Michael J. Fleming
During the 2007-09 crisis, the Federal Reserve took many measures to mitigate
disruptions in financial markets, including the introduction or expansion of
liquidity facilities. Many studies have found that the Fed’s lending via the facilities helped stabilize financial markets. In addition, because the Fed’s loans were well collateralized and generally priced at a premium to the cost of funds, they had another, less widely noted benefit: they made money for U.S. taxpayers. In
this post, I bring information together from various sources and time periods
to show that the facilities generated $21.7 billion in interest and fee income.
Introduction of Liquidity Facilities
As explained in its February
2009 Monetary Policy Report to the Congress, the Fed responded to the
crisis by introducing or expanding liquidity facilities, providing support to
specific institutions, and engaging in direct purchases of assets. With the
facilities, the Fed initially addressed liquidity pressures facing depository
institutions by changing its discount window program in August 2007 to reduce
the institutions’ uncertainty about the cost and availability of funding. Then,
between December 2007 and November 2008, the Fed launched a range of new
facilities to address liquidity pressures experienced by securities dealers and
other market participants, as well as depository institutions.
Balance Sheet Implications of Liquidity Facilities
The rapid growth of lending via the facilities led to a marked change in
the size and composition of the Fed’s balance sheet, as shown below. Then, as
financial markets stabilized, borrowing from the Fed at a rate higher than the
normal cost of funds became less advantageous and the facilities were wound
down, with most expiring in early 2010. The Fed’s balance sheet remained large
after the wind-down because the reduction in lending through the facilities was
offset by increased holdings from the Fed’s asset purchases.
Stabilizing Effects of Liquidity Facilities
There is considerable evidence (reviewed in this recent paper)
that the Fed’s facilities promoted financial stability. To take one example,
the Term Securities Lending Facility (TSLF) was created to promote liquidity in
the secured funding markets relied on by securities dealers. As explained in this study
of the TSLF, the launch of the facility was associated with an immediate
narrowing of financing spreads between less-liquid agency mortgage-backed
security collateral and more-liquid Treasury collateral. This paper
shows that the relationship between the provision of liquid collateral via the TSLF
and the narrowing of financing spreads is statistically significant.
Income Effects of Liquidity Facilities
Not only were the facilities effective at promoting financial stability,
but they also made money for U.S. taxpayers. The table below brings together
information from annual
reports of the Board of Governors of the Federal Reserve, the Fed’s Monthly
Report on Credit and Liquidity Programs and the Balance Sheet, and an article on
the income effects of the Fed’s liquidity facilities. It shows that the gross
interest and fee income generated by the facilities totaled $21.7 billion. Not
surprisingly, most of the income was generated in 2008 and 2009, although the
discount window, central
bank liquidity swaps, and outstanding loans under the TALF
(Term Asset-Backed Securities Loan Facility) continued to generate income into
The biggest money makers were the Commercial
Paper Funding Facility, central bank liquidity swaps, and the Term Auction Facility, as shown below. This ranking largely reflects the extent of lending under the various facilities, but also variation in the fees and
income generated per dollar lent.
Gross versus Net Liquidity Facility Income
The gross income figures do not consider the cost of funds. This article on
the income effects of the facilities estimates the cost of funds for the
facilities through 2009 to be about $7 billion. Since the facilities generated
$20 billion in interest and fee income over this period, the net contribution
from the facilities is estimated to be $13 billion for this period.
Compensation for Credit Risk?
Lending via the facilities did involve some credit risk, so some of the
income generated should be considered compensation for that risk. However, the
Fed kept credit risk to a minimum by establishing eligibility criteria, by
providing short-term loans, and by requiring adequate collateral. As a result
of these measures, as well as the relatively favorable outcome of its lending,
the Fed did not bear any credit losses through the facilities.
To understand the income effects of all of the Fed’s actions during the
crisis, one also needs to look at its support for specific institutions and its
direct purchases of assets. These other measures had different risk
characteristics than the liquidity facilities. Moreover, they were not meant to
wind down as quickly as the facilities and are thus better evaluated over a
longer time period. That said, the liquidity facilities, which made up an
important part of the Fed’s efforts during the crisis, did have a clear
positive effect for taxpayers.
The views expressed in this post are those of the author and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author.
Michael J. Fleming is a vice president in the Capital Markets Function of the New York Fed’s Research and Statistics Group.