Stepping Up to the Fed's Window

How exactly does an investment bank borrow from the Fed? That's what Wall Street is trying to figure out under the Federal Reserve's new lending facility. A number of Wall Street firms are using the Fed's facility to exchange their securities for cash, a potential relief for officials who had worried that the stigma of borrowing from the Fed could keep firms away. Morgan Stanley borrowed $2 billion Tuesday from the Fed using "pretty liquid" assets as collateral, said Chief Financial Officer Colm Kelleher. "We didn't need to, but I felt we should to show there was no stigma, and show support for what the Fed had done," he said. Goldman Sachs Group Inc. tapped it for $100 million Tuesday. Lehman Brothers Holdings Inc. also used it. My Trip to the Discount Window1: Our correspondent braves stigma in the service of the nation's financial stability. The facility was among the more dramatic steps that the Fed has taken to ensure that financial institutions, overloaded with hard-to-sell securities, wouldn't face the kind of cash squeeze that crippled Bear Stearns Cos. The facility allows securities dealers, including investment banks, to borrow cash directly from the Fed by exchanging a range of bonds for overnight loans that can be rolled over daily. Previously, this type of lending had only been available to commercial banks. The terms on these loans are potentially favorable to Wall Street, subjecting firms to relatively easy requirements on some types of collateral and to a low interest rate. Liquidity Machine "The Fed is taking short-term credit risk that it's monitoring very closely, while providing the market with the liquidity it needs," says Art Certosimo, head of broker-dealer services at Bank of New York Mellon, one of the largest clearing banks. Primary Dealer Credit Facility The Fed's facility is called the "Primary Dealer Credit Facility." It works much the same way as regular securities repurchase, or repo, agreements that Wall Street firms conduct with each other every day in normal times. Overnight to 120 days Financial firms enter into repo transactions to borrow or lend short-term money -- a financial institution swaps securities as collateral in return for cash. It agrees to repurchase the securities a day or so later when the agreement matures in exchange for the cash plus interest on the loan. 4.5 Trillion Repo Market The repo market is $4.5 trillion in size. In this case, the lender is the Fed, and the interest rate it is charging on the loans is the discount rate, or 2.5%. Requirements to deal with Fed In exchange for its loans, the Fed is accepting a grab bag of collateral from investment banks. The securities it is taking include debt such as corporate bonds, muni bonds, mortgage-backed securities and even collateralized debt obligations. The Fed requires the securities to have market prices and to be rated "investment-grade" by at least two credit-rating services. To get the loans, the dealers must deposit the securities with a clearing bank, which handles the transfer of securities and cash. Lenders in the repo market typically require that borrowers give them more collateral than the value of the loan, to protect themselves from market-price declines in the event the loan can't be paid back and the securities have to be sold. According to people familiar with the matter, the Fed is lending $95 for every $100 in securities that dealers bring to it, regardless of the type of collateral. In other words, the Fed requires the same amount of additional collateral whether a dealer is borrowing against a Triple A-rated corporate bond or a Triple B-minus subprime-backed bond. Only Fed is so generous In regular day-to-day repos, institutions have been lending less than $90 for every $100 of riskier mortgage-backed securities. The Fed's uniform margin requirements aren't set in stone. So far they have gotten the attention of some bankers. When it makes loans to commercial banks through its discount window, the Fed has varying margin requirements. For example, it lends $98 for every $100 in Treasury securities but $92 for every $100 in foreign-currency corporate bonds that are rated Triple-A. Insights Discount Window(Primary Deal Credit Facility): Collateral can be Repo Collateral _ IG Corp _ Muni + MBS + ABS + CMBS Repot: Collateral only US Govt + Agencies