Appendix: Federal Reserve Initiatives to Address Financial StrainsMonetary Policy Report submitted to the Congress on February 24, 2009, pursuant to section 2B of the Federal Reserve Act
Since the onset of the financial turmoil in the summer of 2007, the Federal Reserve has announced several new measures to address the strains in financial markets, as well as enhancements to its existing liquidity facilities. (For outstanding balances related to these facilities, see table.)
Provision of Liquidity to Banks and Dealers
Modifications to the Primary Credit Program
Following the onset of the financial turmoil, the Federal Reserve Board announced temporary changes to its primary credit discount window facility on August 17, 2007. These changes were designed to provide depositories with greater assurance about the cost and availability of funding. First, the Federal Reserve Board approved a 50 basis point reduction in the primary credit rate to narrow the spread between the primary credit rate and the Federal Open Market Committee's target federal funds rate to 50 basis points. Second, the Federal Reserve Board announced a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower.
To bolster market liquidity further in the face of increasing financial strains, on March 16, 2008, the Federal Reserve Board unanimously approved a request by the Federal Reserve Banks to decrease the spread of the primary credit rate over the FOMC's target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.
Term Auction Facility
To address elevated pressures in short-term funding markets, in December 2007 the Board of Governors of the Federal Reserve System approved the establishment of a Term Auction Facility (TAF). Under this program, the Federal Reserve auctions term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window. By increasing the access of depository institutions to funding, the TAF has supported the ability of such institutions to meet the credit needs of their customers.
|Asset||Dec. 31, 2007||June 30, 2008||Feb. 18, 2009|
|Provision of liquidity to banks and dealers|
|Primary credit program||8,620||24,095||65,144|
|Term Auction Facility||40,000||150,000||447,563|
|Liquidity swaps with foreign central banks||21,000||62,000||375,005|
|Securities lent under the Term Securities Lending Facility||n.a.||104,097||115,280|
|Primary Dealer Credit Facility and other broker-dealer credit||n.a.||1,455||25,268|
|Provision of liquidity to other market participants|
|Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility||n.a.||n.a.||12,722|
|Net portfolio holdings of Commerical Paper Funding Facility||n.a.||n.a.||248,671|
|Net portfolio holdings of LLCs funded through the Money Market Investor Funding Facility||n.a.||n.a.||0|
|Support of critical institutions|
|Net portfolio holdings of Maiden Lane I, II, and III LLCs1||n.a.||29,970||72,231|
|Credit extended to American International Group, Inc.||n.a.||n.a.||37,357|
NOTE: LLC is a limited liability company.
1. The Federal Reserve has extended credit to several LLCs in conjunction with efforts to support critical institutions. Maiden Lane LLC was formed to acquire certain assets of The Bear Stearns Companies, Inc. Maiden Lane II LLC was formed to purchase residential mortgage-backed securities from the U.S. securities lending reinvestment portfolio of subsidiaries of American International Group, Inc. (AIG). Maiden Lane III LLC was formed to purchase multi-sector collateralized debt obligations on which the Financial Products group of AIG has written credit default swap contracts. Return to table
n.a. Not available. Return to table
SOURCE: Federal Reserve Board.
Each depository institution that is judged to be in generally sound financial condition by its Reserve Bank (and likely to remain so over the term of the loan) can participate in TAF auctions. All advances must be fully collateralized. Each TAF auction is for a fixed amount of funds, with the rate determined by the auction process (subject to a minimum bid rate). A depository institution submits bids through its Reserve Bank. The minimum bid rate for the auctions was initially established at the overnight index swap (OIS) rate corresponding to the maturity of the credit being auctioned. In January 2009, the minimum bid rate was changed to the interest rate paid by the Federal Reserve on excess reserve balances.
Initially, TAF auctions were in amounts of $20 billion and provided primarily 28-day term funds. Over the course of 2008, the Federal Reserve extended the term of some auctions to 84 days and raised the regular amounts of both the 28- and 84-day TAF auctions to $150 billion. The Federal Reserve also conducted two forward TAF auctions in November for $150 billion each, which provided funding over year-end.
