Term Securities Lending Facility (US)

The financial crisis that started in the second half of 2007 entered a critical stage in March 2008. Financial markets became severely disrupted and credit was scarce and expensive. Amid falling house prices and downgrades of mortgage-related securities, lenders limited their exposure to only the safest securities. Bear Stearns Companies, the fifth-largest investment bank with $400 billion in assets, teetered on the brink of collapse (GAO 2011; Geithner 2014).

Primary dealers^FNPrimary dealers are about 20 securities firms that the Federal Reserve Bank of New York (FRBNY) has designated to trade US government securities on a regular basis. Most primary dealers are affiliated with banks. However, this doesn’t give them access to the Federal Reserve’s discount window. The discount window is available only to legal entities that are depository institutions. US securities firms had limited ability to source liquidity from their bank affiliates during the crisis. For that reason, the Fed believed it needed to create programs like Term Securities Lending Facility (TSLF) to promote market liquidity by lending directly to securities firms. such as Bear Stearns were particularly vulnerable as they relied on the repurchase agreement (repo) market for funding (Gorton and Metrick 2012). A repo transaction is basically a short-term loan in which a firm sells a security to another firm with the agreement to buy it at a later date for a slightly higher predetermined price. These transactions occur on a very short-term basis, typically overnight.

By March 2008, the repo market, estimated at $10 trillion at the time, had become illiquid (Gorton and Metrick 2010). Primary dealers struggled to obtain financing, as they could no longer sell a large portion of their securities (Geithner 2014). Rates for overnight borrowing of instruments such as Treasury securities, agency debt securities, and agency mortgage-backed securities (MBS) rose from an average of less than 10 basis points (bps) to more than 60 bps (Fleming, Hrung, and Keane 2010). The Federal Reserve (the Fed)—the US central bank—became concerned about market liquidity and the functioning of financial markets (Federal Reserve 2008a).

On March 7, 2008, the Fed introduced the Single-Tranche Term Repurchase Agreements program,^FNFor information about the Single-Tranche Term Repurchase Agreements program, see: https://www.federalreserve.gov/monetarypolicy/bst_tranche.htm. which allocated up to $100 billion to conduct term (28-day) repurchase agreements with primary dealers. This program excluded private-label mortgage-related securities and accepted only high-quality collateral, eligible in the Fed’s regular open market operations (OMOs) in which the Federal Reserve Bank of New York (FRBNY) trades overnight securities with its primary dealers. The Fed, through the FRBNY, crafted a new and larger program, the Term Securities Lending Facility (TSLF), intended to support primary dealers. In view of the great demand for US Treasury securities as a “safe haven,” and to reduce the need for a fire sale of illiquid assets, the FRBNY would lend highly liquid US Treasury securities at a 28-day term—much longer than the typical overnight term—and against a broader range of collateral (Federal Reserve 2008a; Geithner 2014). Throughout the crisis, the Fed created multiple emergency lending facilities intended to restore market liquidity, such as the TSLF.^FNFor a crisis timeline and info on Fed’s actions, see https://www.stlouisfed.org/financial-crisis/full-timeline.^FNFor TSLF information, see Federal Reserve 2018 and FRBNY 2018a.

On March 10, 2008, a week prior to a scheduled regular meeting of the Federal Open Market Committee (FOMC), Fed Chairman Bernanke convoked an emergency conference call. Financial market disruptions rushed the Fed to speed up the creation of emergency lending facilities. That same day, with a unanimous vote of the five sitting Board Governors of the Federal Reserve System and a 9–0 vote of the FOMC, the TSLF was approved. The Fed invoked the emergency powers of Section 13(3) of the Federal Reserve Act (FRA) that permitted it to lend to nondepository institutions “in unusual and exigent circumstances” (Federal Reserve 2009). The TSLF was announced a day later, on March 11, 2008, although without any reference to Section 13(3) or emergency authority. The Fed “worried that trumpeting the invocation of emergency powers last used in the Depression would deepen the panic” (Bernanke 2015).

