The Fed slaps Mr. Market a little harder

Finish the quote: “When central banks innovate, …”

Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS.

I admit I am little out of my depth here, but I shall give it a whirl. Some people are calling this a “nationalization” or “bail-out” of the mortgage industry. I do not think so. These mortgage-backed instruments are already taken as collateral at the discount window, so any bank can already get a 28-day loan against them directly.

What this does, I think, is to increase the supply of Treasuries, especially relative to MBSes. Increased supply = decreased price = higher yield = lower credit spreads. And those spreads are what have been causing the panic recently.

See also my comments on the Calculated Risk blog here, here, and here.

Krugman calls this “a BIG SLAP” in the market’s face.

See also the WSJ blog:

• TSLF reax roundup
• Former Fed Staffer Backs “Appropriate” Action

I am looking forward to reading some analysis from Real People.

Update 19:10

Calculated risk has more. In the comments you can find a little “whoops” from yours truly. This new facility is available not only to depository institutions, but to all primary dealers. And that list includes names like Countrywide, Goldman Sachs, Bear Stearns… Who can now take AAA/Aaa non-agency (i.e., non-Fannie, non-Freddie) mortgage-backed securities to the TSLF and get nice shiny Treasuries in return for 28 days. Depository institutions could already take such collateral to the discount window (or TAF) to get an actual cash loan, so it does not do much for them. The story here is that the Fed’s “lender of last resort” facility is now available, albeit in a limited way, to the shadow banking system.

No sooner do I figure this out than I find this article:

Fed action may have targeted Bear Stearns: analyst

Bingo.

But hey, no worries. This is really only a problem if the collateral is worth less than the loan. And of course the collateral isn’t worthless just because nobody on the planet wants to buy it right now…