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Monday, 6 October 2008

Sunday in Washington

Sunday night was also a working day at the Federal Reserve and US Treasury thinking up how to follow TARP with further measures to jump-start the credit markets e.g. additional liquidity operations, a rate cut, co-ordination with other central banks etc. The Fed is likely to further expand both the size and scope of its liquidity operations. Bankers are complaining about a shortage of US Treasuries to be bought in the normal way - too much is conditional swap material and everyone else is holding what they've got. What happens when US Treasuries are unavailable in the secondary markets? One relief measure may be expanding the Term Securities Lending Facility, created by the Fed in March to help banks access liquidity. Another is the CP market, also shrinking substantially. Money market funds could be permissioned to borrow money from banks to fund their holdings of CP, but they have a lot already from the hedge funds? What is the Fed offers term loans on an unsecured basis to regulated banks at a fixed spread over its main interest, therefore heavily pulling down the 3 month LIBOR? Or, why not just order banks to lend to each other at a fixed rate, especially if the Fed guarantees no more bank failures this year or next? TARP allows the Treasury to guarantee the Fed against any losses incurred in such operations and gives the Fed the power to pay interest on reserves to help smoothe liquidity operations. That would be radical?
Next Monday may see the publication of TARP's detailed guidelines and selection of a handful of private asset managers to run the programme. Hank Paulson, Treasury secretary, vowed to “move rapidly to implement the new authorities, but also methodically” and insisted “transparency” would be important throughout. Transparancy may be TARP's downfall, however, if banks applying to TARP are thereby exposed to reputational risk as discussed below in earlier blogs. TARP's mechanism is a reverse-auction for the acquisition of toxic assets from a range of financial institutions, but cannot function before November! A reverse auction may also expose who among the banks are the most desperate! It says little for the idea that the Fed and US Treasury are going to make fair value valuations of somewhere between fire-sale and hold-to-maturity prices? Why couldn't a reverse auction merely confirm current fire-sale prices? Hey, I'm a private AM; I'd like to earn the fees on this.

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