Tags: Economic- Crisis | fed | defaulted debt | federal reserve

Fed Accepted Nearly $1 Billion Defaulted Debt During Crisis

Thursday, 31 Mar 2011 08:28 PM

The Federal Reserve accepted more defaulted debt than U.S. Treasuries as collateral to back $155.7 billion on the largest day of borrowing from the Primary Dealer Credit Facility, according to documents released today.

The U.S. central bank allowed borrowers to use $929 million in market-valued debt rated D as collateral on Sept. 29, 2008, more than the $905.5 million in Treasuries that were pledged, according to Fed documents released today. The documents included the most detailed view of collateral for the facility, created in March 2008 to provide loans to brokers as Bear Stearns Cos. collapsed.

“The fact that the Fed was willing to accept that collateral was indicative that collateral was very hard to come by at the time,” said Craig Pirrong, a finance professor at the University of Houston. It also highlights “the seriousness with which the Fed viewed the situation,” he said.

Fed spokesman David Skidmore declined to comment today. No public money was lost in the Fed’s emergency lending programs, Chairman Ben S. Bernanke testified to the House Committee on Banking, Housing and Urban Affairs in July, 2010.

The Fed loans on Sept. 29, 2008, were backed by a total of $164.3 billion in collateral based on the market value of the securities, resulting in a 5.49 percent “collateral cushion,” the amount by which the pledged assets exceeded the loan value, according to the Fed data. Equities comprised $71.7 billion, or 43.6 percent of the total. High-risk, high-yield debt, including the defaulted issues, accounted for $18.4 billion, or 11.2 percent.

The Standard & Poor’s 500 index fell 8.8 percent on that day.

Small Cushion

The cushion “was far too small for the risk of the underlying collateral,” Pirrong said. “Collateral that’s junk or defaulted debt and equities at a time when market volatility was huge is pretty eye opening.”

The amount the Fed discounted based on the specific asset classes like the defaulted debt or equity collateral can’t be determined by the data released today.

In September 2008, as Lehman Brothers Holdings Inc. was on the brink of filing for bankruptcy, the PDCF was expanded to accept all types of collateral pledged in tri-party repo deals. In such transactions, a third party functions as the agent between borrower and lender, holding the collateral, which the borrower purchases back at a later date.

Acceptable collateral for the Fed’s dealer facility expanded from only investment-grade debt securities to include high-yield, high-risk securities and equities.

‘Repaid in Full’

“Our broad-based programs achieved their intended purposes with no loss to taxpayers,” Bernanke told lawmakers last year. “All of the loans extended through the multi-borrower facilities that have come due have been repaid in full, with interest.”

The Fed released thousands of pages of secret loan documents under court order, almost three years after Bloomberg LP first requested details of the central bank’s unprecedented support to banks during the financial crisis.

The records -- 894 files in PDF form with 29,346 pages -- reveal for the first time the names of financial institutions that borrowed directly from the central bank through the so- called discount window. The Fed provided the documents after the U.S. Supreme Court this month rejected a banking industry group’s attempt to shield them from public view.

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