"I don't think many investors understand the powers of the Fed when it comes to QE. The Fed is strictly limited, legally, in terms of their powers to buy private assets. That's why they came up with the robbery scheme to use OTC derivatives as collateral for "loans" to the banksters, rather than buying the OTCD garbage dump outright."
The Fed is the government's bank and it is also subject to significant government influence (even though they go through the motions of pretending otherwise). At some point in the past, someone concluded (correctly) that it would be a conflict of interest if the government were allowed to own private companies. For example, the government as a major shareholder in a construction company could create pressures on the company to engage in certain projects for political reasons that have no economic benefit to the company or its other share holders. This explains why the Fed is not allowed to play the stock market directly. Greenspan even had nightmares that all the budget surplus money would end up on his desk and he wouldn't have a place to put it.
Derivatives are not equity in underlying assets. For example, owning an option to buy or sell a stock is not the same as owning the stock. Think of the derivative (option) as a bet that would allow you to buy or sell the stock. So, derivatives are not really the same as the underlying assets. Imagine sitting in a Las Vegas bar and watching a horse race in Kentucky. You could be making bets with the guy next to you, but after all is done, neither of you would own any of the horses.
Derivatives are however traded using currency, and the same people who concluded that Fed ownership of companies would distort the free markets didn't see any problems with the Fed influencing the currency that is used for trading the derivatives (and therefore distorting the free markets).
So, to get around this, the Fed can give banks a loan with the Las Vegas bet ticket acting as collateral, but not for the horse as collateral. They can make the claim that the bet isn't influencing the horse race.
You can see how the whole scheme depends on someone at the end of the chain being able to pay out (think AIG). So what happens if there is nobody at the end of the chain who actually has real assets that can be used to pay off a gambling loss? That's exactly what happened.
That does sound confusing, but there is a huge difference between an outright purchase and a collateralized loan, which unwinds (with an expiration date).
Take the Term Auction Facility, for example (TAF). http://www.federalreserve.gov/monetarypolicy/taffaq.htm The Fed started this lending facility in 2008 auctioning off funds to banks for 90-180 days. Eventually all these loans unwound and the facility stands at a zero balance now. What the Fed took as collateral against this money is what your quote refers to.
Contrast this with mortgage-backed securitites and Federal Agency bonds. These were purchased outright under a special authority granted to the Fed in section 13.3.(A): "In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any participant in any program or facility with broad-based eligibility, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That before discounting any such note, draft, or bill of exchange, the Federal reserve bank shall obtain evidence that such participant in any program or facility with broad-based eligibility is unable to secure adequate credit accommodations from other banking institutions. All such discounts for any participant in any program or facility with broad-based eligibility shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe" http://www.federalreserve.gov/aboutthefed/section13.htm
This is how PIMCO, banks, and other entities unloaded frozen assets at the Fed. There is debate on this message board as to how much these assets are really worth on the market. We know that these assets have been reduced since last August from $1.3T to $1.0T so far and that the proceeds are being recycled into Treasuries.
This authority is a huge power given to Fed. It basically legalizes governmental bail-outs without public consent at the cost of the currency.