I guess it is now official. We no longer have functioning trading markets, at least in terms of serving their alleged purpose of giving companies access to capital. The Fed is no longer the lender of the last resort. It is increasingly becoming not merely a lender, but by adding equities to its list of acceptable collateral, has become the funding source of the only resort.
Willem Buiter once remarked that the Fed could accept a dead dog as collateral for lending, and we are getting close to that. I’m sure he’ll have more than a few withering words to offer on these moves.
The Fed’s announcement is typically anodyne:
The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities….
The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.
The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged…
The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.
The Wall Street Journal tells us:
The Federal Reserve is expected to expand its lending facilities in the wake of the likely demise of Lehman Brothers, taking a wider array of securities, including equities, as collateral for its loans, say people familiar with the matter…
Fed and Treasury officials stood their ground through a high-strung weekend of negotiations in insisting the wouldn’t put public funds at risk to finance the rescue of another financial institution. The expansion of short-term lending facilities might be a twist to that — while they were unwilling to back another bailout, they are still struggling to find ways to ensure broader market stability.
Fed officials have been concerned for months about the resilience of a short-term secured lending market known as “repo” loans. It is the lifeblood of the brokerage industry, through which firms fund their day-to-day operations.
Repo lending is used by banks, brokers and hedge funds. Typically, a borrower hands over securities as temporary collateral for a loan. In normal times, the cheap funding is widely available.
I’m a bit flummoxed, The comment in the WSJ about equities does not track the Fed announcement. To my knowledge, stocks aren’t repoed (why would you? Any exchange traded stock is readily saleable, so there is no reason to hold equity inventories, and repos are a way to finance trading inventories). The Journal may have gotten ahead of the Fed announcement, or the Fed may be saving equities for a later announcement.
If I am reading the press release wrong, please correct me, but I don’t see anything equity-like there.
Or is this simply a deliberate bit of disinformation? This is the Administration that gave us “Saddam had weapons of mass destruction” to the UN no less, so I wouldn’t put it past some friends of the Fed or Treasury to place some calls that the officialdom could deny in a day or two.
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cnbc just said 10 banks are each pitching in 7bn for a private liquidity fund for anybody that can’t qualify for the pdcf.
This is meant to keep shares off the market to prevent people from selling them but does it not become easier to short those shares available? This would only work when combined with a short selling ban. Well at least until the ban was lifted. Ask Pakistan how they’re doing.
mxq
Who is this for? AIG? They going to need a bigger bazooka….
tri party repos can include equity a the collateral.
However, IIRC, voting rights to get transferred. So the FED in accepting equity as collateral can vote on those shares.
“Who is this for? AIG? They going to need a bigger bazooka….”
Seriously. AIG supposedly needs $40 billion, so on the night of its creation if they use it on AIG, there goes 57 percent of the capital pool.
Markets no like. Never thought I’d see a bank holiday but hey who knows.
I googled “acceptable collateral for tri-party repo systems major clearing banks ” – in the links I looked at, nothing about equities being acceptable collateral..
Anybody got a link to the definition of acceptable collateral ?
-K
Does this mean that banks like BOA have the ability to fund MER w depositor’s cash, and if so, how risky is that for depositors?
Re: the banking consortium with the $70 billion pool of loans. Eerily reminiscent of the Panic of 1907. And look, JP Morgan is involved again.
Let’s not forget today’s other losers…
NYS/NYC budget
NYC residential/commercial real estate
WTC rebuilding
cocaine dealers
over-the-hill 27 year old fashion models looking for sugar daddies
On the positive note….will MER traders/bankers get to move to new offices overlooking Bryant Park?
23A allows (by their definition) in time of crisis to take my credit card debt as collateral. Day to day is now 30 days to 30 days then 6 months to 6 months then…….it is a rolling backstop to infinity.
Just more debt in incur to save the world’s financials. Doesn’t seem to be working very well so far. What a difference a year makes.
ruetheday…nice point.
Tony Crescenzi made the point on cnbc that the Fed’s balance sheet is only 800-850bn…after AIG and LEH (he said $100bn for them), the Fed will have committeed about $600bn of its balance sheet. Citi, Wamu and Ford/GM are gonna have to fight over the scraps.
The Financials Took The Bait
First Step: Reduce lending standards.
Second Step: Lower the interest rate.
Third Step: Wait for the companies to load up their balance sheet with loans.
Fourth Step: Buy put LEAPS on the most vulnerable financial companies.
