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									      Understanding the Response of the
        Federal Reserve to the Recent
               Financial Crisis
                              Sandy Krieger
                              April 14, 2010

This presentation presents preliminary findings and is being distributed to stimulate discussion and elicit comments. The views
expressed in the presentation are those of the author and are not necessarily reflective of views at the Federal Reserve
Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.

   All of Fed’s actions were directed at protecting the American
    people from a more severe downturn.

   Fed’s goal was to foster access to credit by businesses and
    individuals to met critical needs and keep the economy moving
    during a very critical period.

               Federal Reserve’s Responsibilities
   Conduct the nation’s monetary policy
     Influence monetary and credit conditions in the economy in
      pursuit of maximum employment, stable prices and moderate
      long-term interest rates
   Supervise and regulate banking institutions
     Ensure  safety and soundness of the nation’s banking and
      financial system
     Protect the credit rights of consumers

   Maintain the stability of the financial system and contain
    systemic risk that may arise in financial markets
   Provide financial services to depository institutions, the US
    governments and foreign official institutions, including playing a
    role in operating the nation’s payment system

                       Federal Reserve Governance
   The Fed’s authority and structure is defined by Congress
    (Federal Reserve Act)
   Fed structure
     Board     of Governors in Washington, DC
          7 Governors, appointed by Congress
            - Responsible for bank supervisory and payment system risk policies, approving
              discount rate change requests
     12   Regional Reserve Banks
        Independent corporations
        Responsible for the loans to Dis in their districts
            - ―Secured to their satisfaction‖

   Monetary Policy: FOMC
     TheGovernors
     Reserve Bank presidents
          5 voting members; 4 on a rotational basis

       Basic ABCP Conduit Structure
                                                Cash Collections             Cash Advances

                                  Enhancement                                                 Liquidity
                                    Provider                                                  Provider

                                  Fees        Credit Support                    Liquidity Support         Fees

              Collateral   Secured Assets and Fees
                                                                                                             Hedge   Hedging
                                                               ABCP Conduit
               Agent                                                                                                  Agent
                                                                                                    Cost of Hedge

                                   Administrator       Fees                  Dividends       Owner

                                                               Placement Agent

                                                Maturity Payments            Price of ABCP


                                              Maturity Payments              Price of ABCP


Source: Moody’s                                                                                                                5
(trillions of dollars)
                         Institutional Composition of Each Sector

                                                Source: Federal Reserve Flow of Funds
Funding Sources by Sector Type

                  Inside institutions benefit from
                  explicit guarantees and have
                  access to official sources of

                    Shadow institutions do not
                    benefit from explicit
                    guarantees and do not have
                    access to official sources of

       Credit Market Debt Holdings by Institution Type
       (trillions of dollars)

(credit market debt is defined as loans and
         fixed-income securities)             Source: Federal Reserve Flow of Funds, Table L1
Evolution of the balance sheet through the crisis

      Problems addressed by new lending facilities (preview)
   Term Auction Facility : illiquid term markets and the stigma that accompanies
    discount window borrowing
   Swap lines: illiquid money markets that became segmented across countries
    and time zones
   Primary Dealer Credit Facility: the lack of market-based back-stop credit in repo
   Term Securities Lending Facility : illiquid functioning in repo funding markets—
    illustrated by abnormal rates and high haircuts
   ABCP Money Market Liquidity Facility: illiquidity in money markets (including the
    ABCP) that prevented money funds from meeting demands for redemption
   Commercial Paper Funding Facility: illiquid functioning in short-term commercial
    paper funding markets
   Money Market Investor Funding Facility: lack of confidence that money market
    investors cannot extend terms of investments beyond overnight and remain
    adequately liquid
   Term Asset-Backed Securities Loan Facility: lack of available credit due to
    frozen ABS market

The first phase of the financial crisis

        (August 2007 through February 2008)

What happened in August 2007?
   Severe pressure on ABCP and term dollar LIBOR markets
     Some  ABCP issuers had subprime exposure
     Investors ran on the entire sector
     Sponsoring banks provided explicit and implicit support
     Need to bring assets on balance sheet pressured term dollar market

           ABCP Funding of Shadow Banks
                                                            Liquidity Number      Amount            Percent
        Shadow Bank Entities           Assets Types         Support of Entities   $ Billion        of Total $

Multi-seller                   Receivables and loans          Full       98        525                45

Hybrid and Other               Combination                    n.a        84        210                18

Securities Arbitrage           Highly-rated long-term ABS     Full       35        148                13

Non-Mortgage Single-seller Credit card and auto loans       Implicit     40        126                11

SIVs                           Highly-rated long-term ABS    None        35         84                 7

CDO                            Highly-rated long-term ABS   Partial      36         47                 4

Mortgage Single-seller         Mortgages and MBS            Implicit     11         23                 2

Total                                                                   339        1163              100

 Source: Covitz, Liang, Suarez (2009); June 2007

                                                                                              13           13
SIV Example: Cheyne Finance PLC

   10 billion us/euro portfolio managed
    by Cheyne Capital Management
    (hedge fund)
   WAL of assets (liabilities) was 2.9
    (0.48) years in August 2007
   US exposure of 78% vs 56% for the
    Moodys-rated SIV sector
   SIV only had $775 million in
    committed liquidity (liquidity
    facilities/breakable deposits)
   Cheyne folded quickly, defaulting
    on ABCP in October 2007, and
    ultimately its MTN issue.

