What Was The Primary Dealer Credit Facility (History)?
The PDCF was established by the federal reserve in 2008 to try to alleviate the pressures on primary dealers that were materialising from the emerging global credit crisis. Its function was to have the authority to bail out primary dealers at very short notice, keeping them liquid and trying to stabilise the faltering economy. Primary dealers belong to a specified list of financial corporations that are integral to the U.S. economy, for example Goldman Sachs. The PDCF was considered to be employing a high-risk strategy and was often labelled as biased in favour of various unregulated financial institutions. However, supposedly every $ of every loan under the scheme has been repaid.
The PDCF was set up specifically in light of Section 13(3) of the Federal Reserve Act, which allows the board to authorise essentially reserve loans to anyone they please when circumstances are ‘unusual and exigent’ such as during a financial crisis. This also explains why the PDCF was disbanded again when the global economy was deemed to be recovering in 2010, although many discussions took place in a bid to make it permanent. Their power to determine the eligibility of collateral and to lend money to investment banks was of particular concern.
The loans approved by the PDCF would become high priority, senior debt and were always secured loans. The interest rate of the loans was variable to track the bank’s primary credit rate. The security of the loans came from the sale of securities in exchange for funds from the Federal Reserve. This sale on a repurchase agreement formed the collateral of the loan (always outweighing the loan in value) and enabled the reserve to lend the money at the aforementioned rate. As these loans matured in 24 hours and because primary dealers would be allowed to reapply for them on a daily basis, fees were introduced to penalise institutions who borrowed for more than 45 consecutive days.
The authority bestowed on the PDCF was not without risk. By expanding what was deemed eligible collateral, the Federal Reserve directly weakened its own financial position to keep liquidity in the market, simultaneously taking on higher risk and mortgage backed securities, essentially lower quality debt. The PDCF also came under fire for lending to non-bank financial institutions that were not as tightly regulated as banks and was pressurised to bring in similar regulation for those institutions. This never happened; in fact the PDCF gradually took more steps to increase eligible collateral and therefore potential liquidity for the rest of its lifetime. The fear factor came from investment banks potentially being able to take on excessive risk with minimum penalties, backed up by the PDCF and its Federal Reserve loans. The fact that the regulation that was specifically put in place for banks to avoid moral financial hazard for the country could now be sidestepped by deregulated institutions that could mitigate their risk by borrowing from the reserve was of great concern to many economists.