Fifth Step: Collect the $ as the LEAPS expire.
Illuminati
Yves,
I appreciate the skeptical end notes regarding recent media information vs. the Fed announcement (press release?) confusion. The fairy tales spun through the media regarding the mythic, economy-protectorate (the Fed + the Congress + the Administration) who have heroically come to the rescue with: the “Bears Stearns bailout – too big to fail,” the “Housing Bailout/Foreclosure Prevention Act,” and the “Evil Necessity of Bailing out the FMs” are becoming less believable to the public at large. The media and the politicians realize this.
Disinformation will be the name of the game for some time to come.
I don’t buy for a minute the notion the SEC Chair, the Chair of the Fed Reserves, and the Treasury Dept Sec’y were wasting their time on attempting a last-ditch, arranged marriage of Lehman Bros. this weekend. First, I doubt their brokerage skills and leverage were necessary. Seems that other big financial deals were in the works this weekend without top-level government and quasi-government officials involved. So what were the SEC, the Fed, and Treasury doing all weekend? Crossing their feet at the ankles, batting their eyelashes, and demurely protesting that would not again allow individual taxpayers and their children to be violated? Calling out to the press, at calculated intervals, don’t worry your pretty heads over this, we have no intention of putting the hoi polloi — over the next seven generations — on the hook tet again. Really, we promise.
Me thinks they protest too much.
Whatever bailout actions the SEC, the Fed Reserves and Treasury have cooked up this weekend, the smoke and mirror games that they are sure to play – with media cooperation – will be sure to hide the steaming piles from public scrutiny until well after the elections.
Equities as collateral is not necessarily problematic in and of itself. It all depends on the haircut, no? If the haircut is, say, 50%, no problem (at least for a while).
Am i right or wrong in assuming that this may have a potential bouying affect on the stock market? Recall the ECB opening its lending program to accept subprime toxic mortgages. The European banks went out issuing more just so they could lend from the ECB.
Joe
Yes, equities are completely unacceptable. They should stick to traditional sound collateral like… uh, agency securities… and, er… AAA-rated mortgage-backed securities. Wait, never mind.
Right now the markets no like and it’s infected the futures chain into Mar 09:
http://finance.yahoo.com/q/fc?s=ESU08.CME
Is it true that there are 1 Trillion dollars of Alt-A’s in the US???
From Financial Week: “Commercial banks borrowed $23.5 billion from the Federal Reserve’s discount window in the one-week period ended Sept. 10 — a record level, according to a report issued by the central bank yesterday…The $23.5 billion borrowed this week was up 23% from $19.09 billion last week.”
Also, WSJ reported about LEH and cds: “Sorting out Lehman’s CDS positions promises to be difficult and time-consuming, because many of the contracts have different terms and maturity dates. In a survey last year by Fitch Ratings, Lehman was listed among the 10 largest CDS counterparties by number of trades and the amount of debt to which the contracts were tied.”
Krugman is says Paulson/Bernanke are playing “Russian roulette” with the US economy and he is “uncertain” whether or not the US financial system will “collapse” in the next few days.
Unbelievable stuff. You couldn’t make this up.
http://www.nytimes.com/2008/09/15/opinion/15krugman.html
Re: ” Previously, PDCF collateral had been limited to investment-grade debt securities.”
Great, no limits, no challenges, just unlimited funding. That should buy plenty of respect for the dollar and help fuel hyperinflation! Thanks guys for contributing to global chaos and hope those bonuses are ok…
Farber on cnbc saying that look for a rate cut in the trading session. Saying bank of america is trading bad paper for worse paper on the 70% premium. Thinks equity markets are short term oversold so downside should be controlled and bottom in Oct for a rebound within range.
Saying people are ignoring the economic risks of the crisis which will become clearer.
Historic stuff
Where do I put weird off topic theory??
FYI: http://seekingalpha.com/article/87653-illegal-short-sellers-may-face-rico-indictments
The SEC’s crackdown against illegal naked short selling and rumor-mongering resulted in more than 50 hedge funds being slapped with subpoenas last week, according to the Wall Street Journal.
Clusterstock.com, reported, “the SEC is demanding both trading records and email correspondences” from subpoenaed firms. The inclusion of cell phone and text messaging records will undoubtedly be scrutinized. Concurrently, the NYSE Regulation Inc. is also investigating how some of its largest firms comply with false and misleading rumors that could undermine a stock’s price. This is going to intensify.
