Federal Reserve Moves to Bolster Liquidity; Will Take AAA-Rated Subprime RMBS as Collateral

Amid growing concern regarding economic stability both here in the U.S. and abroad, the Federal Reserve on Tuesday announced a series of coordinated actions designed to pump up a financial market that has been roiled as of late by deleveraging, concerns over inflation, and fears that the U.S. housing slump will get significantly worse.

Most pertinent to the mortgage market, the Fed said in a statement that it would pump $200 billion into the financial markets via a new Term Securities Lending Facility. The TSLF will alow banks to gain access to funds by posting collateral in the form of federal agency debt, mortgage-backed securities issued by Fannie Mae and Freddie Mac, as well as AAA-rated private-label residential MBS.

The new program is in some ways an analog to the Term Auction Facility that the Fed has been running for the past few months, which was recently bolstered to offer $50 billion in funds this past week.

News of the new Lending Facility immediately led stocks upward, with the Dow Jones Industrial Average trading up 1.58 percent to 11,925 in mid-day trading. Financials in particular rebounded, with Countrywide Financial Corp. rising nearly 10 percent.

Via the Associated Press:

“The big problem has been the financials, and this helps supply money directly to the banks and may take some of the need for aggressive rate cutting off the table,” said Peter Dunay, chief investment strategist at Meridian Equity Partners. “The Fed is basically going to take the bad loans off the banks’ books, and the market seems to be loving that idea.”

There should be some concern about the Fed taking on AAA-rated residential private-party RMBS via this new facility, however, given earlier coverage here on HW suggesting that these assets may not deserve the AAA rating they currently hold.

In addition to the new Lending Facility, the Fed also said it had authorized an increase in existing currency swaps with the European Central Bank and the Swiss National Bank.

Disclosure: The author held a long position in CFC when this story was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.