TAF? What?

The Fed introduced a new toy the night after last month's Fed meeting. The new toy has an acronym "TAF" as everything in finance has to have a stupid acronym. TAF stands for Term Auction Facility. In the scheme of things, it's the Fed's way of being able to mess with libor.
Up till now the Fed had three major tools: the discount rate, the fed funds rate (via open market operations) and the reserve ratio. See my post about the Fed (another "learn the lingo" posting) if you need details about these. Now the Fed has introduced a new tool that lets it have a more direct impact on libor.

But wait! Isn't the fed funds rate directly tied to libor? Well, sorta, not really. There's certainly a relationship, but generally libor trades at a spread over fed funds. That spread historically sticks to 1% or less. Right now it has blown way out, so the Fed needs something to deal with that spread issue. Enter the TAF.

Here's how it works. Memeber banks (note: member banks need to be commercial banks or savings and loan instutions--specifically, this EXCLUDES the investment banks) can borrow up to 10% of a $20Bn sum being auctioned off by the Fed. The auction works as a dutch auction so the money is lent out at whatever rate banks bid for the amounts they specify. The Fed announcement set two auction dates in December (already passed, clearly -- they were fairly successful and didn't show ridiculous demand for cash, which is good) and two dates for the roll in January. In fixed income a "roll" indicates when one needs to go from one security to another, in this case cash borrowed over one term to cash to be borrowed over another term.
By lending directly to banks via this auction, the Fed is creating cash on the balance sheets of banks. Then banks don't need to borrow as much in the libor markets so libor can set down. Brilliant. They're still flooding the cash markets via open market operations for year-end, but we should expect a lot of the cash-hoarding issues to be settled.