Unlimited funding?

The headlines and media articles made it sound rather extreme, "Unlimited Funding" (e.b., Bloomberg with "Fed Says ECB, Others to Offer Unlimited Dollar Funds"), but the latest program from the Federal Reserve and other central banks is in fact not unlimited. In fact, the Fed did not even use the word unlimited. While it is true that the central banks are not putting a dollar limit on how much they are willing to lend, banks are in fact practically limited by the amount of good collateral that they have on hand to pledge in return for a loan from a central bank.

The relevant language from the Federal Reserve announcement:

Counterparties in these operations will be able to borrow any amount they wish against the appropriate collateral in each jurisdiction.

Sure, "borrow any amount they wish" sounds like "unlimited" borrowing, but that is ignoring the constraint of "against the appropriate collateral" which immediately follows. Maybe you could consider it to be fine print, but the media persists in remaining in exaggeration mode for this financial crisis.

So, a proper layman's summary of the program is that banks can now borrow from the Federal Reserve any amount up to the value of their assets that can be pledged to the Federal Reserve as collateral.

Note that MBS and mortgages can in fact be pledged as collateral to the Federal Reserve. It is up to the bank to set the value of its collateral. I have no idea what procedures must be followed by banks when valuing illiquid collateral for the Federal Reserve. My guess would be that it is the same process that is required for FASB accounting and FDIC rules, but that begs the question of interpretation of "mark to market."

But in any case, this new Fed lending program will not allow banks to borrow more than 100% of the value of their collateral.

-- Jack Krupansky