The Legacy Continues to Build

Sometime early this year the Administration stopped calling unsalable assets "toxic," as Secretary Paulson had done, and began calling them "legacy assets." Even that rhetoric has evaporated or just been ignored more as of late. That's unfortunate because the Fed's big moves from early last year have mostly evaporated as the true legacy assets are still accruing.

The figure below shows several Federal Reserve programs that began last year.

The two that were most prominent in 2008, central bank liquidity swap lines and the commercial paper program were sensible, short-term program. The liquidity swap lines were extended to other central banks so that they could obtain US dollars. The commercial paper facility allowed firms to trade on their own short-term debt obligations. The move was important because firms rely on the commercial paper market to manage their day-to-day finances.

The other two programs both show a different view of the bailout. The green Maiden Lane line is the sum total of funds given to bailout and purchases assets from Bear Stearns and AIG. These assets are definitely legacy assets. You can see that after the levels only jump when the Fed picked up Bear and then Later AIG. Since then the Fed has been unable to unload these assets. Much unlike the central bank swaps and commercial paper programs where private markets have stepped into resolve the issue, no one wants to touch Maiden Lane.

Also, it's clear that Maiden Lane is simply a small portion of bailout efforts. While the Bear and AIG episodes have lots of other costs, as you can see that the central bank swap lines become much more important once Bear fails, they are not themselves the big cost.

The real cost and the one most likely to resemble Maiden Lane is the Fed's purchases of mortgage-backed securities (MBS). The Fed has continued buying these up in an effort to cleanse financial markets. These are the quintessential "toxic" assets. The Fed will be unable to sell most of this stuff and have to hold it until the underlying liabilities are paid back. Given that a lot of those are home loans, the Fed could have a good deal of these assets for 20 to 30 years. The recession rhetoric may be over but the legacy will be with us for some time.