Grading the Fed: Was TAF a Success?
The first Treasury Auction Facility (TAF) results were announced today. The rate in the "Dutch Auction", where everyone gets the best rate that completes the offering, was 4.65%. The bid-to-cover was more than 3-1. What should we make of this?
The Stock Market Perspective
As is so often the case, David Merkel has a good handle on how most investors are viewing this. David writes as follows:
What will happen to liquidity conditions when the temporary injection
goes away? My view is that they will go back to how they were before
the temporary injection. The only way that would not be so is if the
temporary injection somehow changes the willingness of parties to take
risk, and I think most large investors can see through the temporary
nature of the injection.
David’s comments on the ECB "scooped" the reaction on the Kudlow show to the Treasury effort. Larry Kudlow and former Fed Governor Wayne Angell agreed that the Fed effort was small and did not add permanent liquidity. They both see the solution to mortgage problems as a (much) lower fed funds rate.
Economists Speak Out
The economists viewed the TAF as a qualified success, easing pressures in interbank markets and providing liquidity at a rate lower than that offered at the discount window. Readers should check out the helpful quotations compiled by Phil Izzo at the Wall Street Journal’s Economics Blog. We thought the comment from Ray Stone was a good observation:
Ultimately the success of this auction and subsequent auctions under
the TAF convention should be gauged in terms of whether the targeted
credit market strains abate.
Please note that all of the comments are focused on how the TAF affects other interest rate markets. No one is testing this against a permanent injection of liquidity.
A Fed Spokesman
Federal Reserve Bank of Richmond President Jeffrey Lacker is not currently a voting member of the Open Market Committee, but certainly knows what is going on. After a scheduled speech today, he was asked about the TAF. He responded as follows:
It’s not clear that this facility will address fundamental issues in
inter-bank markets such as constraints on balance sheets, the need to
raise capital and, importantly, concerns about counterparty risks.
and later …
(I)t’s important to note that the auctions will not actually add funds to
the system because the Fed will have to make less funds available
through its discount window, the traditional way in which the Fed
provides short-term loans to banks. The liquidity auctions, he said,
offset the reduction in discount window lending, so it reallocates
funds “from one to the other.”
Please note that Lacker makes no effort to present this as a permanent injection of liquidity. It is intended to help banks with somewhat questionable collateral borrow from the Fed at reasonable rates. This should reduce the pressure on borrowing from other banks. That is the test, and we do not yet know the answer.
The real performance hurdle for the TAF is how well it did compared to the discount window. Suppose that the Fed had lowered the discount rate by 50 bp’s instead of 25, something that many thought would have been helpful. Had they done this, the market might not have sold off by 300 points. The Fed chose a different path, since they believed the TAF would avoid the perceived stigma of the discount window. They tried to expand the discount window use. After a few symbolic acts by major banks, it had little effect.
Judged from that perspective, the TAF was — well — OK. The demand is there. The rate was better than the discount rate and better than LIBOR. From that perspective it addressed a need, and did so effectively. Since the total amount bid for was not overwhelming, it helps us get a sense of the overall need.
The rate could have been lower, ideally below 4.5%. The Fed has also done a terrible job in explaining the motives and what to expect. We admit that it is difficult to explain.
Our grade is a B- on the TAF and something lower on communication! There will be another auction tomorrow and more Fed speeches to explain.
Meanwhile, the most important takeaway for individual investors is that the Fed is going to keep trying different approaches to provide liquidity where it is needed. Their perceptions of this need may not match those of stock investors.