Economists are calling into question the balance sheet strength of the Federal Reserve, pointing to its newest method for injecting banks with much-needed liquidity, the term auction facility, as increasing its exposure to risky mortgage-backed securities. Through so-called TAF auctions, which were initiated in mid-December and via which the Fed has already issued $130 billion, banks can borrow at rates of as little as 3% for periods ranging between 28 and 35 days. In exchange for the funds, the banks offer up a wide range of assets as collateral, including securities backed by dubious subprime mortgages.

The Fed is carrying $60 billion worth of assets from TAF auctions on its books, including residential and commercial mortgage-backed securities. Of the $60 billion, the Federal Reserve Bank of New York holds nearly $44.9 billion on its balance sheet. In its latest statement, on February 21, the New York Fed had $9.6 billion in capital and surplus against a staggering $317.5 billion in assets, including the TAF collateral.

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The Fed will offer its latest TAF auction today, lending $30 billion in 28-day loans. Many of the TAF auctions have been oversubscribed, with the latest auction, on February 11, drawing 66 bidders in search of $58.4 billion in funds. The Fed offered only $30 billion, at a rate of 3%. While it is not known for how much longer the Fed will hold TAF auctions, it said earlier this month it “intends to conduct biweekly TAF auctions for as long as necessary to address elevated pressures in short-term funding markets.” It will announce plans for the March auctions by Friday.

In its latest issue, financial newsletter Grant’s Interest Rate Observer “downgrades” the New York Fed from “presumptive triple-A to mid-grade junk” because of the assets it has accepted from the banks through its TAF auctions.

“Inside the Fed and out, the TAF is credited with restoring confidence to the interbank lending market and for closing the spread between one-month Libor and the funds rate,” notes the newsletter. “But few things come for free, and the TAF might have achieved these ends by absorbing on its balance sheet the commercial banks’ mortgage problem.”

In response to the newsletter piece, a spokesman for the New York Fed said in a statement: “Reserve banks operate under well-established guidelines regarding margining and collateral.”

Some in the market are skeptical, however, that the Fed is sticking to these guidelines. Last week, as concern over the economy grew, investors drove the price of gold and oil to record levels, with gold climbing to $958.40 an ounce on Thursday, while crude oil reached $101.32 a barrel. The dollar fell against other currencies, including plummeting to $1.48 against the euro, its weakest level this month.

The “principal clients” of the Federal Reserve chairman, Ben Bernanke, “are the New York City commercial banks,” a professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission, Peter Morici, said. “He is basically giving the banks lots of credit without requiring them to fix the structural problems that have created this need for liquidity in the first place.”

Not everyone thinks the Fed is entering troubled waters by accepting mortgage-backed securities as collateral. “I think the whole crisis is a bit overdone,” a banking analyst at Punk, Ziegel & Co., Richard Bove, said. “It is not so much actual losses that are occurring, but the expectation of loss. If the economy doesn’t go into a deep recession, these losses won’t ever occur, so the assets that the Fed is taking on is not that toxic.”

Still, the Fed is accepting subprime mortgages as collateral “if they meet Reserve Bank eligibility requirements, including credit quality and tranche type,” it says on its Web site. “AAA-rated collateralized debt and mortgage obligations are examples of eligible structured debt obligations,” it adds. It is these securities, however, that received their triple-A ratings from the monoline insurers—ratings that are now in doubt and have led the insurers to face their own downgrades.

“Quite simply, Bernanke has failed and the TAF is one element of it,” Mr. Morici said.