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In an attempt to support the markets by providing funding for mortgage-backed assets, as well as certain other consumer loans-backed assets, the US Federal Reserve is taking over the risks previously carried by the US Treasury Department.
The sub-prime crisis, the impact of defaults in the over-rated mortgage-backed securities markets, had resulted in the global lending structure grinding to a halt as banks rationalised their books for sub-prime losses, which, in turn, reduced the amount of money they had to lend, and, in any case, wiped out their willingness to lend to anyone, particular each other.
In September, the US Treasury effectively nationalised Fannie Mae and Freddie Mac, mortgage lenders of last resort, and then floated TARP (the Troubled Asset Relief Program), a US$700 billion bailout planned to buy toxic mortgage-backed assets, take them off the banks’ balance sheets, and make the banks happy and able to lend again. However this was too slow and seemed ineffective so, in October, the Treasury decided that, instead of buying the asset-backed securities, they would use half of the allocated bailout funds to buy up preferred shares in US banks – as the UK government, and others, have been doing. Then, as a major shareholder, they could persuade the banks to start up the lending cycle again.
Again the impact does not seem to have been a great success so now the US’s Federal Reserve, a politically and financially independent body, unlike its Treasury, has stepped into the scene with a return to the initial idea of the bailout and is allocating US$600 billion to buy the old Fannie and Freddie mortgages and mortgage-backed securities from the Treasury. It is expected that the Fed will be able to move faster that the Treasury (a one to one buyer/seller relationship which will speed pricing) and will be independent from the US Congress in spending the money. The Fed also plans to use US$200 billion to purchase AAA-rated credit card, car and student loan debts.
The further removal of the toxic assets should bolster debt markets, and the Treasury gets high rated debt backed by the Fed (the nation’s printers of money!), and the banks get their money “untied”. At least that is the theory. We wait and see if the US action can kick-start the world debt markets.
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