Under the TSLF, the FRBNY was able to lend primary dealers as much as $200 billion in highly liquid US Treasury securities such as Treasury bills, notes, bonds, and inflation-indexed securities. The facility took advantage of existing infrastructure and had some similarities in design to the FRBNY’s open market operations. The FRBNY pulled out US Treasury securities for the operation of this facility from the System Open Market Account (SOMA) (Federal Reserve 2009). However, it took two weeks for the facility to become operational. In the meantime, JPMorgan Chase & Company acquired Bear Stearns for $2 per share with emergency assistance from the Fed.^FNThe price settled at $10 per share. The Fed facilitated a $30 billion emergency loan to JPMorgan Chase. Between March 10 and March 13, Bear Stearns had experienced a depletion of its cash reserves from $18 billion to $2 billion.

The FRBNY offered to lend US Treasury securities at a 28-day term (in some cases adjusted for holidays) against a broader range of collateral. Initially, the list of eligible collateral included illiquid collateral at the time, such as triple-A private-label residential MBS and commercial MBS, as well as agency collateralized mortgage obligations (CMOs) (FRBNY 2008a). By awarding loans through auctions, the Fed intended to encourage broad participation and avoid any stigma in using this facility. The TSLF consisted of weekly auctions (Thursdays at 2 p.m. ET) in which bids represented the fee dealers intended to pay to loan the offered US Treasury securities. At the end of each auction, the FRBNY awarded loans at a uniform fee, based on the “stop-out rate,” which was the lowest accepted bid.

TSLF auctions started on March 27, 2008, and were classified into two categories: Schedule 1 and Schedule 2. While Schedule 1 auctions accepted all collateral eligible in the FRBNY’s open market operations, Schedule 2 auctions offered a larger amount of US Treasury securities, accepted a much broader and less liquid range of collateral, and required a higher minimum bid. The two different schedules were intended “to better calibrate the interest rate on TSLF loans to the level of risk associated with the collateral” (GAO 2011).

Section 14 of the Federal Reserve Act already allowed the FRBNY to trade securities eligible for Schedule 1 auctions for purposes of OMOs. However, the TSLF required FRA Section 13(3) approval because, in expanding the collateral for Schedule 2 auctions to include types of securities that were not authorized in the FRBNY’s open market operations, it was lending to nondepository institutions (the primary dealers) for the purpose of acting as their lender of last resort.

The Fed used the clearing services of the existing clearing banks in the triparty repo market, JPMorgan Chase and Bank of New York Mellon Corporation. The clearing banks acted as intermediaries and provided the daily services of custody and valuation of collateral. The services of the clearing banks came at no charge to the Federal Reserve or borrowers (Federal Reserve 2009).

Participation in the TSLF was voluntary and undisclosed. In July 2010, however, the US Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which requires the Fed to disclose information about OMOs and discount window borrowers, two years after transactions occur. For emergency lending facilities under Section 13(3) authority, the Fed is required to disclose information of borrowers a year after the facility ends (Federal Reserve 2010).^FNFor the Fed’s disclosures, see https://www.federalreserve.gov/newsevents/reform_quarterly_transaction.htm.

The day before a TSLF auction, the FRBNY announced the amount of US Treasury securities offered, which ranged between $25 billion and $75 billion. TSLF auctions lasted for 30 minutes, and the results on awards and stop-out rates were communicated shortly thereafter (Federal Reserve 2008a).

Schedule 1 auctions imposed a minimum bid of 10 bps, while Schedule 2 required a higher minimum of 25 bps. There was no cost to place a bid. Dealers could place up to two bids, with a minimum amount of $10 million and a maximum of 20% of the total offered amount. In case of two bids, they could only be in increments of $10 million. The FRBNY awarded loans in full for bids above the stop-out rate and on a pro rata basis for bids at the stop-out rate and held the right to refuse any bid at its own discretion. Dealers were not allowed to terminate a loan early (FRBNY 2009).

