The Term Securities Lending Facility (TSLF) was recently introduced by the Federal Reserve to promote liquidity in the financing markets for Treasury and other collateral. We evaluate one aspect of the program -the extent to which it has narrowed repo spreads between Treasury collateral and lower quality collateral. We find that TSLF operations have precipitated a significant narrowing of repo spreads. More refined tests indicate the market conditions and types of operations associated with the program's effectiveness. Various additional tests, including a split sample test, suggest that our findings are robust.
Securities loans collateralized by cash are by far the most popular form of securities-lending transaction. But when the cash collateral associated with these transactions is actively reinvested by a lender's agent, potential risks emerge. This study argues that the standard compensation scheme for securities-lending agents, which typically provides for agents to share in gains but not losses, creates incentives for them to take excessive risk. It also highlights the need for greater scrutiny and understanding of cash reinvestment practicesespecially in light of the AIG experience, which showed that risks related to cash reinvestment, by even a single participant, could have destabilizing effects.
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