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!
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.