The FRBNY imposed margins (haircuts)^FNA margin or haircut requires the pledged collateral to be of greater value than the securities borrowed. on all collateral. The TSLF terms and conditions stipulated the daily revaluation of collateral by the clearing banks to make sure the specified margins were applied. Every day, the clearing banks conducted the valuation of collateral. In case the value of the collateral decreased, the FRBNY could ask for substitutions. On the other hand, primary dealers could also substitute collateral for oth0er eligible collateral if needed. To value the pledged collateral, clearing banks used the lowest price available in their valuation systems. This reduced the risk for the Fed in case of bankruptcy of a borrowing primary dealer. The loans were recourse. That is, in case of default, the Fed could come after the primary dealer’s assets to claim the difference between the liquidation of the pledged collateral and the value of the loan (GAO 2011)

With the escalating strains on financial markets, on July 24, 2008, the FOMC arranged a conference call and voted to extend the TSLF until January 30, 2009. The FOMC also approved the TSLF Options Program (TOP) as an extension to the TSLF.^FNOnly Governor Plosser dissented. He considered “the net benefit of the TSLF options as being insufficient to justify adding them to the support already being provided to market liquidity.” See https://www.federalreserve.gov/boarddocs/rptcongress/annual08/pdf/AR08.pdf. The TOP was announced on July 30, 2008. It required administrative changes pursuant to Schedule 2 auctions and not another Section 13(3) authorization (Federal Reserve 2009). The new program authorized the FRBNY to offer through auctions the option to borrow US Treasury securities for a seven-day term, two to three weeks after the auction date and at a fixed rate. The TOP intended to provide primary dealers some relief during periods of “heightened collateral market pressure, such as quarter-end dates” (Federal Reserve 2018). TOP auctions started in late August 2008 and required a minimum bid of 1 bp; all Schedule 2 collateral was eligible. The facility was limited to $50 billion in US Treasury securities, on top of the $200 billion of Schedule 1 and Schedule 2 auctions. The day before each TOP auction, the FRBNY announced the terms and conditions, including the fixed rate of the loans.

On September 14, 2008, a day prior to the failure of Lehman Brothers—the fourth largest investment bank and largest bankruptcy in US history—the Fed took another expansionary step.^FNLehman Brothers had been an active participant of the TSLF up until the September 11, 2008, auction. The investment bank received 18 TSLF loans. Its total borrowing peak was $19 billion. With financial markets in disarray, TSLF Schedule 2 eligible collateral was expanded to include all investment-grade debt securities (BBB- or higher) and auctions increased from $125 billion to $150 billion per month. Schedule 2 auctions started to run weekly, instead of biweekly, until the end of April 2009, when they returned to a biweekly basis. In the January 2009 FOMC meeting, the TSLF was extended until October 2009 (Federal Reserve 2009).

By June 2009, financial markets showed significant signs of improvement. Effective July 1, 2009, the Fed suspended TSLF Schedule 1 and TOP auctions. The TSLF size was reduced to $75 billion for Schedule 2 auctions, which decreased from biweekly to once a month. After July 16, 2009, auctions received no participation. The last auction took place on January 7, 2010. While the TSLF was in operation, the Fed published information on the total amount of propositions, awards, stop-out rate, and bid-to-cover ratio of each auction, but it did not disclose the identity of the participant primary dealers or the bid propositions (FRBNY 2018a).

The TSLF operated between March 27, 2008, and February 1, 2010. Overall, 18 of the 20 primary dealers participated in the TSLF and 11 participated in the TOP as well. All TSLF loans were paid in full and with interest. The Fed collected a total of $781 million in fees (Federal Reserve 2010). The TSLF reached its peak utilization of $236 billion on October 1, 2008. See figures 1 and 2 below.

