Term Securities Lending Facility (US)

In March 2008, the 2007–09 financial crisis reached a critical stage. Amid falling house prices and downgrades of mortgage-related securities, financial markets became severely disrupted. In response, the Federal Reserve Board, in order to act as lender of last resort to primary dealers, invoked the emergency powers of Section 13(3) of the Federal Reserve Act, last used during the Great Depression in the 1930s. Under Section 13(3), the Board could decide to lend to nondepository institutions in “unusual and exigent circumstances.” The approval of a majority vote of the FOMC was also required because the action would affect open market operations. On March 10, 2008, 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 (Bernanke 2015).

In view of the great demand in the markets for US Treasury securities as a “safe haven,” the FRBNY lent highly liquid US Treasury securities such as Treasury bills, notes, bonds, and inflation-indexed securities, at a 28-day term—much longer than the overnight term—and against a broader range of collateral. Initially, the list of eligible collateral included collateral that was illiquid at the time, such as triple-A private-label residential mortgage-backed securities and commercial MBS, as well as agency collateralized mortgage obligations. The FRBNY drew the US Treasury securities from the System Open Market Account. After financial markets improved in June 2009, the Fed reduced its size to $75 billion. The TSLF ended in February 2010 (Federal Reserve 2009; Federal Reserve 2010).

With an auction mechanism, the Fed intended to encourage broad participation and avoid any stigmatization in using this facility. The upper limits for primary dealers on the share of the auction that they could get guaranteed that multiple of them would be awarded TSLF loans. The TSLF consisted of weekly auctions that lasted for 30 minutes. The day before an auction, the Fed announced the amount and securities offered. Participation was voluntary and bids represented the fee dealers intended to pay to loan the offered US Treasury securities. Auction results were communicated shortly thereafter (Federal Reserve 2008b).

The Fed, primarily through the FRBNY, crafted the TSLF. In the open market operations, the FRBNY trades US government securities with designated primary dealers (securities firms) on a regular basis. The TSLF took advantage of existing infrastructure and some similarities in design with the OMOs (Federal Reserve 2009; Geithner 2014).

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 each, while Schedule 2 auctions alternated offering amounts between $50 billion and $75 billion.

On September 14, 2008, one day before Lehman filed for bankruptcy, the Fed revised the timing of Schedule 2 auctions to run weekly, rather than biweekly. It also increased the size 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). As financial conditions improved in 2009, the size and timing of Schedule 2 auctions was decreased, and they eventually ended on January 7, 2010.

The FRBNY relied on the clearing services of the existing clearing banks in the triparty repo market, JPMorgan Chase and Bank of New York Mellon. They functioned as intermediaries and provided the services of custody and valuation of collateral. Their services came at no charge to the Federal Reserve or borrowers.

The clearing banks conducted daily revaluations of collateral to make sure the specified margin was applied. The US Treasury securities awarded remained in the clearing banks, but dealers could use them to settle repo contracts. 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 other eligible collateral if needed. To value the pledged collateral, clearing banks used the lowest price available in their valuation systems (Federal Reserve 2009).

Only the 20 primary dealers of the FRBNY, including the five largest US investment banks and the US securities arms of major foreign financial institutions, were eligible to participate in the TSLF (Fed 2008).

The FRBNY determined margin requirements. These did not change throughout the crisis. Haircuts aimed to reduce the Fed’s risk in case of bankruptcy of a primary dealer (Federal Reserve 2009). Additionally, collateral on review for downgrade was not accepted. For securities posted as collateral that were on review for downgrade, the Fed could demand that they be replaced with other eligible securities (FRBNY 2009).

The loans were recourse. That is, in case of default, the Fed could go after the primary dealer’s assets to claim for the difference between the liquidation of the pledged collateral and the value of the loan (GAO 2011).