Liquidity Swap Lines with Foreign Central BanksTo address the increasing demand for dollar funding in foreign jurisdictions, in December 2007, the Federal Open Market Committee (FOMC) authorized temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements initially provided dollars in amounts of up to $20 billion and $4 billion to the ECB and the SNB, respectively, for use in their jurisdictions. The FOMC approved these liquidity swap lines for a period of up to six months and later extended this term to October 30, 2009.
As demand for dollar funding rose further over the course of 2008, the FOMC authorized the expansion of its existing swap lines with the ECB and SNB. In the fall, the formal quantity limits on these lines, as well as on swap lines that were set up with the Bank of Japan and the Bank of England, were eliminated. The FOMC also authorized new liquidity swap lines with 10 other central banks: the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, the Danmarks Nationalbank, the Bank of Korea, the Bank of Mexico, the Reserve Bank of New Zealand, the Norges Bank, the Monetary Authority of Singapore, and the Sveriges Riksbank.
The Term Securities Lending FacilityOn March 11, 2008, to address increasing liquidity pressures in funding markets, the Federal Reserve announced the establishment of a Term Securities Lending Facility (TSLF). Under the TSLF, the Federal Reserve lends up to $200 billion of Treasury securities to primary dealers for a term of 28 days (rather than overnight, as in the regular securities lending program); the lending is secured by a pledge of other securities. Initially, the eligible collateral included other Treasury securities, federal agency debt, federal agency residential mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. In September, this list was broadened to include all investment-grade debt securities. The TSLF is intended to strengthen the financing position of primary dealers and foster improved conditions in financial markets more generally. Securities are made available through weekly auctions. This facility is currently scheduled to expire on October 30, 2009.
The Primary Dealer Credit FacilityTo bolster market liquidity and promote orderly market functioning, on March 16, 2008, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility--the Primary Dealer Credit Facility--to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility became available for business on Monday, March 17, and was originally instituted for a term of six months; this term was subsequently extended, and the facility is currently set to expire on October 30, 2009. Collateral pledged to secure loans under this facility was initially limited to investment-grade debt securities; subsequently, eligible collateral was expanded to include all collateral eligible for pledge in triparty funding arrangements through the major clearing banks. The interest rate charged on such credit is the same as the primary credit rate at the Federal Reserve Bank of New York.
Provision of Liquidity to Other Market Participants
The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity FacilityOn September 19, 2008, the Federal Reserve announced the creation of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF). Under this program, the Federal Reserve extends nonrecourse loans at the primary credit rate to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds. This initiative is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP markets and broader money markets. Although the AMLF was initially authorized through January 2009, the Board subsequently extended its operation through October 30, 2009.
The Commercial Paper Funding FacilityOn October 7, the Federal Reserve authorized the creation of the Commercial Paper Funding Facility (CPFF) to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby increase the availability of credit for businesses and households. The CPFF is currently authorized to purchase commercial paper through October 30, 2009.
Under the CPFF, Federal Reserve credit is provided to a special purpose vehicle (SPV) that, in turn, purchases commercial paper of eligible issuers. The Federal Reserve Bank of New York has committed to lend to the SPV on a recourse basis, with such loans secured by all the assets of the SPV. The SPV purchases from eligible issuers three-month U.S. dollar-denominated commercial paper through the Federal Reserve Bank of New York's primary dealers. Eligible issuers are U.S. issuers of commercial paper, including U.S. issuers with a foreign parent company. The SPV purchases only U.S. dollar-denominated commercial paper (including ABCP) that is rated at least A-1/P-1/F1.
The maximum amount of a single issuer's commercial paper that the SPV may own at any time is the greatest amount of U.S. dollar-denominated commercial paper the issuer had outstanding on any day between January 1 and August 31, 2008. The SPV will not purchase additional commercial paper from an issuer whose total commercial paper outstanding to all investors (including the SPV) equals or exceeds the issuer's limit. Pricing is based on the three-month OIS rate plus fixed spreads. At the time of its registration to use the CPFF, each issuer must pay a facility fee equal to 0.1 percent of the maximum amount of its commercial paper the SPV may own.
