The Fed has taken another quite radical step to somehow stop the downward de-leveraging spiral in the banking system.
Previously the Fed had initiated a $100 billion ‘TAF‘ program through which it lended money equivilants to banks for renewable 28 days periods. It allowed as collatoral mortgage-backed securities (MBS) issued by federal chartered agencies, i.e. Fannie Mae and Freddie Mac, which are deamed to be somewhat secure though currently difficult to sale.
That didn’t stop the downward spiral but slowed it down for a while only to accelerate again.
Now the Fed initiated another program with a volume of $200 billion. This ‘TSLF‘ program works the same way but accepts an additional type of collatoral, privately issue MBS.
Agency backed MBS and privately, bank issued, MBS seem to be equivilant as both are rated as high quality AAA papers. But while agency-securities may be safe and only temporarily hard to sell, the private AAA rated MBS do look the same but are a different animal in disguise.
As Bloomberg reports:
Even after downgrading almost 10,000 subprime-mortgage bonds, Moody’s and S&P have yet to cut the AAA securities in the ABX indexes used to track the debt. Downgrades of those securities would strip bonds valued at an additional $120 billion of their top rankings.
The Fed now starts to lend money to banks while taking as collatoral paper that is likely to be worth much less than what the current rating agency imprint says.
The pawnbroker of last resort started to lend big money against steel rings with glass splinters because some obviously falsificated certificate pretends that those rings are platinum each with a 1 carat diamond.
What will the pawnbroker do when the loan he gave to such collatoral will not be payed back?
The Dow is up 300+ points today using the Fed announcement as a pretense for a relief rally. But how long with such fudging with reality hold? Two days. Three?
Hey Bernanke, may I offer some of my used cloth to lend a few billion bucks? I really promise not to default and my neighbor says that they still look like they are worth trillions.