Wednesday, March 12, 2008
$200 billion credit exchange for MBS
The Fed said it would lend Wall Street as much as $200 billion from the central bank's own trove of sought-after Treasury bonds and bills for 28 days in exchange for a roughly equivalent amount of mortgage-backed securities, including some that can't ordinarily be used in transactions with the Fed. Uncertainties about the value of the underlying mortgages, plus forced selling by some investors to repay broker loans, have led many investors to spurn these securities, making them especially difficult to trade. By taking some of these securities on its own books, the Fed is seeking to make its primary dealers -- the network of 20 Wall Street firms with which it typically does securities business -- more comfortable buying them from their own clients. It hopes this could lead to higher prices and thus lower yields on the mortgage-linked debt. A decline in those yields could help banks offer lower interest rates to prospective homebuyers. Still, the Fed's efforts won't eliminate the root cause of the economy's problems: falling home prices and a mounting wave of mortgage defaults. Four foreign central banks, including three in Europe, joined in coordinated action with the Fed yesterday, announcing related measures. The Fed aided those efforts by offering the central banks lines of credit, enabling them to make dollar-denominated loans to European banks The centerpiece of the Fed's latest initiative is the Term Securities Lending Facility, under which the Fed will lend its primary dealers as much as $200 billion of Treasury securities from its own $713 billion portfolio of those securities. The Fed initiative is similar in intent to its term-auction facility, launched in December to offer credit to banks. Both focus on specific trouble areas -- the term-auction facility on interbank lending and the new initiative on mortgages. That probably is more effective than blunderbuss interest-rate cuts. As collateral, the Fed will accept debt or mortgage-backed securities issued or guaranteed by Fannie and Freddie, also known as "agency" securities. It will also accept other residential-mortgage-backed securities, provided they are rated triple-A and not on watch for downgrade, though it didn't specify what type. Such "private label" securities have been especially difficult to trade, in part because the Fed doesn't accept them as collateral for ordinary money-market operations. The Fed is requiring the collateral to exceed the amount of the loan to protect against losses, so dealers could be surrendering more than $200 billion of mortgage-backed securities to the central bank. That figure still equals less than 5% of all agency mortgage-backed securities. But it provides a strong incentive to dealers to play their role of holding such securities on their balance sheets temporarily as they try to match would-be buyers and sellers. Indeed, the sum roughly equals all holdings of agency bonds and agency mortgage-backed securities by the primary dealers, said Anthony Crescenzi, bond strategist at Miller Tabak & Co. However, the step falls short of Wall Street hopes that the Fed would buy agency mortgage-backed securities or agency bonds. Senior Fed staffers told reporters that while the central bank has that authority, such purchases could distort the prices of the securities. Spreads between yields on agency mortgage-backed securities and Treasurys soared to 3.5 percentage points last week, their widest since 1986, from 2.5 points a month ago, according to Bear Stearns Cos. They had slipped to 3.36 points by Monday and narrowed further to 3.22 points yesterday. It is the first time the Fed has accepted as collateral MBSs that aren't guaranteed by Fannie Mae or Freddie Mac. Swapping MBSs that are falling in price for iron-clad government bonds will reduce the amount of mortgage securities outstanding in the market, helping to stabilize prices. Still, the Fed shouldn't become a long-term holder of mortgage credit risk. If the government decides to bail out the sector, it should come clean about it and not engineer a surreptitious risk transfer through the central bank. There also is the risk that financial institutions may rely on these injections from the Fed rather than stepping up efforts to bolster their capital and sort out their assets. The Fed should make clear under what circumstances it will begin withdrawing its relief programs. For example, it could use price improvements in MBS instruments as a guide. Or it could say it will tighten collateral requirements gradually. Such measures would give its Wall Street charges both the time and incentive to wean themselves from the central-bank faucet.