The Money Market Investor Funding FacilityOn October 21, 2008, the Federal Reserve announced the creation of the Money Market Investor Funding Facility (MMIFF). Under the MMIFF, the Federal Reserve Bank of New York will provide senior secured funding to a series of SPVs to facilitate an industry-supported private-sector initiative to finance the purchase of eligible assets from eligible investors. Eligible assets include U.S. dollar-denominated certifi cates of deposit and commercial paper issued by highly rated financial institutions and having remaining maturities of 90 days or less. Eligible investors currently include U.S. money market mutual funds and other similar entities. By backstopping the sales of money market instruments in the secondary market, the MMIFF should improve the liquidity of money market investors, thus increasing their ability to meet redemption requests and their willingness to invest in money market instruments. Improved money market conditions enhance the ability of banks and other financial intermediaries to accommodate the credit needs of businesses and households.
The SPVs will purchase eligible money market instruments from eligible investors using financing from the MMIFF and from the issuance of ABCP. The SPVs will issue to the seller of each eligible asset ABCP equal to 10 percent of the asset's purchase price, with the remaining 90 percent of the transaction funded in cash. The Federal Reserve Bank of New York will commit to lend to each SPV 90 percent of the purchase price of each eligible asset. These loans will be on an overnight basis and at the primary credit rate. The loans will be senior to the ABCP, with recourse to the SPV, and secured by all the assets of the SPV. At the time of an SPV's purchase of a debt instrument issued by a financial institution, the debt instruments of that financial institution may not constitute more than 15 percent of the assets of the SPV, except during an initial ramp-up period when the concentration limit may be 20 percent. The SPVs financed by the MMIFF are scheduled to enter a wind-down process on October 30, 2009.
The Term Asset-Backed Securities Loan FacilityOn November 25, 2008, the Federal Reserve Board announced plans for the Term Asset-Backed Securities Loan Facility (TALF), a facility that will help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. The TALF is designed to increase credit availability and support economic activity by facilitating renewed issuance of consumer and small business ABS at more normal interest rate spreads.
Under the current design of the TALF, the Federal Reserve Bank of New York will lend up to $200 billion on a nonrecourse basis to holders of certain AAA-rated ABS backed by consumer and small business loans.
Eligible securities must have been issued on or after January 1, 2009, and all or substantially all of the credit exposures underlying eligible ABS must be newly or recently originated exposures to U.S.-domiciled obligors. Originators of the credit exposures underlying eligible ABS must have agreed to comply with, or already be subject to, the executive compensation requirements of the Emergency Economic Stabilization Act of 2008.
On February 10, 2009, the Federal Reserve Board announced that it is prepared to undertake a substantial expansion of the TALF. The expansion could increase the size of the TALF to as much as $1 trillion and could broaden the eligible collateral to encompass other types of newly issued AAA-rated asset-backed securities, such as commercial MBS and private-label residential MBS. An expansion of the TALF would be supported by the provision by the Treasury of additional funds from the Troubled Asset Relief Program (TARP).
All U.S. persons who own eligible collateral may participate in the TALF, and each borrower must use a primary dealer to access the TALF. The Federal Reserve Bank of New York will offer a fixed amount of loans under the TALF on a monthly basis. Via a competitive, sealed-bid auction process, the Federal Reserve Bank of New York will award loans in amounts equal to the market value of the ABS less a haircut. The loans will be nonrecourse, will be secured at all times by the ABS, and will have a three-year term, with interest payable monthly. The Treasury, under the TARP, will provide credit protection to the Federal Reserve Bank of New York in connection with the TALF. The facility will cease making new loans on December 31, 2009, unless the Board agrees to extend the facility.
Direct Purchases of AssetsOn September 19, 2008, the Federal Reserve announced that, to support market functioning, the Open Market Trading Desk would begin purchasing federal agency discount notes in the secondary market for the System Open Market Account. These instruments are short-term debt obligations issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Similar to secondary-market purchases of Treasury securities, purchases of Fannie Mae, Freddie Mac, and Federal Home Loan Bank debt are conducted with the Federal Reserveís primary dealers through a series of competitive auctions.
