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Did Arminio Fraga Turn Down the Harv...   There's No Transparency in the Carbo...
Dec 12 2007 3:55PM EST

The Fed's Collateral Requirements: It'll Take Anything

The Fed won't just lend out $40 billion in an attempt to inject some liquidity into the banking system, oh no. It requires collateral. But, as jck says in the comments to my earlier blog entry, it seems as though "any junk will do" in terms of the collateral the Fed will accept.

The details can be found on the Fed's website, where the margin tables can be downloaded in Excel or PDF form. But to give you an idea of what the Fed will lend, consider a AAA-rated subprime-backed CDO – the kind of thing which is causing billions of dollars in losses all over the financial system. If the CDO has a market price, the Fed will lend up to 98% of that price if it's a short-term CDO, up to 96% if it's medium-term, and up to 93% if it's long-term.

But what if the CDO is completely illiquid, and you can't find a price for it at all? No worries, the Fed will still accept it as collateral, and lend up to 85% of par value. (There's an interesting thought experiment here: what happens if a long-term CDO has a market value of, say, 90 cents on the dollar? In that case, an illiquid version of that CDO would actually be worth more to the Fed than the liquid version.)

Do keep on looking down that list, though: it turns out that banks can even put up as collateral subprime credit-card receivables – they don't even need a AAA rating.

Now it's worth noting that the Fed is going to be repaid on its loans no matter what happens to the collateral. We're not talking non-recourse loans here: there's really no chance that one of the Fed's borrowing banks is going to suddenly go bankrupt and leave the Fed holding some paper of dubious value. But it certainly seems that any bank sitting on a bunch of nuclear waste and suffering from liquidity problems has now found its savior in the Federal Reserve. As Steve Waldman says, never mind the mortgage plan – this is a bailout.

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