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The War of Financial Innovation

Posted by: Michael Mandel on March 11

Call this the war of financial innovation. This credit crunch came about, in part, because of the misuse of new financial instruments. Now Fed Chairman Ben Bernanke is responding with some financial innovation of his own, announcing today a $200 billion ‘term securities lending facility” (TSLF) as a way to combat the crunch.

Will the Fed’s new policy attack work? It’s got a good shot. The TSLF enables banks and other big financial institutions to borrow nice and shiny Treasury securities from the FED, using their battered mortgage-backed bonds as collateral. That is, if a bank has $20 billion in mortgage-backed securities that it is having trouble unloading, it can use them as collateral to borrow Treasuries from the Fed for 28 days. With these Treasuries available, it should be a lot easier for the banks to borrow and lend, unclogging the financial markets.

True, the banks will only be able to use high-quality bonds as collateral. The low-quality drek will have to stay on their balance sheets. But from the perspective of the Fed, that’s a feature, not a bug. The Fed wants the banks to absorb the losses on the really bad stuff.

One benefit of the TSLF: It gives the Fed a new way of pumping liquidity into the markets without actually cutting rates. The credit markets need more help than the real economy, which is still relatively strong, and this directs the assistance where it is most essential.

The TSLF is also scaleable—if the credit markets need more help, the Fed can ramp up the size of the program very easily. Two hundred billion is a lot of money, but the markets may need more.

Finally, Bernanke’s ability to pull new policy instruments out of his hat may throw a bit of fear into investors who are betting on a downturn. Just when the Fed looks boxed in, he comes up with a new way to pump out liquidity—while preserving his real silver bullets, the rate cuts.

However, the TSLF is not a panacea. If the economy keeps slowing and more loans go bad—or if some of the banks go under—the Fed could find itself holding a lot of bad debt. In the end, Bernanke is making a bet that the Fed faces a temporary liquidity crisis, rather than a long-term downturn.

[Changed as of 11:38AM to better characterize the program]


Paul Krugman writes

So basically the Fed is going to be swapping Treasuries for dubious securities, in an attempt to give the market a REALLY BIG slap in the face. I understand what they’re doing, and might have done the same in their place. Still, all I can say is Wheeeee!

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Reader Comments

Brandon W

March 11, 2008 11:50 AM

And then, 28 Days Later...

This won't work any better than all the other things that didn't work. Watch.

Mike Mandel

March 11, 2008 12:24 PM


Robert V

March 11, 2008 02:20 PM

We are so afraid of government intervention (healthcare just one of the areas), yet the Fed in its supposed objective role is providing more government intervention. What's next, my phone calls being listen to? ... oh yeah, right that's already happening ...
PLEASE let then market decide!!!

Ben Lee

March 11, 2008 02:24 PM

I see this as just another slap in the face for the tax payers. These lending institutions who deliberately chose to market the bad loans and junk bonds are once again able to offer up the worthless un insurable bonds for the easily prinable cash from treasury.

This is just another scam dumped upon the American tax payer to bail out people in the financial world that should be put in prison. Mark my words, the bottom of this debacle is yet to come. Where were our oversight politicians while all this graft and corruption was going on? You got it! Sitting on their worthless rumps in Washington taking money from these crooks to pad their re election campaigns.


March 11, 2008 04:19 PM

Bad business again by the Fed. Maybe the reserve will lend me money on high risk collateral as if it were actually AAA. -This is fundamentally wrong-

This is a fun skit about the lending mess: copy and paste

Ron Paul for president?!


March 11, 2008 04:21 PM

What does the Bunny say?


March 11, 2008 04:26 PM

Ben Lee. I agree with you a 100%. This debacle has just begun. Another example of how slow our government responds. Thanks to all of them, we have to fund the pseudo mortgage market.

Mike Mandel

March 11, 2008 05:17 PM

For the moment, the bunny is silent


March 11, 2008 09:57 PM

Is Bernanke the head of the Fed? Or is it the former CEO of Goldman Sachs?


March 11, 2008 10:49 PM

The Feds just don't get it do they. Don't they know that Banks, being Banks, will use the TSLF and create more financial innovation to make more profit and pay themselves another country-budget-equivalent paycheck in 2008? $200bil now will create another $500bil credit crunch one year down the road. In the meantime, taxpayers suddenly end up funding each other's mortgage.


March 11, 2008 11:50 PM

I said a year ago, before almost anyone knew there was a problem, I said that, "If they bail out the homeowners and the banks, I am moving out of the country." Guess what: Switzerland here I come. This has become the most screwed up developed country in the world. It is f*****.

Thomas A. Coss

March 12, 2008 12:47 AM

Quick question: Are we messing with the big knob on the microscope or the small one?

Mike Mandel

March 12, 2008 11:13 AM

yep, this will probably lead to another boom. I'm not sure this is a bad thing.

George Willoughby

March 12, 2008 02:45 PM

The banking cabal, with Bernanke as their frontman, has just dumped another $200 Billion of worthless mortgage debt on the American citizens, yet another ingenious way to steal money from us. They've already stolen nearly $10 Trillion from us, yep, that's the national debt at this point. We're paying nearly $400 Billion per year in INTEREST on that debt.

We need to abolish the Federal Reserve immediately, nationalize the banks, and put the cabal in the psych ward of a federal prison.

Mike Reardon

March 12, 2008 07:12 PM

This move by the Fed looks like a new form of the Bank of Japans not seeing its poor quality loans to corporation that were never called due as the way to avoid the last move. They think in decades. In our open transparent market its being willing to let the pain play out but over a longer time line that is being accomplished.

I think we and world investors can fix this over time. I would think the next Administration (either sides) will embrace a national multi-trillion dollar civic infrastructure repair program. That decade long build out would be a competition for materials with devalued dollars against the world markets. That would guarantee to keep the work inside America, though the majority of profits may end elsewhere.

Both sides of Congress and the business community can get behind a program that serves one of the largest voting demographics with no problem. Add National Medical Insurance that is also required for the next few decades as job one for national revitalization. Its getting a tax program that gives a greater return on direct national health investment rather than financial manipulation that needs to come out of this election.

We still have an open creative financial market willing to continue transfer of wealth in exchange for investment. If the world wants a better return on its present investment here, just don’t stop our building out now, when our economy can use there inflated valued Euros and Pounds better than other developing economies. Its in the corporate tax’s return on investment that we can find a new direction, that and massive debt until a return growth cycle fills the economic balance.

john lazarin

April 7, 2008 12:25 AM

I'm sick and tired
of this country sticking it to the middle class! Lou Dobbs is right, this is "War on the middle class!"
Were doomed when this country continues its ways and people are getting more and more
numbed by crisis after crisis. We're turning into animals at the slaughterhouse of the market. Literally! The government plays a shell game with the market and hides everything under the rug! We're turning into a nanny state(Utopia) whereby nobody loses!
Is'nt that called lala land. I'm going to get my last $20 and bet it on the stock market. It's heads they win and tails I win. Uncle Sam will pick up the tab for us and everyone else in the WORLD!

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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