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How the Fed Prepared to Buy Bank Stocks in 2007: Street Whispers

Stocks in this article: GS MS JPM BAC C BCS AIG

PDCF was an overnight lending facility created by the Fed, which was targeted at securities dealers and accepted new forms of collateral as risky as equities, low-rated debts, and unknown unrated financial instruments, in order to help investment banks finance themselves when short term funding markets dried after the collapse of Bear Stearns.

According to data released to the public by the Fed between Sept. 15, 2008 and May 5, 2009, PDCF accepted roughly $2.18 trillion in equity securities as collateral for overnight funds, primarily from investment banks Bank of America Merrill Lynch (BAC - Get Report), Morgan Stanley (MS - Get Report), Goldman Sachs (GS - Get Report) and Barclays (BCS). The Fed's public data, however, doesn't show what equities those holdings were in. Presumably, some were in bank stocks.

More granular data was sent to Bloomberg after the news agency won a multi-year Freedom of Information Act battle with the Fed that went all the way to the U.S. Supreme Court. Bloomberg has since made those documents public, however, the data doesn't appear to specify the Fed's holdings beyond a daily breakdown of its collateral by bank and asset type.

As Bloomberg noted, much of the PDCF data raises more questions about the crisis than it answers -- for instance, the $1.5 trillion in collateral the Fed accepted with a moniker 'ratings unavailable.' In total, roughly $9 trillion was lent to dealers in PDCF, backed by $9.67 trillion in collateral.

Overall, the Fed's various crisis-time facilities expanded the central bank's balance sheet by about $3 trillion, pumping that amount into U.S. financial system.

While Fed Governor Mishkin's Sept. 18, 2007 recommendation that the Fed buy up bank stocks proved a light moment at the time, it also foreshadowed the unthinkable action the central bank would take as the financial crisis intensified in 2008. Transcripts to 2008 Fed meetings will be released next year.

For more on the Fed's Friday disclosure, see inside the Fed's first financial crisis meeting. Also see Jim Cramer's reflections on the Fed's inaction in mid-2007.

-- Written by Antoine Gara in New York

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