U.S. Fed Now Accepts Credit Card Debt as Collateral
The U.S. Federal Reserve got even more deeply involved in the credit crisis on Friday by offering more loans to the banks through two of its newly established "facilities."
There's a famous poem we want to introduce you to. We thought of it today when trying to explain what the Fed is doing. It's called "The New Colossus" by an American named Emma Lazarus. It's the poem that appears on the base of the Statue of Liberty.
Not like the brazen giant of Greek fame,
With conquering limbs astride from land to land;
Here at our sea-washed, sunset gates shall stand
A mighty woman with a torch, whose flame
Is the imprisoned lightning, and her name
Mother of Exiles. From her beacon-hand
Glows world-wide welcome; her mild eyes command
The air-bridged harbor that twin cities frame.
"Keep ancient lands, your storied pomp!" cries she
With silent lips. "Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tossed to me,
I lift my lamp beside the golden door!"
The Fed has become the mother of all credit exiles, accepting Wall Street's over-valued, under-performing, dead-beat loans. At least that is what it's done in a metaphorical sense. What did it do practically?
First the Fed increased by US$25 billion the amount of money it will auction to banks (commercial and investment) through its Term Auction Facility (TAF). Here banker people, borrow more. Please.
Second, the Fed expanded the list of collateral it will accept for asset-swapping through its Term Securities Lending (Facility). Remember, that's the one that lets banks and prime brokers swap mortgage-backed securities for Treasury bonds for up to 28-days.
The Fed is now expanding that list of asset-backed securities to include collateralized car loans, credit card receivables, and student loans. It's doing so because the lack of demand for bonds backed by those assets has had a real political impact in an election year. Students can't get loans for American universities because investors won't buy bonds issued by the banks who made the loans to the students. No funding, no college.
We don't know if you are as agitated reading about the Fed loan programs as we are writing about them. It's pretty agitating. You have to translate what the Fed has done from Central Bank speak to what it really means.
What it really means is that that the Fed has lowered interest rates as far as it can to deal with the bank lending crisis. It still hasn't encouraged banks to loan to each other, or investors to buy bonds backed by various kinds of consumer liabilities. But it HAS had some effects.
Remember last week we said the interest rate on U.S. Treasury bonds is below the rate of inflation? Well, American real estate speculator Sam Zell says this has lured some investors back into the market for residential mortgage-backed securities. "Is it in large volumes? No. Is it the natural first step in the evolution? Yes."
The evolution of what? New credit markets? A credit market where the Fed trashes the yield on U.S. government debt in order to make the yield on mortgage-backed debt look less trashy? One asset might look less trashy in a side-by-side comparison. But for investors, isn't this like choosing which leper you'd like to take home and introduce to your mother?
Our take is this: the Fed has probably stopped cutting rates for awhile because it's apparent that cutting rates has not solved the problem in the credit markets. That problem is still the same: poor asset quality. But even on that score, not everyone agrees.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by justin on 5 May 2008:
Is it perhaps possible that rather than banks not lending to each other because they don't know with whom the bad debt lies, that banks can't lend to each other because their 'assets' were nothing but 'credit' to begin with and so they have nothing to lend?
I have read that the word credit is derived from the latin word credere, meaning 'to believe'. Thus if people don't believe that credit is an asset, then it is worth nothing.
Furthermore, how will the reserve bank offering more 'credit' help the situation?
Comment by mike on 6 May 2008:
..and now...from wikipedia.."In his first book Theodore Geisel features the character the Cat in(The Cat in the Hat, 1957), the Cat brings a cheerful, exotic and exuberant form of chaos to a household of two young children one rainy day while their mother is out. Bringing with him two creatures appropriately named Thing One and Thing Two, the Cat performs all sorts of wacky tricks to amuse the children, with mixed results. The Cat's antics are vainly opposed by the family pet, who is a sentient and articulate goldfish. The children (Sally and her older brother, who serves as the narrator) ultimately prove exemplary latchkey children, capturing the Things and bringing the Cat under control. He cleans up the house on his way out, disappearing seconds before the mother arrives."
Comment by ex-sunnyvale-renter on 8 May 2008:
Doesn't this mean that the poor wage-slave who's lost their job, and can't pay their CC debt, will now have the Feds after them?
Suddenly CC debt, dischargeable through bankruptcy or the statute of limitations, will now become Federal debt, not dischargeable at all, but following the wage-slave for life, like US student loans?
If this does not get my fellow US subjects rioting in the streets I guess nothing will.
Australia you are far away, but some of us know now to sail. Prepare for refugees.
Comment by Joe on 8 May 2008:
NYU Economist Nouriel Roubini predicted this move back on March 4/08 as part of an article for Finance Week entitled “The Rising Risk of a Systemic Financial Meltdown: Twelve Steps to Financial Disaster” http://tinyurl.com/2uhx24
So far, Roubini's predictions are gaining in unerring credibility each day, as though he had a crystal ball the actual events parallel his predictions so closely. His work warrants paying close attention.
Comment by JD on 8 May 2008:
This is merely another method of nationalizing the debt. Soon, the US Govt. will literally own their citizens.
Comment by Hmmmm.... on 10 May 2008:
I'm wondering what good a 28 day loan does for the Auction Rate investors. Banks can't literally "swap" ARS for Treasuries, that's FALSE. They can pledge them as collateral, but the Fed never owns the ARS. Further, the Fed isn't loaning 1:1 for the ARS, more like 80-90 cents on the dollar. The term "swap" which has shown up in several articles is overly optimistic and just flat out wrong.
A 28 day loan doesn't help investors stuck with 30 year bonds.
Comment by Hmmmm.... on 10 May 2008:
Also, if the problem is poor asset quality, why then are the student loan ARS being shunned so? They're 97-98% guaranteed as to principal AND interest by the Department of Education.
Go figure.
Comment by Yellow Credit Card on 16 June 2010:
U.S. Fed Now Accepts Credit Card Debt as Collateral i want get some knowledge this topic
mech