Another day, another crisis measure

March 11, 2008 9:29 AM (Archive)

Only on Friday, did the Fed take two sizeable steps to reliquefy financial markets: firstly by increasing its new Term Auction Facility to $100 billion from the previous $60 billion and also by introducing another $100 billion of 28-day term special repos.

The importance of the first is that the facility is not just available to primary dealers, as are ordinary repos, but to all Fed member banks; that of the second is not only that it offers longer-term liquidity than the norm, but that it explicitly relieves dealers of having to offer up their best collateral first, before they get to the stuff they really can't finance, as was the traditional practice.

Now, just two working days on, we have been informed that the currency swaps conducted in December with the ECB and the SNB will be rolled over and increased from $20 and $4 billion to $30 and $6 billion respectively.

The last time around, this helped alleviate the dollar funding shortage and so capped the QIV bear market rally in the greenback. With no such movement underway this time, it will be interesting to see if it increases selling pressure - certainly any would-be dollar bears, worried about covering their positions, can theroretically now take on an extra $12 billion or so of risk over the quarter/ Japanese FY end, if they so desire.

Additionally, the Fed is making $200 billion available through its securities lending programme. The subtlety here is that the Fed will lend out US Treasuries, not cash, against other USTs, Agency bonds (Fannie Mae, Freddie Mac, Ginnie Mae), Agency guaranteed mortgages and - in alternative tranches - any other AAA MBS paper offered.

Given that spreads on all these other, non-UST categories have exploded in the last week or so, dragging Fannie and Freddie's share prices down to 15-year lows and threatening the functioning of the entire mortgage system, well beyond the murky depths of sub-prime, it should be obvious what the motivation for this somewhat technical move is.

Though this 'asset-side' management is clearly very important, it should be noted that, strictly, it has not yet resulted in a greater than normal degree of Fed-based USD expansion since the Fed has, to this point, run down its portfolio of T-Bills and ordinary RPs in order to offset most of the injections now being conducted in these novel forms. Net-net, therefore, none of this constitutes a 'pumping' of liquidity, per se, (though we remain sensitive to what other Open Market Operations are undertaken in coming days as these new facilities are taken up).

Balance sheet degradation we may have (where would the Fed's CDS spread be now that it is the world's biggest prime broker, one wonders!), but we do not yet have 'quantitative easing'. With an extra $352 billion involved in all this shuffling, and with $713 billion in owned USTs and $59 in traditional RPs on its books, that leaves it room to do another $320 billion before it HAS to increase reserves... which, it will hope, should be quite enough, thank you.

It should be noted, however, the Bank of England has also decided to roll over its existing extra sterling injection from before Xmas and has said that it may increase the scale of these if the need arises. Additionally, the Bank of Canada is also providing some extra reserves - not sizeable, but significant, nonetheless. And then, of course, there's the ECB which HAS dramatically increased its provision of reserves, much to the relief of the Spanish, Irish, and Belgian banks. (NB with a report today from the RICS suggesting the UK property market is in as bad shape as it was during the real estate crash of 1990-91, we might also expect the Brits to be quietly intensifying their grip on this lifeline)

No move yet from Japan, but it will be seen that the three main contenders for the governorship were each competing this week to tell us HE was the ideal man to 'offset downside risks aggressively', etc, etc, so do not expect too much resistance from that quarter, either.