Excerpt from Bloomberg

At the height of the financial crisis, the Federal Reserve allowed the world’s largest banks to turn more than $118 billion in junk bonds, defaulted debt, securities of unknown ratings and stocks into cash.

Collateral of those asset types made up 72 percent of the total $164.3 billion in market-rate securities pledged to the Fed on Sept. 29, 2008, two weeks after the bankruptcy of Lehman Brothers Holdings Inc., according to documents released yesterday. The collateral backed $155.7 billion in loans on the largest day of borrowing from the Primary Dealer Credit Facility, which was created in March 2008 to provide loans to brokers as Bear Stearns Cos. collapsed.

The cushion “was far too small for the risk of the underlying collateral,” Pirrong said. “Collateral that’s junk or defaulted debt and equities at a time when market volatility was huge is pretty eye opening.”

Morgan Stanley (MS) was the largest borrower on Sept. 29, 2008, totaling $61.3 billion, the data show. The New York-based firm pledged $66.5 billion in collateral, including $21.5 billion in equities, $19.4 billion in unknown rated securities and $6.7 billion in junk or defaulted debt.

Merrill Lynch was next, with a $36.3 billion loan. Its $39.1 billion in collateral included $23.3 billion in equities, $6.3 billion in unknown rated securities and $3 billion in junk or defaulted bonds.