The FRBNY held a total of 97 TSLF auctions: 58 Schedule 2, 33 Schedule 1, and six TOP. Overall, the FRBNY awarded a total of 559 TSLF loans; 156 Schedule 1 and 403 Schedule 2. Of the 403 Schedule 2 collateral loans, 17 were TOP. Schedule 2 auctions received the most demand. The highest stop-out rates occurred in the Schedule 2 auctions of September 17, October 9, and October 15, at 300 bps, 305 bps, and 322 bps, respectively.^FNFor TSLF data and statistics, see Federal Reserve 2018 and FRBNY 2018b.

TSLF auctions started on March 27, 2008, and ran weekly, alternating between Schedule 1 and Schedule 2, until September 11, 2008. In these first months of operation, the Fed offered $175 billion of the available $200 billion: $50 billion for Schedule 1 auctions and $125 billion for Schedule 2 auctions. Schedule 1 auctions offered $25 billion on each auction, while Schedule 2 auctions alternated offering amounts between $50 billion and $75 billion. See figure 3 below.

The initial TSLF auction on March 27, 2008, was Schedule 2. It offered $75 billion in US Treasury securities and was oversubscribed. The FRBNY awarded loans to 15 dealers at a stop-out rate of 33 bps. Schedule 2 auctions offered a significantly larger amount of US Treasury securities compared to Schedule 1, which offered $25 billion in all its TSLF auctions. With the exception of the first Schedule 2 auction of March 27, 2008, all Schedule 2 auctions until September 11, 2008, were undersubscribed. Following the collapse of Lehman Brothers on September 15, 2008, Schedule 2 auctions ran weekly, instead of biweekly, and the Fed increased its offerings from $125 billion to $150 billion per month. From September 17, 2008, until April 15, 2009, all Schedule 2 weekly auctions offered $37.5 billion (only three $35 billion).

On September 17, 2008, $70 billion in US Treasury securities were split into two auctions of $35 billion each. The first auction introduced a relatively shorter term of 14 days (term offered only once), while the one later the same day offered the regular 28-day term. Both of the September 17, 2008, auctions were fully subscribed at stop-out rates of 250 bps and 300 bps, respectively. All Schedule 2 auctions from September 17, 2008, until November 5, 2008, were oversubscribed.

Starting on April 22, 2009, Schedule 2 auctions returned to a biweekly basis and offered $75 billion each. From December 10, 2008, until July 16, 2009, auctions were undersubscribed. Thereafter, participation stopped completely and Schedule 2 auctions started to phase out, eventually ending on January 7, 2010.

There were 33 biweekly Schedule 1 auctions between April 3, 2008, and June 25, 2009. Each offered $25 billion. After March 19, 2009, there was no participation. From the 26 auctions with participation, 14 were undersubscribed. Only three consecutive Schedule 1 auctions in the fall of 2008—following Lehman’s bankruptcy—saw a considerable hike in the stop-out rate. These were on September 18, October 2, and October 16, with stop-out rates of 151 bps, 42 bps, and 46 bps, respectively. Overall, 15 auctions awarded loans at a stop-out rate of 10 bps (the minimum bid) and eight awarded loans within 6 bps of the minimum bid.

The FRBNY held six TOP auctions between August 27, 2008, and June 3, 2009. The initial two auctions of August 27 and September 10 offered $25 billion of US Treasury securities with a fixed rate of 25 bps. Both of these auctions were fully subscribed, and dealers were awarded the options to borrow US Treasury securities on September 24, at stop-out rates of 2 bps and 3 bps, respectively. The remaining four TOP auctions offered $50 billion in options. These were held in the end of 2008, on November 10, and December 2, and in 2009, on March 3, and June 3. The two auctions in 2009 were undersubscribed, and the options awarded were not exercised. The TOP ended in July 2009, in view of low demand and improved market conditions.