15 January 2009

Hamilton interprets Bernanke

James Hamilton explains how to interpret the Treasury's $20 bn in supplementary loss protection mentioned by Bernanke in his 13 January 2009 speech about the recent blowing up of the Fed's balance sheet. Full interpretation today would require foreknowledge of how much the Fed will end up lending through its latest facility, TALF:

Bernanke also discussed some of the Fed's new plans:

In addition, the Federal Reserve and the Treasury have jointly announced a facility that will lend against AAA-rated asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. The Federal Reserve's credit risk exposure in the latter facility will be minimal, because the collateral will be subject to a "haircut" and the Treasury is providing $20 billion of capital as supplementary loss protection. We expect this facility to be operational next month.

Here at least we have a number-- $20 billion-- that will give us some idea of what Bernanke assesses the ballpark risks to be. If, for example, we see that the Fed lends $100 billion in this program, I'd take that to mean he's thinking the underlying assets are really worth at least 80 cents on the dollar; if $200 billion, we're talking about 90 cents on the dollar. If this gets into the hundreds of billions, it's hard to see how $20 billion would be regarded as a significant equity cushion.

Thanks, James Hamilton.

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