To help reduce the cost and increase the availability of residential mortgage credit, the Federal Reserve announced on November 25 a program to purchase up to $100 billion in direct obligations of housing-related government-sponsored enterprises (GSEs) and up to $500 billion in MBS backed by Fannie Mae, Freddie Mac, the Federal Home Loan Banks, and Ginnie Mae. Purchases of agency debt obligations began in December, and purchases of MBS began in January.
The program to purchase GSE direct obligations has initially focused on fixed-rate, noncallable, senior benchmark securities issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. Over the course of the program, the Federal Reserve may change the scope of purchasable securities. Purchases will be made through a multiple-price competitive auction process. Primary dealers are eligible to transact directly with the Federal Reserve and are encouraged to submit offers for themselves and their customers.
Support of Critical Institutions
Bear StearnsIn mid-March of 2008, The Bear Stearns Companies, Inc., a major investment bank and primary dealer, was pushed to the brink of failure after losing the confidence of investors and finding itself without access to short-term financing markets. A bankruptcy filing would have forced the secured creditors and counterparties of Bear Stearns to liquidate underlying collateral, and given the illiquidity of markets, those creditors and counterparties might well have sustained substantial losses. If they had responded to losses or the unexpected illiquidity of their holdings by pulling back from providing secured financing to other firms and by dumping large volumes of illiquid assets on the market, a much broader financial crisis likely would have ensued. Thus, the Federal Reserve judged that a disorderly failure of Bear Stearns would have threatened overall financial stability and would most likely have had significant adverse implications for the U.S. economy.
After discussions with the Securities and Exchange Commission and in close consultation with the Treasury, the Federal Reserve determined that it should invoke emergency authorities to provide special financing to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Co. JPMorgan Chase agreed to purchase Bear Stearns and assume the companyís financial obligations. The Federal Reserve agreed to supply term funding, secured by $30 billion in Bear Stearns assets, to facilitate the purchase. A limited liability company, Maiden Lane LLC, was formed to facilitate the arrangements associated with the purchase by acquiring certain assets of Bear Stearns and managing those assets through time to maximize repayment of the credit extended and to minimize disruption to financial markets. JPMorgan Chase completed the acquisition of Bear Stearns on June 26, and the Federal Reserve extended approximately $29 billion of funding to Maiden Lane on that date.
American International GroupIn early September, the condition of American International Group, Inc. (AIG), a large, complex financial institution, deteriorated rapidly. In view of the likely systemic implications and the potential for significant adverse effects on the economy of a disorderly failure of AIG, on September 16, the Federal Reserve Board, with the support of the Treasury, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the firm to assist it in meeting its obligations and to facilitate the orderly sale of some of its businesses. This facility had a 24-month term, with interest accruing on the outstanding balance at a rate of 3-month Libor plus 850 basis points, and was collateralized by all of the assets of AIG and its primary nonregulated subsidiaries. On October 8, the Federal Reserve announced an additional program under which it would lend up to $37.8 billion to fi nance investment-grade, fixed-income securities held by AIG. These securities had previously been lent by AIGís insurance company subsidiaries to third parties.
In November, the Treasury announced that it would purchase $40 billion of newly issued AIG preferred shares under the TARP, which allowed the Federal Reserve to reduce from $85 billion to $60 billion the total amount available under the credit facility. Further, the interest rate on that facility was reduced to Libor plus 300 basis points, the fee on undrawn funds was reduced to 75 basis points, and the term of the facility was lengthened from two years to fi ve years. The Federal Reserve also announced plans to restructure its lending related to AIG by extending credit to two newly formed limited liability companies. The first, Maiden Lane II LLC, received a $22.5 billion loan from the Federal Reserve and a $1 billion subordinated loan from AIG and purchased residential mortgage-backed securities from AIG. As a result of these actions, the securities lending facility established on October 8 was subsequently repaid and terminated. The second new company, Maiden Lane III LLC, received a $30 billion loan from the Federal Reserve and a $5 billion subordinated loan from AIG and purchased multisector collateralized debt obligations on which AIG has written credit default swap contracts.