The Fed is Now Bailing Out COMMERCIAL Real Estate?

March 20, 2008

The Open Market Trading Desk of the Federal Reserve Bank of New York (“Desk”) has engaged in extensive consultation with market participants on the overall design and technical features of the Term Securities Lending Facility (“TSLF”) since it was announced on March 11, 2008. As a result of this consultative process, the Desk is announcing a few modifications to the previously released program terms and conditions, as well as providing more details on the parameters of the first auction, scheduled for Thursday, March 27, 2008 at 2:00 p.m. Eastern time.

The Desk will conduct the first TSLF auction on March 27. The offering size will be $75 billion for a term of 28 days.The first TSLF auction will be a loan of Treasury securities against Schedule 2 collateral rather than against the Schedule 1 collateral previously proposed.

To facilitate the operational processes of the facility, the Federal Reserve has also expanded the list of eligible collateral for Schedule 2 to include agency collateralized-mortgage obligations (CMOs) and AAA/Aaa-rated commercial mortgage-backed securities (CMBS), in addition to the previously announced AAA/Aaa-rated private-label residential mortgage backed securities (RMBS) and OMO-eligible collateral.

The minimum fee rate for the TSLF Schedule 1 and Schedule 2 auctions will be set at 10 basis points and 25 basis points, respectively, with the actual fee rate resulting from the TSLF single-price auction format. The auction-determined lending fee rate should be approximately equal to the spread between the Treasury general collateral rate and the general collateral rate for the pledged collateral over the term of the loan.On Wednesday, April 2, the Desk will announce the size and the Schedule of eligible collateral for the second auction to be held on April 3. The size and Schedule of eligible collateral of all future auctions will be based upon the Desk’s assessment of auction demand, as well as on information gathered in ongoing discussions with market participants and prevailing funding market conditions. In total, the Desk has been authorized to lend up to $200 billion of Treasury securities through TSLF auctions.

US Dollar Long Term Chart - March 21, 2008

Hey Ben! What's in Your Wallet?

Technically that dollar in your pocket, a Federal Reserve Note, was debased this week.

Most people don't realize that the dollar is a unit of measure. There are dollars, and then there are those pieces of paper you may have called Federal Reserve Notes. They are IOUs from a private bank called the Federal Reserve. They are usually backed, or collateralized, by 100% US guaranteed debt, Treasuries and select agencies like Ginnie Mae (and not pseudo-guaranteed agencies like Fannie and Freddie).

Did we just witness an historic first this week? Did the Federal Reserve Note just get debased by about fourteen percent? Is a portion of the Federal Reserve Note now backed by the private and illiquid obligations of Wall Street?

Here is an excerpt from the Fed's Balance Sheet that comes out in the H.41 report every Thursday after the markets close.

Only 86% of Federal Reserve notes, rightfully IOUs from the Fed or Federal Reserve Notes, are still backed by AAA debt obligations.

There was quite a flash bang around Bear Stearns, the dollar and the metals this week. While we were distracted did Ben just cross the Rubicon by backing the FRN 'dollar' with junk? Treasuries are still Treasuries. Agencies are still agencies. But this ain't your daddy's dollar anymore. And certainly not your granddaddy's. We've taken a step almost as great as the loss of gold backing for the US dollar in circulation. Now it is not even backed by 100% AAA debt.

Welcome to interesting times.

And now even commercial real-estate is in there too.

2007-9 Bear Market Update: March 20