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The Federal Reserve put $150 billion (the "cover") of 84-day credit up for auction on June 15, but the loans that banks requested amounted to only $48 billion (the "bid"). This low bid-to-cover ratio continues a trend of increasingly undersubscribed term auctions. That banks are not clamoring for credit at the Term Auction Facility (TAF) could signal that the credit crunch is easing. It raises the question of how effective the TAF has been and how long this “temporary” facility will last.
Source: Board of Governors of the Federal Reserve System
The Term Auction Facility, authorized under Section 10B of the Federal Reserve Act, is one of the Fed’s innovations to make credit more readily available to banks. During the October 2007 credit crunch, the interest rate on term loans (loans for periods longer than overnight) rose far above the overnight interest rate. It was a sign that banks were reluctant to lend to each other. Concerned that banks would shun the stigma associated with borrowing from the Fed’s discount window and so fail to get needed liquidity, the Federal Reserve held its first auction of $20 million of 28-day credit on December 17, 2007. The privacy of the auction structure, and the possibility of a low interest rate, attracted many propositions for loans. The spread between term and overnight interest rates fell over the following months, and a study by the New York Federal Reserve concluded that TAF had worked.
Through the weekly TAF auctions it has held since 2007, the Federal Reserve has cumulatively made over $3.1 trillion of term loans. However, the auctions’ privacy means that observers do not know who is getting this credit. Some observers, wondering how the European Central Bank could have paid back the billions of dollars that it borrowed in liquidity swaps with the Fed, have speculated that European banks with U.S. branches may have bid at the TAF to obtain the needed funds.
The very low bid-to-cover ratios of the past few months, shown in the chart above, do not necessarily signal that banks’ credit needs are decreasing. The bid-to-cover ratio is low mainly because the Federal Reserve has expanded the credit available in each auction. The number of bidders in each auction is as high as when TAF started, suggesting that the facility is still helpful to many banks. Whether or not there is a great need for the TAF, it will probably remain the same for some time – if only to provide increased certainty to the market.
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