Via Wolf Street

Indirectly via its Special Purpose Vehicles and its Primary Dealers, the Fed can buy even old bicycles, as long as taxpayers take the losses.

By Wolf Richter for WOLF STREET:

With its announcement this morning, the Fed expanded its three fundamental mechanisms in which it is once again bailing out the biggest risk takers, over-leveraged companies, hedge funds, mortgage REITs, and PE firms; wiping out cash-flows for crash-averse savers and holders of Treasury securities; and creating special opportunities for well-connected individuals who have access to the Fed’s programs. And let’s get this straight: None of the programs are going to fix the economy.

These bailout programs fall into three mechanisms:

1. Fed buys assets directly. Until this morning, this was limited to Treasury securities, agency debt, and residential MBS backed by Ginnie Mae (US government agency) and the GSEs, Freddie Mac and Fannie Mae. This morning, the Fed added agency-backed commercial mortgage-backed securities (CMBS) to the list.

2. Fed sets up special purpose vehicles (SPV) and lends to the SPVs which then buy assets or lend. These SPVs can buy assets the Fed is not allowed to buy and they can lend to entities and individuals to buy certain assets. Under the Federal Reserve Act, these SPVs require taxpayer backing from the Treasury Department to protect the Fed from losses.

3. The Fed lends to its 24 Primary Dealers against collateral, and that collateral can be anything the Fed decides, including now stocks – and in the end finally old bicycles.

The entire alphabet soup of new programs will take a while to get set up and get started. And since they won’t fix the economy and its underlying problems, they might not work as well in accomplishing their goals – making the wealthy wealthier – as they did during the Financial Crisis. So we’ll have to see how this works out.

New Today, March 23.

This morning, March 23, the Fed announced a slew of programs and expansions of existing programs:

QE unlimited: The purchases of Treasury securities and MBS will be unlimited (previously the limit had been $500 billion of Treasury securities and $200 billion of MBS). For this week is said it would buy $375 billion in Treasury securities and $250 billion in MBS.

QE CMBS: QE purchases will now include CMBS but only those that are backed by the GSEs and Ginnie Mae.

PMCCF to lend to large companies. Via the Primary Market Corporate Credit Facility, the Fed will lend to a Special Purpose Vehicle (SPV) that then provides bridge loans with maturities of four years to large investment-grade corporations. They can defer interest and principal payments for six months, which is extendable at the Fed’s discretion. With this, the Fed is trying to kill the pricing of risk of overleveraged companies and protect and make whole the shareholders and creditors of these companies

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SMCCF to buy corporate bonds and US-listed bond ETFs. Under the Secondary Market Corporate Credit Facility, the Fed lends to an SPV to buy existing investment-grade corporate bonds and corporate-bond ETFs.

The insidious TALF is baaaaack. The Fed concocted this Term Asset-Backed Securities Lending Facility during the prior Financial Crisis. Under this program, the Fed lends money to an SPV which lends on a non-recourse basis to entities and well-connected individuals so that they can buy recently issued asset-backed securities (ABS) that they post as collateral.

“Non-recourse” means that if the asset blows up, the individual can just walk away from it unharmed and let the SPV deal with the debris.

These ABS can be backed by credit card loans, auto loans, student loans, equipment loans, floorplan loans, insurance premium finance loans, some loans guaranteed by the Small Business Administration (SBA), and eligible loans on receivables. The loan amounts will be “equal to the market value of the ABS less a haircut and will be secured at all times by the ABS,” the Fed says.

A little history on TALF: At the end of 2010, under orders from Congress, the Fed released data on over 21,000 transactions it performed during the Financial Crisis, which revealed among many other outrageous acts, that the Fed lent to well-connected individuals and all kinds of hedge funds and others under its TALF program so that they would buy certain assets, such as these consumer loan ABS, drive up their prices, sell them to pension funds and others later for a huge profit, and pay back the loans to the Fed.

These well-connected individuals included John A. Paulson, Michael Dell, Christy K. Mack (wife of former Morgan Stanley CEO John Mack), Kendrick R. Wilson III (former Goldman executive and top aide to Hank Paulson Jr.), H. Wayne Huizenga (founder of AutoNation and Waste Management), Jonathan S. Sobel (head of Goldman’s mortgage department), etc. Some very wealthy people made a lot of money off the Fed’s bailout programs even as workers and the economy was in deep trouble.

Expanded MMLF to municipal demand notes and CDs. This Money Market Mutual Fund Liquidity Facility was announced last week (see way below). Via SPVs, it buys short-term corporate paper that normally is bought by money market funds. Companies borrow short term from investors by selling corporate paper to money market mutual funds. This short-term corporate debt is now perceived as riskier, including the rising risk of defaults, and these money market funds have come under stress, much like their long-term brethren, regular corporate bond funds.

