The FED and unintended consequences

Robert Peston (via FT alpahville) has a suspicion:

Well, the point of Tuesday’s dramatic $200bn intervention by the Federal Reserve in mortgage-backed markets was to stabilise the price of US government agency AAA-rated residential mortgage-backed securities and – by implication – to encourage the big banks NOT to seize assets in the way they’ve been doing at Carlyle.

Right now, it’s not clear that the Fed’s medicine has worked.

In fact, it’s arguable that the banks’ seizure of Carlyle’s $20bn-odd in assets has actually been encouraged by the Fed's mortgages-for-Treasuries offer. Because the Fed’s new lending emergency lending facility allows the banks to swap mortgage-backed debt for Treasury Bills in a way that Carlyle could not do.

So it would be rational for the banks to take Carlyle’s assets and exchange them for top-quality, liquid US government bonds, rather than leave loans in place to a business, Carlyle, whose assets remained highly illiquid.

I think if this were true, we could safely call it an unintended consequence of a safety mechanism. It is worth pointing out, though, that Carlyle was not that highly leveraged given its assets. 32:1 (or 28:1, accounts differ) on Agency pass throughs is not a huge gearing. The Banks do have an incentive to liquidate at the moment -- CCC is basically a one way bet on the Treasury/Agency spread so CCC's default is strongly correlated with the value of its collateral. However, is it legal not to sell the collateral after a credit support default? I rather thought that any excess of the sale price over the amount owing on the repo belonged to Carlyle (remember there is a repo haircut so the banks have not lent the full face value of the bonds), so don't they have to sell the bonds rather than put them into the TSLF?