Since the credit crunch, central banks have been injecting massive amounts of money into the banking system in an effort to keep credit flowing. These measures have only been partly successful. In December, central banks in Europe and the US took the step of introducing term auction facilities (TAFs) as a further measure against the turmoil. A total of $65 billion was provided by the Federal Reserve, the European Central Bank and the Swiss National Bank, and the Bank of England added a further £8.5 billion.
At the time, the TAFs were given a mixed reception, with many investors hoping for “a bolder response to the growing housing and mortgage crisis”. Bankers too were unconvinced, saying that the cash injections would not be sufficient and needed to be augmented by other measures from the banks themselves.
However, unlike some other efforts to reopen the interbank market, TAFs have survived. The Fed is now launching two more to follow its two in December. Initially they were slated for the same amount as the first, at $20 billion apiece. But the Fed has increased the size of the second pair by 50%, to $30 billion each. Market participants are also beginning to recognize the benefits.
The key to that recognition lies in the objectives of the TAF programme. Essentially, TAFs are an extension of the central banks’ more traditional lending practices. Although they are new in the US, in Europe auction facilities are relatively common, and the only real difference with the new TAFs is that the collateral requirements have been relaxed. The programme was never going to return markets to any form of normality. However, in allowing markets to begin operating to some measure of efficiency, it has proved valuable. TAFs are not in place to deal with the underlying cause of the turmoil in the markets but with the consequences of credit risk aversion. In that, they have been successful. Jean-Claude Trichet, president of the ECB, has said that the TAFs have “proved efficient technically”, but that the central banks “cannot be complacent in terms of inflation and the question of significant correction in the markets”.
Trichet is alluding to the possible costs attached to the TAFs. At a time when central banks, especially in Europe, are trying to curb inflation, pumping billions into the money markets could work against that objective. Also, central banks are supposed to make only the safest of investments, and stocking up on mortgages under a relaxed criteria could well backfire, especially if the eventuality of another “significant correction” comes to pass.
It is also possible that the success of the TAFs will give rise to problems of market sentiment. The reason that the TAFs were necessary is that banks did not want to exploit central banks’ more traditional lending measures, namely the discount loan window, as the stigma attached to borrowing from central banks often outweighs the capital benefit. The auction facilities allow banks to access capital without it being seen as a sign of weakness, so they will be happy to see the programme being continued. But from the central banks’ point of view, the TAFs were launched specifically to help deal with a crisis, and the continuation of the programme might just smack of central bank panic, suggesting that traditional lending methods are not feasible in such a difficult environment. It will be a balancing act for them to scale back their liquidity injections.
It is probable that the TAFs will become just another tool at central banks’ disposal, rather than being discontinued. Certainly the Fed is not considering halting the programme. When announcing the second round of TAFs, it reiterated that it would continue with the auctions “for as long as necessary to address elevated pressures in the short-term funding markets”. It could be a long wait.