                                           14   14
      Initial Policy Response to Illiquid Term Markets
   Lower discount rate and offered term credit at Discount Window
   But depository institutions borrowed using cheaper term funding
    from the FHLB system
   And, limited access of foreign institutions to term dollar funding
    meant continued pressure on LIBOR-OIS

Why not the Fed (at least not right away)?

           All-in-Cost Spread, Discount Window LESS FHLB NY Advance

Funding: ABCP, FHLB Debt and FHLB Advances

Policy Response to Illiquid Term Mkts & DW Stigma

   Lower discount rate and offered term credit at Discount Window

   Introduced Term Auction Funding and FX swaps in December
    2007 to address term dollar funding needs of foreign institutions
    and stigma associated with DW use

                   Pressure in Term Dollar Markets
                       … some improvement in late 2007

                 ABCP crisis
                               Bear Stearns
(basis points)


The second phase of the financial crisis

         (March 2008 through August 2008)

What happened in March 2008?
   Repo market
     Brokers-dealers   relied heavily on repo funding, but they had
      significant residential and commercial exposure on their balance
      sheets, which made investor nervous
     Bank-affiliated dealers had indirect access to official liquidity (23A
      waivers), but stand-alone brokers had no liquidity backstop, making
      them vulnerable
          Bear Stearns, Merrill Lynch, Lehman Brothers, Morgan Stanley, Goldman
     In   March, repo investors ran on the weakest stand-alone dealer
   Policy response (term dollar liquidity for broker-dealers)
     Maiden   Lane LLC - 13(3) loan
     Primary Dealer Credit Facility - 13(3) lending
     Term Securities Lending Facility – 13(3) lending
     Single tranche OMOs

Repo market is an important money market for broker-dealers

Primary Dealer Credit Facility
   The PDCF provides an alternative source of financing to a dealer
    that has difficulty financing a security in the market.
   It was necessary to provide such an alternative in the unusual
    and exigent circumstances surrounding the near-failure of Bear

PDCF usage high after Bear Stearns and Lehman failures

Term Securities Lending Facility
   The TSLF addresses the illiquid functioning in various repo
    financing markets, including abnormal rates, wide bid-ask
    spreads, and large and increasing haircuts on collateral.

   Adds Treasuries to dealers’ portfolios, reducing their scarcity in
    the repo market
   Reduces the roll-over risk for dealers in their financing of the
    alternative assets used as collateral
   Format assists in setting the right price for the Treasuries lent
   Avoids any reserve management problems

High overnight agency and MBS spreads to Treasury

   Source: Bloomberg

The Rise and Fall of Shadow Institutions’ Funding

            (The vertical axis scaled to 1.0 in 1994)

The third phase of the crisis

   (September 2008 through December 2008)

                      What happened - Fall 2008?
   Failure (or near failure) of at least eight large financial institutions
    in matter of weeks
      Break-down  in Agency debt and MBS markets accelerates demise of
       Fannie Mae and Freddie Mac
      Run by repo counterparties pushes Lehman Brothers into bankruptcy,
       sending shock waves through repo, money, and term ABS markets
        Merrill Lynch sold to Bank of America
        Goldman Sachs and Morgan Stanley become bank holding companies
      Liquidity   crisis pushes AIG to brink of bankruptcy
        Large securities lending program which funded non-agency RMBS with
         repo counterparties under pressure as the lenders wanted out
        Potential downgrade action by rating agency would trigger the need to post
         massive amounts of collateral against financial guarantees, which the
         company did not have

   Run on Money Funds: Reserve Fund breaks the buck
   Washington Mutual is closed and Wachovia is taken over

Spread: One-Month London Interbank Offered
Rate (LIBOR) to O/N Index Swap (OIS) Rate

                                    June 1, 2007 – October 23, 2009

   Source: Financial times, Bloomberg, Haver Analytics                30

Asset-Backed Commercial Paper Rate
                                  June 1, 2007 – October 23, 2009

