–Liquidity Swap Arrangements With Foreign Central Banks ‘Safe’

By Claudia Hirsch

NEW YORK (MNI) – The Federal Reserve stands to make a good return
on its crisis liquidity facilities, which successfully restored
functionality and confidence to credit markets, New York Fed Executive
Vice President Brian Sack said Wednesday.

“Achieving these returns, of course, was not an objective of the
programs, but it does suggest that the Federal Reserve was prudent in
the way it which it established these programs,” Sack said in remarks
prepared for delivery to a luncheon of the New York Association for
Business Economics. “Substantial” returns are likely, he said, because
financing was offered when risk premiums were very high.

“The central bank therefore captures a high expected return
relative to the actual risk it is assuming, especially when the lending
is adequately collateralized to limit such risk.”

Indeed, Sack, who oversees the vast markets group at the New York
Fed as well as the Federal Open Market Committee’s open market
operations, said the TALF program posed only “limited” risk to the
central bank’s balance sheet.

Of $200 billion in funds available, only $70 was loaned through
that facility, and credit outstanding today stands at about $44 billion,
he said.

The Term Asset-Backed Securities Loan Facility, which provided
liquidity for consumer, student, small business and commercial real
estate loans, successfully aided credit to households and Businesses and
“impressively” supported the securitized credit market, he said. TALF
officially winds down later this month.

“At this point, those asset-backed securities markets that were
supported by TALF appear to be standing on their own.”

Sack said TALF’s design incorporates its own exit strategy through
penalty pricing that provides an “incentive” to users to “stop borrowing
from the central bank and to pursue better rates in private funding
markets.”

TALF’s success, he said, was in no small part due to its loans
being non-recourse — allowing repayment in the form of collateral if
the collateral’s value falls by enough — as well as the TALF loans’
longer maturities than those of its other temporary liquidity facilities
and the Fed’s discount window.

Sack said another of the Fed’s dollar liquidity programs, the
reintroduction of swap lines with five foreign central banks, is also
performing with only limited risk.

“[T]he liquidity swap arrangements are safe,” he said, and added
that only a “very small amount” of outstanding credit was extended
through these arrangements with the Bank of Canada, the Bank of England,
the European Central Bank, the Swiss National Bank and the Bank of
Japan.

“The swaps were essentially put in place in a preemptive manner,
under the view that their presence would provide a backstop for dollar
funding markets and help to bolster market confidence.”

**Market News International New York Bureau, tel. 212-669-6430**

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