week’s FOMC. With inflationary data looking more worrisome in recent weeks and the dollar hitting new lows, we are glad that rate cutting will not be the Fed’s default response to struggling credit markets. Rate cuts can sometimes be effective, but they are an extremely blunt tool with possible unintended inflationary effects. Rate cuts have not proven very effective in stemming the current credit crisis. This proposal seems to be directed towards adding liquidity rather than simply following the Helicopter Ben’s recent downturn playbook of cuts, cuts, and more cuts.
This proposed solution will not eliminate the problems in the credit market, but our hope as well as the Fed’s hope is that the injection of liquidity will make these big banks more able to withstand margin calls in the future. From the Wall Street Journal,
The Fed believes it has plenty of cushion in the form of extra collateral and guarantees behind those other assets to virtually eliminate the risk of loss.The reality is that the Fed’s role in our evolving economy has transitioned from lender of last resort to a lender trying to avoid the worst. However, it is unrealistic to think that the Fed could virtually eliminate the risk on these securities. It is more accurate to say that they can print more money to pay off the loss if this proposal does not substantially improve liquidity. Certainly that is not an optimal solution, so we sincerely hope that the boost of liquidity spurs a recovery in the credit markets. If not, do not look to the Fed for answers.