Today, the Fed expanded the securities that its SPVs are buying to include municipal variable rate demand notes (VRDNs) and bank certificates of deposit.

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Expands CPFF to municipal paper. Last week the Fed announced the Commercial Paper Funding Facility, where the Fed lends to an SPV that then buys corporate commercial paper. Today the Fed expanded CPFF to where the SPV can buy “high-quality,” tax-exempt commercial paper issued by municipal borrowers.

Taxpayers eat the losses of SPVs. Under the TALF, PMCCF, SMCCF, MMLF, and CPFF, the Fed provides loans to SPVs. These SPVs then do the actual deals. If the assets they buy or take on as collateral default, they may produce losses for the SPV. To avoid transferring those losses to the Fed, the Treasury Department, via its Exchange Stabilization Fund (ESF), provides $10 billion in taxpayer money as equity capital to each SPV to start with. Once an SPV blows through $10 billion in losses, it just takes a technical adjustment for taxpayers to be on the hook for more.

The Fed referenced Section 13(3) of the Federal Reserve Act as giving it authority, with approval of the Treasury Secretary, for the TALF, PMCCF, SMCCF, MMLF, and CPFF.

Last week.

Unlimited repos. There is now not much demand for repos, and they’ve been undersubscribed, but the Fed is now offering essentially unlimited cash under overnight and term repurchase agreements, amounting to over $1 trillion a day, if anyone wants it, but there are not a lot of takers.

Expanded MMLF to municipal-debt money market funds (announced March 20). The Money Market Mutual Fund Liquidity Facility, announced earlier in the week, was expanded to allow the Boston Fed “to make loans available to eligible financial institutions secured by certain high-quality assets purchased from single state and other tax-exempt municipal money market mutual funds.”

Enhanced standing US dollar liquidity (swap) arrangements with major central banks (announced March 20). The Fed, the Bank of Canada, the Bank of England, the Bank of Japan, the ECB, and the Swiss National Bank agreed to enhance the frequency of the US dollar liquidity swap line operations of 7-day maturities from weekly to daily. The swap lines are designed to reduce the stress in the overseas US dollar funding market (can’t they borrow in their own currencies, for crying out loud?).

New swap agreements with lesser central banks (announced March 19). The Fed made available up to $60 billion each to the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Korea, the Banco de Mexico, the Monetary Authority of Singapore, and the Sveriges Riksbank (Sweden); and $30 billion each to the Danmarks Nationalbank, the Norges Bank (Norway), and the Reserve Bank of New Zealand.

Established the MMLF to bail out money market mutual funds  (announced March 18). Via the Money Market Mutual Fund Liquidity Facility, the Boston Fed will make loans to US banks or US branches of foreign banks that then buy “high-quality” assets from money market mutual funds and post those as collateral. Eligible assets are unsecured and secured commercial paper, agency securities, and Treasury securities.

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Taxpayers provide $10 billion in credit protection to the Fed for the MMLF, via the Treasury Department’s ESF and with approval of the Treasury Secretary. Authority cited is Section 13(3) of the Federal Reserve Act. Taxpayers eat the losses.

Established the PDCF to lend to Primary Dealers (announced March 17). Under this Primary Dealer Credit Facility, the Fed lends directly to its 24 “primary dealers” – large broker-dealers and banks, the majority of which are US branches of foreign banks (list of the 24 primary dealers and their country). These loans will be overnight funding and term funding with maturities up to 90 days. Interest rate is the Primary Dealer Credit Rate of currently 0.25%. Collateral for these loans are a broad range of securities in addition to Treasury securities, agency debt, and agency MBS:

  • Investment-grade corporate bonds
  • International agency securities
  • Commercial paper, rated A1/P1 and A2/P2
  • Municipal securities
  • Mortgage-backed securities
  • CLOs (Collateralized Loan Obligations) rated BBB- (one notch above junk) or above.
  • CMBS (Commercial Mortgage Backed Securities) rated BBB- or above.
  • CDOs (collateralized debt obligations) rated BBB- or above.
  • Stocks
  • “Additional collateral may become eligible at a later date upon further analysis.”

In other words, the Fed doesn’t have to buy the assets; the banks will do that, and the Fed lends to them to do it. And the banks post the acquired assets as collateral.

Established the CPFF to bail out entities that rely on borrowing via commercial paper (announced March 17). Under the Commercial Paper Funding Facility, the Fed lends to an SPV, which then acquires a broad range of US-dollar denominated unsecured and asset-backed commercial paper (rated at least A-1/P-1/F-1). So things get a little rough and they need to be bailed out.

The taxpayer provides $10 billion in equity in the SPV via the Treasury Department’s ESF and will eat the losses. Authority cited is Section 13(3) of the Federal Reserve Act.

This is the moment when yield-chasing turns into a massacre. ReadLeveraged Loans Blow Out. Distressed Corporate Debt Spikes

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