Fed to treble lending

The Federal Reserve increased its Term Auction Facility (TAF) auctions by $300 billion on Monday, and expects its lending to reach $900 billion by November; three times the amount of liquidity provision given to date.

Starting on October 6, the plan will provide an extra $150 billion each to both 28-day and 84-day Term Auction Facility (TAF) auctions. The Fed estimates this new measure will bring the amounts outstanding under the regular TAF program to $600 billion - a figure which will grow to $900 billion by the end of the year, following two forward TAF auctions to be conducted in November.

Gus Faucher, director of macroeconomics at Economy.com, a subsidiary of rating agency Moody’s, said an expanded TAF is “not going to be enough in and of itself, but the hope is that together with all the other Fed and Treasury department moves it will be enough”.

In every auction since the inception of TAF there has been substantially greater propositions submitted than accepted. In the auction of September 22, a week after the collapse of Lehman Brothers, 85 bidders made a record $133.56 billion worth of propositions and received only $75 billion worth of funds.

The correlation between submitted and accepted propositions is expressed in a bid/cover ratio. The first TAF auctions, which took place on December 17 and December 20, 2007, recorded the highest ever bid/cover ratios at 3.08 and 2.88 respectively. On December 17, $61.54 billion worth of propositions were submitted by 93 bidders, but only $20 billion were accepted. On December 20, 73 bidders submitted $57.67 billion worth of propositions and only $20 billion were accepted.

The bid/cover ratio has generally fallen since then, with the highest ratios in 2008 coming on February 25 when 72 bidders made $67.96 billion worth of propositions, with only $30 billion of bids accepted - a bid/cover ratio of 2.27. The second highest ratio in 2008 was 2.19 recorded on August 11. But the fall is largely due to successive increases in supply rather than any drop in demand. September 22 saw a total of $133.6 billion in bids for $75 billion offered, the highest total of bids so far.

The TAF is a short term lending facility which was introduced on December 12, 2007 to try to alleviate pressures in short-term funding markets by allowing depository institutions to borrow from the Federal Reserve for a fixed term against the same collateral that is accepted at the discount window.

In Monday’s announcement, the Federal Reserve Board also said that it would begin to pay interest on the required and excess reserve balances of depository institutions. Faucher commented: “This allows Fed monetary policy to be more effective” - both by allowing the central bank to control short term rates, and by doing away with the complicated process of buying and selling securities that previously determined the Fed’s fund rate. “In combination with other efforts this will help,” he added.

Recent changes in law as a result of market turmoil have also aided this process. The Financial Services Regulatory Relief Act of 2006, which originally authorised the Federal Reserve to begin paying interest on these balances from October 1, 2011, has been overridden and replaced by this year's Emergency Economic Stabilisation Act, which brought this date forward to October 1, 2008.

See also: TAF auctions hint at liquidity improvement
Fed ramps up bank support to $75 billion