Term Asset-Backed Securities Loan Facility (TALF)

Discussion in 'Economy' started by gonegolfin, Nov 25, 2008.

  1. gonegolfin
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    gonegolfin Member

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    The Fed and Treasury can spin this however they like, but the truth is that the new Term Asset-Backed Securities Loan Facility (TALF) employs more quantitative easing (expanding the Fed's balance sheet) to facilitate the asset purchases in this new $800 billion program. The Fed will not be removing cash from the financial system (such as selling treasuries from its portfolio - a tact the Fed employed until early September of this year) to offset these cash injections (sterilization), but will increase bank reserves with these purchases in an interest rate environment that has federal funds trading effectively at zero (interest paid by the Fed on excess reserves is an artificial prop). This is the equivalent of the nuclear option in fighting deflation, especially when the assets purchased are not treasuries. It will result in a substantial increase in bank reserves and thus the monetary base. However, the money supply aggregates will not rise until the banks begin lending their excess reserves. I saw a comment on a financial web site aptly stating that you can throw a horse into a lake, but you cannot make the horse drink.

    Bloomberg.com: U.S.

    US officials have been quite uneasy about rising spreads between GSE Agency debt (Fannie/Freddie/FHLB) and Treasury securities of similar maturity. After all, the government backing of both agency debt and agency packaged mortgage securities has had an explicit backing ever since Fannie and Freddie moved into conservatorship status. But Asia, principally China, has not only curtailed its purchases of agency debt, it has dumped an impressive stake in these securities and replaced them with treasuries. This has had the unwanted effect of rising mortgage rates. The solution implemented in the new TALF is essentially more subsidization of housing (among other things) at the expense of the currency. Mortgage interest rates responded today by dropping an astounding 1.125%. Agency debt, swaps, and MBSs traded much tighter to treasuries today.

    The Fed is planning to purchase up to $100 billion of GSE debt along with a maximum of $500 billion of GSE issued mortgage backed securities. The remaining $200 billion is targeted at purchases of securities backed by auto, credit card, education, and small business loans. The Treasury is also providing $20 billion of "credit protection" to the Fed, funded by the TARP.

    This move by the Fed has many wondering why we had all the fuss with the $700 billion TARP plan. Why not just bypass all of the resistance and simply create the money. Well, there are several answers for this, two being obvious. One is that the Fed monetizing anything other than treasury debt entails even more risk and has serious ramifications (a last resort option). GSE debt and agency backed mortgage securities are not treasuries, but they do serve as collateral in Fed open market operations (as opposed to privately issued mortgage backed securities or equity stakes in financial companies). Second, if it is perceived globally that the US will simply tackle all of its problems by issuing new currency (instead of borrowing from existing money stock), foreign investor sentiment/response may become more radical.

    On a final note, these extra reserves being held by the banks are the perfect fuel for financing the sale of more treasury debt. This entails the banks using cheap excess reserves to fund the purchase of higher yielding treasuries and other securities. A large enough spread between short term loan interest rates offered by the Fed (and/or interest rates paid by the banks for deposits) and interest rates paid by longer term treasuries allows the banks to engage in a profitable carry trade (at the expense of dollar holders). From the point of view of the banks, this beats lending to the private sector as risk is greatly reduced. This is essentially handing the banks a pile of money ... one method of recapitalizing the banks.

    Brian
     
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