US Economy

Going Once, Going Twice

By, 03/10/2008

Story Highlights:

  • The Federal Reserve announced it will increase funds lent through the Term Auction Facility (TAF) from $60 billion to $100 billion.
  • This sounds big, but is just a fraction of total lending for the Fed, let alone the broader economy.
  • Some view the TAF as a move of desperation to quell current financial woes; in reality the TAF shows the Fed can be dynamic, innovative, and non-intrusive in supporting capital markets!


A surefire way to guarantee confusion about a new financial institution is to give it a name no one understands. Take "Term Auction Facility," for example. Is that a technical name for a Sotheby's auction? Did a new Monet go on the market and we didn't hear about it?

Nope, it's a new tool the Federal Reserve implemented last December in response to today's liquidity concerns. The Fed recently announced funds auctioned this month will increase from $60 billion to $100 billion. While this sounds like a lot, a closer look at the Term Auction Facility (TAF) reveals it's not a huge deal—it's a lemonade stand in a world of soda counters.

Before TAF, banks had two short-term liquidity sources: the Fed's discount window, and each other. In recent months, inter-bank lending has experienced moments of turbulence. But to banks, borrowing from the discount window is like a college grad borrowing from their parents to make ends meet—parents are great, but they make you swallow your pride. TAF gives banks a third option: borrowing money from a cool aunt and uncle—the stability of borrowing from parents, without the humiliation! Through TAF, banks are able to borrow money from the Fed for longer periods of time, at lower rates, and without the stigma associated with the discount window. Banks have taken advantage of this plentiful source of cheap funds by borrowing $130 billion over the five auctions held since December (currently, there is $60 billion of TAF funds outstanding).

This brings us to today's announcement, which inconveniently followed more job loss headlines (for more on unemployment, see today's re-run of our January cover story "Employment Drizzle"). The Fed quickly pointed out their decision was based on "heightened liquidity pressures" rather than the jobs report. Enough people act rashly on insignificant monthly data—we don't need the Fed jumping on the bandwagon too.

So why do we care about liquidity pressures? If you believe the hype, banks are having problems securing enough cash to support lending—potentially stalling loans to companies and individuals. People need credit, so the Fed improving access to it is good.

But how does TAF rate as a solution? Favorably, it turns out. TAF is a great example of central banks innovating and evolving over time. TAF is a market-driven solution—helping out without tinkering too much! Yep, that's right—funds borrowed through TAF have no net effect on money supply. The Fed doesn't print money when it loans through TAF, and the amount lent is offset with sales of Treasury bonds from the Fed's inventory. But TAF loans don't impact the budget deficit either—the Fed earns interest on the loans, so TAF lending is actually a source of revenue for the Fed. Gee… increased revenue, increased liquidity… sounds refreshing!

TAF shows the Fed's ability to act quickly when needed, helping reassure nervous investors and institutions. Of course, there's no telling how many banks will show up at the Fed's lemonade stand next week—just because the Fed increased the limit doesn't mean the full amount will be lent. More importantly, TAF represents just a fraction of all Fed lending. At the end of the day, it's a token hug from the Fed, not a grand gesture—but it still helps us sleep at night. So don't fear the unknown—raise your glass of lemonade and cheer progress!

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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