Fed Faces Losses

Remember back when the Federal Reserve started taking on private debt exposure and swore that it would not incur any major losses? It may have been a little too optimistic. The Wall Street Journal reports that the Fed could face a significant loss from a commercial real estate holding connected to the Bear Sterns sale to JP Morgan last year, with which it helped to facilitate. This is troubling news.

The WSJ explains:

The Fed, through a fund called Maiden Lane, wound up holding about $900 million in Extended Stay debt in the wake of Bear Stearns's failure. A team at the New York Fed is working with BlackRock Inc. and other private-sector advisers to try to maximize its recovery on that debt. But under a controversial plan proposed by Extended Stay and endorsed by a small group of creditors, the Fed's position could take big hits.

This development raises questions about the Fed's nonchalant attitude concerning potential losses. Given that this situation arose from one of its earliest interventions in the financial crisis, some may interpret it as only the first domino to drop. The commercial real estate market is widely regarded as the next bad thing to watch, so the extent to which the Fed is exposed to commercial mortgages or commercial mortgage-backed securities (CMBS) matters a lot.

And its exposure to CMBS is growing. Last spring the Fed began accepting CMBS as collateral for its Term Asset-Backed Securities Loan Facility (TALF). That includes newly issued CMBS and even legacy CMBS issued prior to 2009. As a result, its exposure to CMBS, past and present will continue to grow.

How much exposure to CMBS are we talking about? Given the Fed's lack of transparency it's difficult to tell. But just last month, $669 million of legacy CMBS TALF loans were requested. Another CMBS TALF operation is scheduled for August 20th, so stay tuned.