    Source: Federal Reserve Board/Haver Analytics

                          Public Sector Responses
   GSEs
      Conservatorship with keep-well agreement
      UST MBS purchase program
      Limited Fed purchases of Agency debt and MBS

   AIG credit facility
   Money markets
      US Treasury guarantee
      Fed special liquidity programs: AMLF, MMIFF

   Large systemically important institutions
      TARP Capital Purchase Program
      Citigroup and Bank of America ring-fence transactions
      Term Liquidity Guarantee Program (TLGP)

   Commercial Paper markets
        Fed liquidity program: Commercial Paper Finance Facility (CPFF)

                   AIG - a $1 Trillion Company
   In Sept. 2008, AIG was the largest insurance company in the
    world, comprising 223 companies, operating in over 130
    countries, and servicing 76 million customers
   AIG Commercial Insurance insured over 175,000 entities,
    employing over 100 million people in the US, including comercial,
    military and other organizations
   In the financial markets, AIG was a large issuer of CP and a
    mortgage lender and guarantor
   AIG FP was a large participant in the market for a wide variety of
    derivatives and other financial products
     At its peak, AIG FP insured assets worth $2.7 trillion across a wide
      range of asset classes
   ILFC was the largest commercial customer of Boeing (order value
    of $12.5Bn), GE, Honeywell, Rockwell International and United
               Potential Consequence of AIG Failure
   With a massive surrender of insurance policies resulting from an AIG bankruptcy, there might
    have been insufficient capital or liquidity to pay all policyholder claims, and existing AIG
    policyholders might have been unable to obtain insurance coverage from other insurance
   Based on experience of prior failures of insurance companies significantly smaller than AIG,
    the sudden loss of AIG insurance capacity would have seriously disrupted the market,
    potentially resulting in a shortage of market capacity and significant price increases for
    numerous businesses and financial institutions
   Seizure of insurance subsidiaries by state regulators would have had an adverse impact on
    state guarantee funds, which are unfunded, resulting in assessments against other insurance
   An AIG failure could have de-stabilized confidence in other insurers and possibly triggered a
    devastating global ―run on the industry‖
   The scope of the failure could have put retirement savings significantly at risk
   Rapid unwinding and liquidation of AIG’s many investment portfolios would likely have caused
    enormous downward pressure on valuations across all asset classes held by AIG
   Default by AIG on its commercial paper could have harmed the money markets (AIG had
    issued approximately $20 billion in commercial paper, roughly 4 times as much as Lehman)
   More than 1,400 counterparties of AIGFP would have been affected; losses would be suffered
    by municipalities, pension plans and investors in $34Bn of purportedly conservative Stable
    Value funds, potentially triggering a run on plans with 4400 Bn of assets
Policy Objectives with Respect to Lending to AIG

   Stabilize markets                                        AIG Facts
      Post-Lehman bankruptcy
                                                  Operates in more than 130
      Severe financial market distress            countries
                                                  Over 76 million customers globally
                                                  One of the largest domestic
   Stabilize AIG with sufficient liquidity        insurance companies – 24 million
                                                   customers and 50,000 employees
                                                   in the U.S.
                                                  Customer base includes
   Enable AIG to dispose of certain               commercial, institutional and
                                                   individual customers
    assets over time
                                                  AIG Commercial Insurance protects
      Maximize value                              and insures operations of over
                                                   180,000 entities that employ 106
      Avoid undue disruptions to markets          million people in the U.S.
      Reduce risk of loss to Federal             AIG’s domestic insurance
       Reserve, the government, the taxpayer       subsidiaries are in 19 states and
                                                   Puerto Rico
                                                  ILFC is the largest commercial
                                                   customer of Boeing (order value of
                                                   $12.5 billion), GE, Honeywell,
   Ultimately, render AIG systemically            Rockwell International and United
    ―unimportant‖                                  Technologies

                Money Funds: The Problem

   The Reserve Primary Fund, a Money Market Mutual Fund
    (MMMF) ―breaks the buck‖ on September 16, 2008. Heavy
    redemptions are related to investor concern about $785MM in
    holdings of Lehman Brothers commercial paper.

   A ―run‖ on other MMMFs is created. Redemptions for the
    week ending September 23, 2008 are $120.5 billion.

   MMMFs have difficulty liquidating asset-backed commercial
    paper (ABCP), one of their largest holdings, as financial
    markets cease normal functioning

   Some sponsors provide support for affiliated MMMFs.

