Tuesday, March 11, 2008

Comments on the TSLF

by Calculated Risk on 3/11/2008 05:38:00 PM

Professor Krugman writes Sterilized intervention, big time

[B]asically the Fed is going to be swapping Treasuries for dubious securities, in an attempt to give the market a REALLY BIG slap in the face. I understand what they’re doing, and might have done the same in their place. Still, all I can say is Wheeeee!
Also Krugman suggests Bernanke is following the paper he co-authored in 2004: see Non-standard Ben:
[A]nyone trying to understand what the Fed’s up to should look at the 2004 paper Ben Bernanke co-authored on “Monetary Policy Alternatives at the Zero Bound”. One alternative was “quantitative easing” — basically forcing extra reserves on banks, whether they want them or not, which is what the Fed did in the first wave of panic. Another is “changing the composition of the central bank’s balance sheet”, that is, buying assets other than the usual T-bills.
Steve Waldman at interfluidity writes: The Fed's Balance Sheet Constraint
After the FAF expansion, repo program, and TSLF, the Fed will have between $300B and $400B in remaining sterilization capacity, unless it issues bonds directly.
In the simplest terms, there are two related problems: a liquidity crisis (now in the 3rd wave), and a solvency crisis. With the TSLF, the Fed is trying to keep credit available for the most credit worthy borrowers in the short term, while they wait for fiscal and monetary policy to hopefully stimulate the economy later this year.

As Waldman notes, the Fed has used up a significant portion of their available resources already. So, this "slap in the face" better work. If we start talking about a 4th wave of the liquidity crisis, watch out!

The solvency crisis will persist until housing prices near their nadir. Since the solvency crisis will remain a threat to spillover into another liquidity crisis, it might be difficult for the Fed to unwind these "temporary" actions any time soon.