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Friday, August 10, 2007

"To Facilitate the Orderly Functioning of Financial Markets"

The Fed accepted mortgage backed securities as part of today's operations to offset the fall in liquidity from the mortgage market meltdown. More on that below, but first, the Federal Reserve issued this Press Release today:

Press Release, FRB: The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets.

The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent. In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets. As always, the discount window is available as a source of funding.

The Fed is making sure that financial market participants are aware that the discount window is available to banks should they have no other place to find needed liquidity, and that it has committed to providing as much liquidity as needed to stabilize the federal funds rate at, or at least close to, the target rate of 5.25%.

Bloomberg reported that:

Central Banks Add Cash to Avert Crisis of Confidence, by Scott Lanman and Christian Vits, Bloomberg: ...In the U.S., the federal funds rate opened at 6 percent, the highest in six years. The rate fell to 5.25 percent after the New York Fed bought $19 billion of mortgage-backed securities and then followed up with $16 billion of funds in a second operation. ...

''The Fed has almost unlimited ability to supply liquidity if they feel that is appropriate,'' [Alice] Rivlin said. She noted that it was ''symbolic'' that the New York Fed's first operation today involved mortgage-backed debt -- the type of securities that investors are unloading. ...

If that's true - if the Fed purchased mortgage backed securities directly in an open-market operation, that would be very unusual and noteworthy. But further checking leads to the conclusion that the Fed accepted mortgage-backed securities as collateral in a repo agreement, something it does routinely. So which it is - the unusual or the routine?

In another story on this, Bloomberg says:

Fed Adds $35 Bln in Funds, Most Since September 200, by Ye Xie, Bloomberg: The Federal Reserve added $35 billion in temporary funds to the banking system through the purchase of securities including mortgage-backed debt to meet demand for cash...

The Fed's additions totaled the most since September 2001. They came in two weekend repurchase agreements, of $19 billion and $16 billion, for which the Fed accepted securities including mortgage-backed debt, so-called agency debt and Treasuries as collateral...

The central bank probably received only mortgage-backed debt in today's operations, said Louis Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. The central bank likely wanted to avoid taking Treasury debt at a time when government securities are in demand as a safe haven, he said.

''The Street has special demand for the highest-quality Treasury collateral right now, so the Fed chose to leave Treasury collateral,'' Crandall said. ''It should not be taken as a sign that basic Fannie Mae and Freddie Mac mortgage pools are difficult to finance.''

The Fed typically only accepts so-called agency mortgage- backed securities, such as those guaranteed by government- chartered Fannie Mae or Freddie Mac, rather than non-agency home-loan bonds from other financial institutions. ...

In repos, the Fed buys U.S. Treasury, mortgage-backed and so-called agency debt from its 21 primary dealers for a set period, temporarily raising the amount of money available in the banking system. At maturity, the securities are returned to the dealers, and the cash to the Fed. ...

And from the AP:

New York Fed accepts $35 billion in mortgage-backed securities to inject cash in system: Responding to credit crunch fears in the stock market, the Federal Reserve of New York said Friday it would buy a total of $35 billion in mortgage-backed assets to inject more cash into the banking system.

According to the New York Fed's historical data, which goes back to July 2000, the bank in that time has never accepted that much in mortgage-backed securities in a three-day repurchase agreement.

When the New York Fed ... made its huge three-day repurchase of $81.25 billion the Friday following the Sept. 11, 2001 terror attacks, only Treasury securities were accepted and submitted.

In a "repo," the Fed buys securities from dealers, who then deposit the money into commercial banks. ... The central bank did not comment on why it was accepting more mortgage-backed securities than usual, but it's possible that the Fed was trying to remove some of the stigma that these assets currently hold in the financial markets. ...

So, it is not unprecedented for the Fed to accept mortgage backed securities as collateral, but the amount is unprecedented for a three day period. Two reasons are offered for this move, one is to ensure that the supply of Treasury Bills, which are in demand as a safe haven, does not fall due open market operations (as suggested in the Bloomberg story), and the other is to show faith in the value of these securities (as suggested in the AP story). Update: See Jim Hamilton and William Polley for more on this. After noting that these are agency backed securities (as noted above, and also discussed in comments), William Polley says, "the Fed was NOT bailing them out by buying distressed subprime loans... This kept anyone from unloading good quality assets at fire sale prices just to get liquidity." 

    Posted by on Friday, August 10, 2007 at 10:17 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (22)


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