What the Fed Can Do Besides Cutting Interest Rates

The U.S. Federal Reserve on Tuesday said it would extend the terms of three emergency liquidity programs by three months, to April 30, 2009.

The Fed said the extension made the Primary Dealer Credit Facility (PDCF), the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility (AMLF) and the Term Securities Lending Facility (TSLF) consistent with the terms already authorized for other liquidity facilities.

The following is a look at the Fed's evolving liquidity toolkit.

Discount Window

The discount window is the Fed's traditional way of providing liquidity to depository institutions that it regulates. The Fed's first liquidity salvo was on Aug. 17, 2007, when it unexpectedly lowered the discount rate by a half percentage point, narrowing the spread above the benchmark federal funds rate--the rate banks charge each other for loans--to a half percentage point. It narrowed the spread to just a quarter point on March 16. The Fed accepts a broad range of collateral for loans at the discount window.

Shoring Up Money Market Mutual Funds, Mortgage Debt

The Fed on Sept. 19 said it would make discount window loans to financial institutions to allow them to buy asset-backed commercial paper from money market mutual funds. It also said it would buy notes issued by mortgage agencies Fannie Mae, Freddie Mac and Federal Home Loan Banks.

On Nov. 26 the Fed expanded those potential purchases by $100 billion and mortgage security purchases by $500 billion.

Term Asset-Backed Securities Loan Facility

The Fed on Nov. 25 announced it will lend up to $200 billion on a non-recourse basis to holders of some AAA-rated asset-backed securities (ABS) that hold fresh consumer and small business loans. The Treasury will pitch in $20 billion to help underwrite those investments.

Commercial Paper Funding Facility

The Fed on Oct. 7 said it would fund purchases of highly rated, U.S.-dollar denominated, three-month commercial paper.

Purchases will be made through a special purpose vehicle that would begin purchases on Oct. 17. The CPFF will cease purchases on April 30, 2009, unless extended.

Money Market Investor Funding Facilities

The Fed on Oct. 21 announced a measure to help restore liquidity to money markets by facilitating lending by mutual funds and investors. The facility will be authorized to buy $600 billion in certificates of deposits and commercial paper with remaining maturities of 90 days or less. The facility is scheduled to wind down starting on April 30, 2009.

Swap Lines With Other Central Banks

The Fed has established several currency swap lines with other central banks so they have U.S. dollars to lend in their markets. All of the swaps initially had set limits, but on Oct. 13 the Fed lifted the cap on its swaps with the European Central Bank, Swiss National Bank and Bank of England. On Oct. 14, it erased the upper limit on its line with the Bank of Japan. The Fed also has authorized swap lines with the central banks of Canada, Norway, Australia, Sweden and New Zealand.

Primary Dealer Credit Facility

Traditionally, the Fed has lent only to insured depository institutions through its discount window. However, on March 16 it launched a new facility for investment banks, marking the first time since the Great Depression that it had lent to non-depositories. The program was to sunset after six months but the Fed first extended it until Jan. 30, 2009, and now until April 30, 2009.

Term Securities Lending Facility

Under the $200 billion TSLF, the New York Fed conducts weekly auctions of 28-day loans of Treasury securities to primary dealers. Those auctions will continue until at least April 30, 2009.

Auction of Term Securities Lending Facility Options

The Fed authorized the New York Fed to auction options for primary dealers to borrow securities from the TSLF. The Fed said the options will be for exercise ahead of periods when market conditions have become stressed, like quarter-ends. The facility allows up to $50 billion of draws on the TSLF, which would be in addition to the $200 billion that may be offered under regular TSLF auctions.

Term Auction Facility Loans

The Fed launched the Term Auction Facility in December 2007 to provide funds over a longer period to a wider range of banks and has steadily enlarged it. On Oct. 6, the Fed increased TAF to $150 billion for both 28- and 84-day auctions. The increases eventually will lift outstanding amounts under the regular TAF to $600 billion. The Fed also has held two forward TAF auctions in which it offered $150 billion in each, although the auctions were undersubscribed.

Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

The AMLF, announced Sept. 19, provides loans to depository institutions to buy asset-backed commercial paper from money market mutual funds. The program is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally. The program was first set to run through January but will now run through April 30, 2009.

Term Repurchase Agreements

The Fed on March 7 announced a series of 28-day repurchase transactions for primary dealers, expected to add up to $100 billion.

Paying Interest on Reserves

The Fed was authorized as part of the $700 billion bailout program for financial firms to pay interest on the reserves banks hold at the central bank, which allows the Fed to expand its balance sheet without pushing down interest rates.

Other Traditional Tools

The Fed also provides liquidity through its traditional open market operations and securities lending to primary dealers. The loans of funds or Treasury securities are typically overnight repurchase agreements against collateral of Treasuries, agencies, or agency MBS.

Copyright 2008 Reuters. Click for restrictions.