The Fed and Other Central Banks Expand Market-Support Activities

LIBOR borrowing spreads continue to see upward pressure due to persistent, and acute, concerns about counterparty risk. This is an ongoing process that is linked to further pending commercial bank write-offs in major banking centers around the globe, related to reduced valuations of securitized mortgage and other assets. This has led to a high level of demand for funds under the TAF, with the cost of funds under the April TAF recently tracking above the comparable LIBOR rate.

In addition, the Federal Open Market Committee authorized an expansion of the collateral that can be pledged in the Fed's Term Securities Lending Facility (TSLF) auctions. Primary dealers may now pledge top-rated (AAA or Aaa) asset-backed securities, in addition to already-eligible residential and commercial mortgage-backed securities and agency-collateralized mortgage obligations. The wider pool of collateral should promote improved financing conditions in a broader range of financial markets, particularly in the securitized student loan, credit card, and auto loan markets—which have also seen a substantial reduction in trading volumes and a lack of liquidity.

Finally, in conjunction with the increase in the size of the TAF, the FOMC has authorized further increases in its existing temporary reciprocal currency arrangements with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts up to $50 billion and $12 billion, respectively, to the ECB and the SNB (representing increases of $20 billion and $6 billion). The FOMC also extended the term of these reciprocal currency arrangements through January 30, 2009. The expansion of currency-swap arrangements reflects efforts by central banks in Europe to relieve significant U.S. dollar funding pressures on European-based banks, which are exacerbating pressures in the LIBOR funding markets around the globe.