Dick Fuld, CEO of Lehman Brothers (LEH), told market regulators that he has information that short-selling hedge funds colluded to bring down Bear Sterns (BSC). If Fulds’s “information” is of evidentiary value, these hedge fund managers, and their cast of cohorts, could find themselves behind bars.
See Also: On September 7, 1988, Milken’s employer, Drexel Burnham Lambert, was also threatened with a RICO indictment under the legal doctrine that corporations are responsible for their employees’ crimes. Drexel avoided RICO charges by pleading guilty to lesser felonies; a RICO indictment would have almost certainly put Drexel out of business since its capital would have been tied up in its defense,[2] and banks will not extend credit to securities firms under RICO indictments.
Lehman CEO: Short-Sellers Took Down Bear
http://www.cnbc.com/id/23903238
Lehman Brothers CEO Richard Fuld has instructed his legal staff to tell regulators that he has information suggesting that short-selling hedge funds colluded to help cause the demise of Wall Street investment bank giant Bear Stearns, sources told CNBC.
>> I love this conspiracy stuff!
Hi Yves-
Sorry for this lengthy post. In my defense, I won’t be posting much today. Today is a very special day for me, my introduction into the film world of San Francisco, a debut of sorts. Very exciting!
Congratulations for your improved analysis of a Federal Reserve policy move.
As you know, the press needs to get up to speed more in terms of what the Fed is actually DOING before racing to conclusions.
For example, I recently pointed out in this forum that some commentary was attempting to draw conclusions from an insufficient data set by speculating on the policy implications of a recent large open market RP move by the Fed without knowing if we were discussing system or customer RPs.
I privately emailed you a short discussion of the difference, for review at your convenience. You can check with any senior economist at any Fed branch Fed to confirm.
Without knowing whether an RP is a customer or a system RP, any accurate inference of the Fed’s thinking is highly uncertain.
My conversations on the scope and type of securities available for open market operations with various members of the Fed, representing a divergent group of views within that organization, convinced me that the Fed would indeed feel comfortable, if necessary, accepting equities as collateral for open market operations.
Indeed they could do more than this. I won’t explore that here. I feel my insights here offer a trading edge for me.
These conclusions are drawn over time from multiple sources AT THE OPEN MARKET DESK ITSELF.
That DOES NOT MEAN that this policy statement from the Fed today says that they are using that tool now. I share your robust and healthy skepticism of this WSJ article.
Yet another example of the inferior WSJ coverage of the Fed. But it’s been like that in the 29 years that I have followed the Fed closely, back in the days when Lindley Clark at that paper falsely represented that St. Louis was the font of all competent Fed analysis.
A Federal Reserve official who would later become head of the open market desk at the NY Fed thought my ridicule of Mr. Clark (and the WSJ reporting of the Fed) was pretty funny.
Let’s see what Krishna Guha at the Financial Times has to say about this. I’ll bet you breakfast that he won’t even mention it.
Of course this could be a rumour planted by the National Security Agency on national security grounds to stabilize…oh excuse me, I was just kidding.
I withdraw that comment. Admiral Inman, I’ve been a fan of yours for a long time and I do have stellar character referrences. I mean that sincerely. I know what you are faced with against that other faction and I strongly support…..
Matt Dubuque
Congratulations Hank Paulsen. Your theft of shareholder capital one week ago made it impossible for institutions to raise equity capital and led directly to the bankruptcy of LEH, the forced sale of Merrill, the collapse of AIG, and who knows what else. Your move to “calm the markets” has failed miserably. Heckuva job, Hankie, we haven’t seen the federal government mismanage an emergency response this badly since Katrina. The economic damage from this could be worse. History will show that your taking of the GSEs was on par with the passage of Smoot Hawley for stupidity and counterproductivity.
I don’t know why the Fed should accept equities as collateral. It should do as Treasury does and simply keep the equity for itself.
TAXATION WITHOUT REPRESENTATION!
Equities are definitely used as triparty repo collateral, at least in the US. Equity is I think one of the two largest asset classes (along with Treasuries). The easy availability of reliable, daily pricing makes it quite attractive, even if it is traditionally more volatile than credit.
Great. The Federal Reserve is now a margin lender.
Next step after that is to accept watches and jewelry — become a pawn shop lender.
Welcome to the banana republic — rule by decree — who are we at war with this week?
“The U.S. economy is fundamentally sound,” said President Hoover …