Crud for Cash

By Fester:

A year ago, if a bank wanted to borrow cash from the Federal Reserve, the bank had to put up as collatoral a very high quality security.  These securities included mortgage Agency bonds or a US Treasury bond. The collatoral were items that were AAA and golden.  This made the risk to the Federal Reserve minimal.  Either the bank would repay the loan or the collatoral could be seized and sold at par value.

However in the past year, the Federal Reserve has introduced a bunch of new lending facilities with significantly different rules.  The rules have loosened collatoral requirements.  Banks can exchange collatoral backed obligations, mortgage backed securities and weaker Agency bonds for cash from the Fed.   

These bonds are worth no where near their face value, but banks are getting cash for them as if they are.  The banks are exchanging illiquid crud for cash while the Federal Reserve and thus the US taxpayers are ultimately left holding the bag.   

Ian Welsh at Firedoglake makes a very sobering point concerning the Merril Lynch sale of CDOs and how this is setting a reasonable market price for bad securities:

I will also note, for the record, that the Fed's term facility is taking exactly this sort of trash at near face in exchange for loans. I and others have long argued that they were at great risk of winding up holding a bunch of toxic waste worth only cents on the dollar, and that what they were doing was a huge government bailout. We now have an idea of just how much the government is on the hook for. All the debt may not be this bad, but then, wouldn't you give the Fed the worst stuff as collateral and try and hawk the better stuff? So the US taxpayer may indeed be looking at losing more than 78 cents on the dollar.

If the Federal Reserve had to mark to market all of its new collatoral that it holds from the alphabet soup lending facilities what would it be worth?  And how much of a punch in the gut are we taking as taxpayers?

graph from Janet Yellin @ the Federal Reserve via Calculated Risk 

Comments

[Frank Wilhoit]

The long-term purpose of this is to discredit the Federal Reserve and grease the skids for its abolition.

They will never stop reading their fairytales. Never mind the fact that this one is nearly a hundred years old; their fathers and grandfathers taught it to them and they will teach it to their children and grandchildren.

[Fraud Guy]

Per http://bigpicture.typepad.com/comments/2008/07/merrill-writedo.html; the value is actually lower, closer to 5 1/2%, because Merrill is loaning the buyer 75% of the purchase price.

Ouch.