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More than half of the Fed's Term Auction Facility went to foreign banks

The Financial Times reports today that more than half of the TAF went to foreign banks. It was an outright transfer of wealth from US tax payers to foreign banks (excerpted below):

Ed Clark, TD chief executive, said that using Taf was logical even though his bank never had a liquidity problem. “That wasn’t how we made a lot of money. But you make a dollar here, you make a dollar there. What’s the spread you make on a billion dollars?” he said.

In the summer of 2008, TD was borrowing $1bn from TAF at rates of between 2 and 2.5 per cent. For that borrowing it used the lowest quality – and hence highest yielding – collateral acceptable to the Fed.

More than 80 per cent of its collateral had a triple B credit rating at a time when such bonds yielded about 7 per cent. TD could therefore have made a notional gross spread of about $4m a month during 2008.

Mr Clark said the authorities were encouraging healthy banks to use schemes such as the Taf so as not to stigmatise their weaker counterparts. In January 2008, Ben Bernanke, the Fed chairman, said the Taf appeared to be succeeding because “there appears to have been little if any stigma”.

“You go through the whole crisis and there were lots of things we did that weren’t necessarily economic but were the right thing to do for the system,” said Mr Clark. “So I’m not embarrassed by this at all.”

One presumes not, given that Mr. Clark played by the Fed's rules, but the Fed has no such cover. It ought to be embarrassed.  The US taxpayer lent at 7% to non-US AAA rated banks (or banks including RABO) based on putatively BBB quality collateral.  And presumably the collateral were paying cash. This wasn't however a loan: it was the provision of contingent equity capital to foreign banks (Canadian, European and Asian) for no consideration, all courtesy of the US taxpayers.

WWB understands bank liquidity, solvency, and systemic risk. All should know that the melding of sovereign and trans national bank risk leads to reckless underwriting (QED), more risk, and then to a vitiation of contract & property rights and ultimately to democracy itself. Managing systemic risk is not hard, but you have to forgo some of the social agenda that has been attached to it. If you want to reduce systemic risk, break it down into its components and start taking them off the table, piece by moral hazard piece.

The alternative is to manage systemic risk as the Fed has done, and apparently will continue to do, by aggregating it into larger and larger amalgamations of undefined, hence unmanageable, risk structured as an uber asymetrical option in favor of rent seeking financial institutions and underwritten by the taxpayer. And all US taxpayers know what that means: "Heads, I win. Tails, you lose."

Lastly, if gas hits $5/gallon in 2012 as the former President of Shell Oil today predicts, will the energy sector be declared to pose a systemic risk under Dodd-Frank? Well, are volatility and duration the primary drivers of option value?

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