Government Bailouts and Weapons of Mass Liquidity

The lending capacity of the United States financial system has declined significantly over the last eighteen months as huge losses on loans and toxic securities have smashed capital in the financial sector. Hence, in a attempt to inject additional liquidity into the financial system, the U.S. Treasury along with the Federal Reserve has set out a series of programs to clean up the balance sheet of distressed financial institutions.

So far, seven assistance programs were introduced: the Troubled Asset Relief Program (TARP), the Term Asset-Backed Securities Loan Facility (TALF), the Capital Assistance Program (CAP), the Commercial Paper Funding Facility (CPFF), the Temporary Liquidity Guarantee Program (TLGP) and the Public-Private Investment Program (PPIP).

The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase assets and equity from financial institutions. TARP allows the Treasury to purchase both “troubled assets” and any other asset the purchase of which the Treasury determines is “necessary” in order to further economic stability. Troubled assets include real estate and mortgage-related assets and securities based on those assets. This takes into account both the mortgages themselves and the various financial instruments created by pooling groups of mortgages into one security to be bought on the market

The goal of TARP is to encourage banks to resume lending again at levels seen before the crisis. TARP should theoretically allow banks to increase lending instead of hoarding cash to cushion against future, unforeseen losses from troubled assets. Increased lending equates to 'loosening' of credit, which the government hopes will restore order to the financial markets and improve investor confidence in financial institutions and the markets. As banks gain increased lending confidence, the interbank lending interest rates (the rates at which the banks lend to each other on a short term basis) should decrease, further facilitating lending.

Source: Anna Fedec,
5/31/2009 1:55:48 PM