We first learned our ABCs in kindergarten, which for most of us probably seems like a distant memory. Well, this year may be the year to re-learn those ABCs; not just the elementary ones such as A for Apple, B for Bear, and C for Cat. This time around the words are more complex and visual aids are non-existent. I am referring to the alphabet soup of programmes implemented by the Federal reserve and the US Treasury to stimulate the economy. With fifteen programmes in total and acronyms like TALF, PDFC, and CPFF, who can remember them all? I will not attempt to elaborate on the details of each programme for fear of having a very dull and lengthy discussion; who is interested in the intricate details anyway? The only question worth answering is “Will these programmes work?”
Before attempting to answer that question, we should at least for a few of the programmes examine the event that pre-empted their creation. For every symptom the ailing economy experienced since the financial crisis started in 2007, the Federal Reserve essentially tried to find a panacea.
On 16 March 2008, the Fed introduced a liquidity facility called the PDFC (Primary Dealer Credit Facility). This programme was designed to prevent another Bear Stearns-like failure, by allowing primary dealers to access the discount window, previously only available to depository institutions. This would be the first time since the 1930s that the Fed extended access to a primary dealer. Although created to provide a lifeline, the programme could not stave off the collapse of Lehman Brothers.
To assist banks the Fed established the TAF (Term Auction Facility), a liquidity facility whereby the Fed auctions off a set amount of cash to depository institutions for a predetermined term, pledged against a wide range of collateral. The goal of the TAF is to provide banks with an avenue to obtain funding for their less liquid collateral. This programme remains popular expanding it to USD 400 billion in size since its inception in December 2007.
By focusing on addressing the problems of the banks and the primary dealers other corporate borrowers were neglected. To fill this void the Fed introduced yet another programme termed CPFF (Commercial Paper Funding Facility), specifically designed to alleviate the strains faced by corporate borrowers. The Fed is able to purchase 3-month commercial paper directly from issuers, providing the option as a buyer of last resort. The total amount of loans currently outstanding under this program is USD 166 billion.
A review of just three out of the fifteen programmes clearly illustrates that the Fed is committed to assist not only the banks, but dealers and other corporate borrowers as well. With the overwhelming quantity of very sizeable liquidity programmes (an increase in balance sheet assets of $1.3 trillion), we should not be surprised that the Fed will ultimately win the battle to restore liquidity and confidence in the economy. Although not every single programme has been completely effective many are bound to work; a 100 per cent success rate may not be necessary. Maybe a 75 per cent or 50 per cent success rate is sufficient to have the desired outcome. One thing is for certain, the lower the overall success rate, the longer the recovery period.
Many lessons will be learned from this extraordinary crisis and many books will be written or re-written. The ABCs of monetary policy will undergo revision as well. Before this financial crisis started in 2007 most business schools would have focused on three tools in the Fed’s arsenal, historically used to influence monetary and credit conditions in the economy: (1) The required reserve ratio, (2) The discount rate, and (3) Open market operations (purchasing and selling of government securities). We have subsequently learned that the Fed can also be creative and invent new and powerful tools. When it became evident that the Fed’s standard box-end wrenches in its toolbox could not do the job of a pipe wrench, they designed and manufactured their own wrenches to loosen the extremely tight liquidity pipe!
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.