Term Auction Facility - Explained
What is the Term Auction Facility?
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Table of ContentsWhat is the Term Auction Facility (TAF)?How a Term Auction Facility Works? Academic Research on Term Auction Facility
What is the Term Auction Facility (TAF)?
TheTerm Auction Facility, or TAF, is a provisional fiscal policyinitiative employed by the United States Federal Reserve, that seeks to ameliorate heightened business pressure that threatens short-term funding markets. The primary goal of TAF is to increase liquidity in credit markets in the United States by allowing the Federal Reserve toauctionoff a fixed number of short-term loans that are backed by collaterals todepositoryinstitutions such as savings or commercial banks, credit unions, etc. However, as a precondition for obtaining such loans, depositoryinstitutions must first be evaluated by their corresponding local reserve banks as being in sound financial condition. The term for such collateral-backed loans is typically either 28 or 84 days.
How a Term Auction Facility Works?
The Term Auction Facility (TAF) program came into being on December 17, 2007 as a countermeasure against financial problems stemming from the United States subprime mortgage crisis that occurred between 2007 and 2010 and that finally resulted in the Great Recession in the United States (December 2007 June 2009). The Federal Reserve devised this program in order to facilitate loans to member banks the primary goal was to ensure that a shortage of funds at one bank did not in any way disrupt the flow of funds and credit within the banking system as a whole. To qualify for such loans, depository institutions were required to be in sound financial condition and were expected to maintain this status quo over the terms of TAF loans. Generally, financial institutions that were eligibleto borrow under the primary credit program could potentially also participate in the TAF program. Depository institutions that did qualify for participation in the short-term loan auctions were required to place bids through their respective local reserve banks. Typically, minimum bids were fixed at an overnight indexedswap rateconsistent with the maturity of the loans. Also, the borrowing rate was usually set below the discount rate.
The workings of the TAF are fairly simple.
- Every two weeks, the Federal Reserve would decide on the amount of money it would lend on a particular day, and also fix a minimum rate of interest at which it would disburse the loans.
- This would be followed by the commencement of the bidding process during which bids would be received from various member banks and sorted according to the interest rate offered.
- The Fed would then add up the loan amounts requested until the total amount requested equaled the amount the Fed wanted to disburse. While doing this, the Fed would prioritize loan bids that offered the highest interest rate and gradually work its way down. In such an arrangement, the interest rate payable would equal the lowest rate offered among the member banks whose bids were accepted.
Despite the Federal Reserves bullish attempt to increaseliquidity by decreasing itsdiscount rate, its efforts failed to achieve any desirable outcome. This led the central bank to join forces with othercentral banksaround the world in an effort to create a sustainable monetary policyinstrument so as to ameliorate the fiscal situation. Central banks of other nations that cooperated with the Federal Reserve in the TAF program include the European Central Bank, the Bank of Canada, and the Bank of England. The Term Auction Facility program allowed the Fed to offer loans to member banks at significantly lower rates compared to the associated market rates. In return, the member banks had to put up collateral in the form of bad loans. This arrangement was finally successful, and by the first quarter of 2009, the Federal Reserve had already disbursed loans to the tune of $500 billion. It had also acquired around a trillion dollars worth of collateral from these disbursements. As an offshoot, the TAF program also resulted in increasing confidence that banks had in each other. However, in what can safely be considered the greatest embodiment of the success of the Term Auction Facility program, all TAF funds have since been repaid to the Federal Reserve without involving as much as a dollar of taxpayers money to subsidize any of these loans.
Academic Research on Term Auction Facility