Some questions and answers about what the Fed is doing to open up the nation's credit spigots, which were in danger of running dry.
WASHINGTON — Think of the Federal Reserve as a sort of über-lender for banks and investment houses. In the past weeks and months, it has created a number of innovative — some unprecedented — lending programs to open up the nation’s credit spigots, which were in danger of running dry. The free flow of credit is essential to keeping the country’s financial and economic wheels turning.
Some questions and answers about what the Fed is doing:
Q: Why are financial institutions having problems?
A: A meltdown in the housing and credit markets spooked banks, investment firms and other financial institutions, making them reluctant to lend, buy, sell and do business with each other.
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Financial institutions racked up multibillion-dollar losses when mortgage-linked investments soured with the housing market’s stunning collapse. Problems spread and fear tightened its grip on financial institutions, which shunned risk and fled to super-safe Treasury securities, backed by the U.S. government.
Q: Why did the Fed set up the new lending facilities?
A: By giving financial institutions new lending options, the Fed was not only offering relief to squeezed companies but also trying to stop a broader panic from taking hold that could freeze the U.S. financial system.
Thus, the Fed’s actions also were intended to restore confidence and trust among financial players — ingredients needed for the smooth functioning of the financial markets.
Q: OK. These lending facilities — for instance the TAF or the TSLF — seem like a confusing alphabet soup to me. What is the TAF?
A: When credit problems took another turn for the worse in December, the Federal Reserve set up a new program, the Term Auction Facility, or TAF, for squeezed banks to get their hands on cash through 28-day loans offered by the Fed.
There was a twist: The Fed would conduct auctions, where banks bid for a slice of the total pot offered at the auction.
The Fed has provided a total $260 billion in short-term loans to banks through eight auctions that started in December.
Q: How does that help individuals and businesses?
A: If banks have adequate cash on hand, they may be more likely to make loans to people and businesses. People depend on credit to make big-ticket purchases and businesses use it to build, expand and create jobs.
Q: Why set up this facility if banks already have the option of going to the Fed’s “discount window” for an emergency loan?
A: Tapping the Fed’s discount window can put a stigma on a bank if word gets out. Analysts say it is akin to getting branded with a financial scarlet letter.
When the credit crisis intensified in August, the Fed worked hard to remove that blot.
But banks remained fearful that market watchers would find out if they got a loan through the window, which could undermine customers’ confidence in the institution’s soundness.
The Fed does not reveal the identity of banks using the discount window and doesn’t reveal which banks tap the auction facility for loans.
Q: What is the TSLF?
A: As credit problems spread from banks to other institutions, the Fed on March 11 announced a new lending program for big Wall Street investment houses called the Term Securities Lending Facility.
Instead of cash loans, these big investment firms could borrow much-in-demand Treasury securities from the Fed and put up more risky investments, including certain shunned mortgage-backed securities as collateral for the 28-day loans.
Like the TAF, these loans of Treasurys would be made available through an auction, the first of which was slated for today.
As much as $200 billion worth of Treasurys will be made available; the first slice up for bid is for $75 billion.
This effort has a number of purposes. It is designed to make investment houses more inclined to lend to each other.
“My balance sheet appears stronger because I own more Treasurys that are rock-solid. Then other financial institutions are less nervous about extending credit to this institution,” explained Mark Zandi, chief economist at Moody’s Economy.com.
The program also is aimed at providing relief to the distressed market for mortgage-linked securities.
Questions about their value and dumping of these securities have driven up mortgage rates, aggravating the housing crisis.
Since the Fed’s announcement of this new program, however, mortgage rates have eased somewhat, suggesting the Fed may have helped to restore some confidence.
Q: Didn’t the Fed recently announce another lending program for Wall Street firms?
A: Yes. In an extraordinary move March 16, the Fed — in the biggest expansion of its lending authority since the 1930s — created a new lending facility where big Wall Street firms could go directly to the Fed for overnight loans of cash.
For years, that privilege was only given to commercial banks through the Fed’s discount window.
At the time, the nation’s fifth-largest investment firm, Bear Stearns — which had invested heavily in mortgage-backed securities that soured — was on the verge of collapse.
It was hit with a flood of margin calls, forcing it to pony up more money or sell assets.
In a matter of hours, customers and investors fled. Fears grew that other big investment firms could be in jeopardy.
Goldman Sachs, Lehman Brothers and Morgan Stanley last week said they had begun to test the new lending mechanism.
On one day alone, lending reached $28.8 billion, according to a Fed report.
Q: Does the Fed have the authority to lend to others?
A: It does. The Fed has the power “in unusual and exigent circumstances” to expand emergency lending to other types of companies and even to individuals.
Q: Where does the Fed get its money?
A: The Fed is funded from the interest earned on its vast portfolio of securities. It is not funded by Congress.
Any profit or loss from the loans ultimately would end up with taxpayers.
After covering its expenses, the Fed gives what is left over to the Treasury Department. Last year, the Federal Reserve gave the Treasury $34.4 billion.