The minimum bid for Schedule 1 auctions was 10 bps and for Schedule 2 was higher at 25 bps. There was no cost to place a bid (FRBNY 2008). Many of the Fed’s lending programs during the crisis were intended to be self-liquidating as markets improved. Minimum bid rates and collateral requirements were set to be attractive when markets were disrupted but unattractive when markets functioned well (Kohn 2008).

At the end of the auction, the uniform fee was set based on the stop-out rate, which was the lowest accepted bid (GAO 2011).

Auctions were classified into two categories: Schedule 1 and Schedule 2. While Schedule 1 auctions accepted all collateral eligible in FRBNY open market operations, Schedule 2 auctions 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).

Schedule 1 eligible collateral included: Treasury securities, agency debt securities, and agency MBS.; whereas Schedule 2 collateral included: all Schedule 1 eligible collateral, plus triple-A private-label residential MBS and commercial MBS, and agency CMOs (FRBNY 2008a). On April 29, 2008, Schedule 2 collateral was expanded to include triple-A asset-backed securities (Federal Reserve 2008b). And on September 14, 2008, a day prior to the collapse of Lehman Brothers, the Board and the FOMC broadened the list to include all investment-grade debt securities (BBB- or higher) (Federal Reserve 2008c).

Primary dealers could place up to two bids, with a minimum amount of $10 million and not higher than 20% of the total offered amount. In case of two bids, they could only be in increments of $10 million. Primary dealers could be awarded a maximum of only 20% of the total offering amount, regardless if the auction was undersubscribed. The Fed set limits “to ensure that the lending [was] distributed across multiple institutions” (Logan 2009). The FRBNY held the right to refuse any bid at its own discretion (FRBNY 2008a). Awards were determined on a pro rata basis, and dealers were not allowed to terminate a loan early (Federal Reserve 2008).

While other Fed lending facilities involved cash, the TSLF involved only securities. Through the TSLF, primary dealers settled repurchase agreements in which they received highly liquid US Treasury securities in exchange for less liquid securities.

Officials from the FRBNY have stated that the TSLF, as a securities-for-securities lending program, did not affect the supply of bank reserves and that “the benefit was that the Fed was not adding more cash to the economy and therefore did not have to take offsetting actions to manage the fed funds rate. This was a key difference in TSLF from the Single-Tranche repo program and from the Primary Dealer Credit Facility, and meant it could be scaled up or down more quickly” (Logan, Nelson, and Parkinson 2018).

While the TSLF was in operation, the Fed published information on awards, stop-out rates, and bid-to-cover ratios, but it did not disclose the identity of the participant primary dealers or the bid propositions.

In July 2010, the US Congress passed Dodd-Frank. The measures included to promote transparency required the Fed to disclose certain information on their emergency lending programs. In regard to the TSLF, on December 1, 2010, the Fed disclosed detailed information about borrowers between December 1, 2007, and July 21, 2010. The information included the identity of the borrowers, dates, type and amounts of financial assistance provided, the interest charged, and pledged collateral.

The TOP was approved on July 24, 2008, and announced on July 30, 2008. It was an extension to the TSLF and required administrative changes pursuant to Schedule 2 auctions and not another FRA Section 13(3) authorization. The TOP intended to provide primary dealers some relief during periods of “heightened collateral market pressure, such as quarter-end dates.”

The new program authorized the FRBNY to offer “options” to loan US Treasury securities for a seven-day term, two to three weeks after the auction date and at a fixed rate. In some way, the TOP was a pre-auction that gave primary dealers the guarantee that they could have access to liquid assets at a later date, without the commitment to exercise the options. The TOP was limited to $50 billion in US Treasury securities, on top of the $200 billion of Schedule 1 and Schedule 2 programs. The minimum bid rate was 1 bp, and all Schedule 2 collateral was eligible. The day before each TOP auction, the FRBNY announced the terms and conditions, including the fixed rate of the loans. The TOP held its first auction on August 27, 2008 (OIG 2010.).