The success of TSLF is due to its usage. Primary dealers have widely used the TSLF program which helped to promote liquidity in the secured funding market. Without TSLF and the Primary Dealer Credit Facility, JP Morgan would not have been able to purchase Bear Sterns, which could have been a catastrophe for markets. JPM used TSLF and liquidated the treasuries received to complete the purchase. Because TSLF auctioned treasuries with other securities used as collateral, the auction was collateral for collateral, which did not affect bank reserves.
This new fed policy tool was announced on March 11, 2008 with its first auction on March 27, 2008. As shown in Exhibit 2, the announcement itself didn’t change the functions of the market and the actual auction was necessary to improve market conditions. This wasn’t surprising because prices in overnight markets on any day are dependent on the supply of collateral on that given day. Exhibit 2 also shows the success of TSLF by presenting the decreasing spread between the overnight agency and agency mortgage backed securities after the first TSLF auction.
One policy tool which has not been as effective in helping the market is interest on reserves. In October 2008, the FED announced it will pay interest on reserves, both required and excess. This has created an incentive for banks to hold reserves and not lend them out into the economy. Banks are nervous to lend reserves because they don’t believe they will make their money back due to defaults. Instead they are choosing to keep their excess reserves with the FED and make a risk free profit. This is exemplified in Exhibit 3, which shows the excess reserves in the banking system.
Currently banks, who have received reserves due to the TAF auctions, aren’t lending. When banks lend this helps to move money throughout the markets helping to ease the recession. Another FED policy tool which also has not been very successful is the Term Asset-Backed Securities Loan Facility, or TALF. The intent of TALF was to encourage the issuance of new asset backed securities. TALF provides loans, which support the issuance of these new ABS. All persons or institutions who hold high rated ABS can borrow money from the FED if they use these ABS as collateral.
As shown in Exhibit 4, TALF has not been widely used which shows it hasn’t been as successful. TALF has also provided a moral hazard, essentially rewarding people for taking excessive risk. TALF is also backed by twenty billion dollars worth of TARP funds, which has created a stigma. People don’t want to be regulated or scrutinized by the treasury because they took TALF funds. The FED is also bearing large risk, for little reward which can prove to be worse in the long run if these ABS’s default. A duration mismatch has also occurred.
The collateral posted can have a duration of 20 years, but the ABS that must be made with the TALF funds can only have a duration of 3 years or less. Even though TALF only allows highly rated ABS to be used as collateral, if the Nationally Recognized Statistical Ratings Organization had rated these ABS correctly in the first place, many of these default situations would not have occurred. Past ratings have not been successful, and the AAA requirements do not give tax payers much comfort. This is evident in a statement released October 5, 2009 by the FOMC which explains even stricter regulations on TALF collateral.
TALF in the end may prove to help the success in the market, but as of right now it needs some work. These new fed policy tools have worked well all in all and have provided more and more liquidity in the markets. Some have proved to be better than others, but in the long run it is unknown which tool will prove to have been the best at not only ending this recession, but ending it the fastest while combating the problems inflation could create, a double dip recession, or even a depression. ?