BENDING THE RULES

I read earlier today that this was the first time the Fed would take equities as collateral for loans and that seems to be true.

Federal Reserve Offers No Cash but Loosens Standards on Emergency Loans
By EDMUND L. ANDREWS
Published: September 15, 2008
NY Times

In an obscure but highly important announcement late Sunday evening, the Fed said it would let Wall Street firms post as collateral much riskier assets — including equities, junk bonds, subprime mortgage-backed securities and even whole mortgages — in exchange for emergency loans through the Primary Dealer Credit Facility.

The Fed created the emergency loan program in March, at the same time that it engineered the shotgun marriage of Bear Stearns by JPMorgan. In itself, the program marked a historic expansion of the Fed’s lending to cover investment banks rather than only commercial banks.

Before the Fed’s announcement on Sunday, investment banks could pledge as collateral any kind of “investment grade” debt securities, which meant securities rated BBB or higher and included many securities backed by subprime mortgages.

But with the new announcement, the Fed will accept stocks and some debt that has junk-bond status and some securities that may have few real buyers.

It was unclear Sunday night just how much in the way of high-risk collateral the Fed would be willing to accept. The central bank said it would broaden its list of eligible collateral to “closely match” the practices of the “tri-party” overnight lending facilities run by two major clearing banks — JPMorgan Chase and Bank of New York.

Those programs allow about 15 percent of their collateral to be in equities or debt that is below investment-grade, and most of that is reserved for equities.

I was wondering how BOA could pull off the purchase of Merrill and this helps explain how:

For example, if Bank of America completes its acquisition of Merrill Lynch, its capital reserves would immediately fall below the minimum requirements for bank holding companies. Regulators, including the Federal Reserve, would have to show lenience for as long as it takes the capital markets to regain their confidence — which could be quite a while.