Understanding the run on money funds

                 Money Funds: Solutions
   The U.S. Treasury Department opened its Temporary
    Guarantee Program for Money Market Funds on
    September 29, 2008, which covers share balances as of
    September 19, 2008. Termination: September 18, 2009.
   The AMLF, managed by the Federal Reserve Bank of
    Boston, began operations on September 22, 2008.
    Termination: February 1, 2010.
   The Money Market Investor Funding Facility (MMIFF),
    managed by the Federal Reserve Bank of New York, was
    announced on October 21, 2008. Termination: October
   The Commercial Paper Funding Facility (CPFF), managed
    by the Federal Reserve Bank of New York, began
    operations on October 27, 2008. Termination: February1,
    AMLF Design

                         Cash $1,000                 Cash $1,000
           FRB                            Bank
          Boston                                                      MMMF
                      Non Recourse      (Borrower)   ABCP $1,000
                       Note $1000,
                                                     Purchased at
                       ABCP Pledged
                                                     Amortized Cost

                          Key Design Features:
                   No loss to MMMFs (purchased at amortized cost)
        Potential positive spread for borrowing bank (and essentially risk free)
   No recourse to borrower, but credit risk mitigated by SEC restrictions on MMMFs
        FRB Boston monitors ratings of pledged ABCP programs and sponsors
        FRB Boston                                                         39
ABCP Money Market Mutual Fund
Liquidity Facility (AMLF)

                                                         AMLF Program Activity
                                                       Weekly averages as of 8/13/09

                     $140          10/8/08 peak borrowing =
                                   $146 billion

  Billions of USD



                      $40                                                              8/13/09
                                                                                       borrowing = $0.1
                      $20                                                              billion


                    Source: F.R. Board H.4.1 Release

                         Fall 2008 Run on the Prime Funds

                          Daily Asset Changes in Prime Funds ($millions)
                                    Treasury Temporary
                                    Guarantee Program
 40,000                             Announced 9/19/08
 20,000                             and Opened 9/29/08


 (40,000)     Announces
              Bankruptcy                                                                 MMIFF
 (60,000)                                                             CPFF
               9/15/08                     AMLF                                         Announced
 (80,000)                                                          Announced
                                         Announced                                       10/21/08
(100,000)                                                            10/7/08

(120,000)          Reserve Fund            9/19/08
                  Breaks the Buck

                                     Prime Retail Change   Prime Institutional Change
                                                                                        Source: imoneynet

            FRB Boston                                                                      41
            Commercial Paper Funding Facility
   Funds the purchase of 3-month unsecured CP or ABCP directly
    from eligible issuers
     Restrictions   apply
   FRBNY lends to an SPV, which purchases CP from issuers
    through primary dealers
   Purchase rates
     OIS + 300 bps for ABCP
     OIS + 100 bps for CP, with a 100 bps surcharge for non-TLGP issuers


Impact of CPFF on quantities

Spread: One-Month London Interbank Offered
Rate (LIBOR) to O/N Index Swap (OIS) Rate

                                    June 1, 2007 – October 23, 2009

   Source: Financial times, Bloomberg, Haver Analytics                45

Asset-Backed Commercial Paper Rate
                                  June 1, 2007 – October 23, 2009

    Source: Federal Reserve Board/Haver Analytics

Fourth phase of the financial crisis

         (January 2009 through present)

Shut-down in term ABS markets

Need for a new investor base

   Implementation of new-issue ABS Term Asset-Backed Securities
    Loan Program (TALF) starting in March 2009
   Legacy TALF and securities Public Private Investment Program
    (PPIP) program announced in March 2009 and implemented over
    summer 2009
   Implementation of Federal Reserve large scale asset purchases
    (LSAP) throughout the year
   Implementation of Supervisory Capital Assessment Program
    (SCAP) exercise for large depository institutions
   Bankruptcy and re-organization of Chrysler and GM with
    assistance from UST

TALF and New-Issue ABS Spreads

TALF and new issue ABS for major asset classes

  2005   2006   2007   2008   2009   2010

           Impact of public sector support for legacy assets

                                                 Typical AAA capital structure

(basis points)




                             Super senior

TALF: Large Impact but Limited Exposure

Flight by Foreign Official Accounts from Agency Debt
                        Change in foreign holdings held in custody by Federal Reserve
(billions of dollars)

                                       (four week cumulative sum)

 Impact of LSAP on mortgage loan coupons

             (Freddie Mac Primary Market Mortgage Survey
            Conventional Mortgage Rate LESS 10-year UST)

                               What’s Next?
•   Expiration of Special Liquidity Facilities
•   Conclusion of LSAP
•   Portfolio Management

Broader Questions
•   Future of Securitization
•   Improvements in Regulation and Supervision
•   Strengthening Capital Requirements
•   Improving Liquidity
•   Addressing Too-Big-To-Fail
    •   Resolution Regime for Systemically Important Institutions


   All of Fed’s actions were directed at protecting the American
    people from a more severe downturn.

   Fed’s goal was to foster access to credit by businesses and
    individuals to met critical needs and keep the economy moving
    during a very critical period.


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