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| 2007/8/10-13 [Finance/Investment, Finance/Banking] UID:47579 Activity:nil |
8/10 http://tinyurl.com/2vz45a (iht.com) Fed accepts MBS bonds, kicking back $35 billion in cash to banks in short-term loans, delaying mark-to-market valuations on the bonds (encouraging mark-to-Fed accounting schemes). \_ http://www.csua.org/u/jbd (Economist's View) That is not really an accurate summary of what really happened. The MBS were all Agency backed and therefore gov't guaranteed in the first place. Secondly, they did not buy them, they accepted them as collatoral for a very short term (72 hour) loan. More discussion about it here: http://www.csua.org/u/jbe (I know you don't like this blog, but unless you can find a better source of economic explaination, too bad emarkp) -ausman |
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| tinyurl.com/2vz45a -> www.iht.com/articles/ap/2007/08/10/business/NA-FIN-US-Fed-Mortgage-Backed-Assets.php 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. 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. The Fed's move pushed the fed funds rate down to 5375 percent, still above its target. If that rate greatly exceeds the Fed's target rate, the central bank puts money into the system to stabilize that demand. The central bank in a short statement Friday said it would provide "reserves as necessary" to help the markets and do what it can to "facilitate the orderly functioning of financial markets." |
| www.csua.org/u/jbd -> economistsview.typepad.com/economistsview/2007/08/a-significant-l.html first post of Brad's linked above: This morning, the ECB allocated about $130 billion in a one-day quick tender to calm jittery markets. The scramble for liquidity in Europe spilled over into the US: The Fed, in an effort to get the federal funds rate back down to its target 525% and meet the spike in demand for cash, twice entered the market today to inject cash. Just for fun, I thought I'd present a textbook version of this event. where the supply and demand for bank reserves intersect (this is a picture of the federal funds market, ie the market for overnight loans of bank reserves between banks). The demand curve slopes downward because the federal funds rate is the opportunity cost of holding bank reserves. Thus, when the cost of holding bank reserves falls (ie the ff falls), more reserves are held (as insurance against deposit outflows, and for other purposes). in the diagram is controlled by the Fed through open-market operations. At any point in time, the supply of reserves is fixed, so the line is vertical (or at least approximately so in more general models). Banks can borrow money in many different places using different financial instruments, but two places to obtain reserves are the federal funds market and the discount window. So long as the ff-rate is lower than the discount rate, banks will choose the ff market over the discount window. But if the ff-rate tries to rise above the discount rate, banks will switch to the discount window since that will be the cheaper source of funds. In the diagram, this is represented by a vertical supply of reserves up to the discount rate, then a horizontal line at that the discount rate (which is always the ff+1% under current bank operating procedures) since the Fed stands ready to lend as much as banks want through the discount window at the discount rate. from the WSJ Economics blog), "The scramble for liquidity in Europe spilled over into the US" This is shown as an increase in the demand for reserves (ie for liquidity) indexed by in the diagram. If the Fed did not respond, the ff-rate would begin rising, potentially even reaching the discount rate. To avoid this, and maintain a federal funds rate of 525%, the "Federal Reserve subsequently poured a little more cash than usual into the US banking system in order to deal with demand spilling over from Europe." The total amount of the injection was $24 billion, and this is represented by the shift in the supply of reserves indexed by in the diagram. where reserves have been increased to accommodate the increase in demand, and the ff-rate is at 525%. Update: I should have noted that this was an attempt to illustrate the statement from the WSJ: "The Fed, in an effort to get the federal funds rate back down to its target 525% and meet the spike in demand for cash." Demand for reserves would go up, for example, if banks anticipate bad mortgage loans in the future since they would want to have extra reserves on hand as insurance against that eventuality (to the extent they are exposed), or if alternative sources of funds dry up due to the evaporation of liquidity. The graph does not show the effects of the problems in mortgage markets on the supply of reserves, ie a fall in the supply of reserves from bad loans would also increase the ff-rate and require an injection of reserves to offset it. Looks like the mental notes I was making for my intermediate macro course which starts in a couple weeks. What a way to start a macro course with this in the news. I notice the money is being "injected" into borrowing and lending markets, not into the pockets of the people who stand to lose the most - homeowners. The fundamental aim is to prevent bankruptcies among financial intermediaries, not to alleviate the basic problem of creeping poverty. So far as I understand, the Federal Reserve liquidity injection was of no consequence. About $20 billion is injected on any given day, less at times, more at times. So $24 billion was of no concern to me, no matter the news. The issue that interests me is finding which institutions are holding difficult mortgage debt. I know for sure which do not, but finding the holders is tricky. watch the bond market and there was no investment-grade difficulty at all today. Investment-grade debt has been fine, as has high quality below investment-grade. The liquidity issue appears to be a selected institutional problem, with banks appearing secure. I am prepared to be entirely wrong, and I want to understand who is holding difficult mortgage debt, but not worried. Paul Krugman will write on liquidity tomorrow, and I always take Krugman completely seriously and am prepared to worry some although after my run now I am too darn tired to worry. but then where does one go for a derivatives quote but to illiquid private markets. The only issue is which Glass-Stegalless entity goes first. albeit one hopes Geithner, surveying the battlefield has ample troops. Your explanation of the liquidity event is just what I need for my new AP macro students. Our Fed Challenge team was a national finalist and recently presented the current state of the economy at the Board of Governors in May Earlier today after listening to many TV pundits get it all wrong about the ECB and Fed--never once mentioning reserves and increasing demand for reserves, I emailed my Fed Challenge team--most on their way to college soon. Their question was why has the demand for fed funds increased--what is/are the event behind this increased demand, do we know them yet? These kids understand and know the Fed conducts open market operations on a daily basis--and they know the fed funds rate is a "target rate". Well, there has been a significant international liquidity event and my dismissing of the significance was entirely wrong. The evidence is not in the middle or long term investment-grade bond markets, but in highly unusual volatility in short term bond markets. Anne, understanding comes from information and there is so little on opaque and lightly regulated markets that straddle the regulated markets. It is why I follow Geithner's speeches and await a calming word from him; His speech of May 15 on "Liquidity Risk and the Global Economy" is worth a read. Mark wrote: Demand for reserves would go up, for example, if banks anticipate bad mortgage loans in the future since they would want to have extra reserves on hand as insurance against that eventuality... In particular, it seems to confuse reserves with capital. If a bank is forced to write down or write off a loan, that impacts its capital, but has no direct impact on its reserves at all. I suspect this confusion has to do with the use of the term "reserve" in financial accounting ("creating a reserve for bad loans"), which has nothing to do with "reserves" kept on deposit with the Fed. Brad DeLong Angry Bear Econbrowser macroblog Marginal Revolution Greg Mankiw's Blog Calculated Risk The Big Picture Dani Rodrik's weblog The Borjas Blog Brad Setser Nouriel Roubini William J Polley Beat the Press Vox Baby Robert's Stochastic thoughts Felix Salmon Environmental Economics Economics and... Sources New Economist Daniel Gross MaxSpeak, You Listen! Weblogs Disclaimer The views expressed on this site are my own and do not necessarily represent the views of the Department of Economics or the University of Oregon. |
| www.csua.org/u/jbe -> economistsview.typepad.com/economistsview/2007/08/jim-hamilton-wh.html The banking system as a whole usually holds only a small amount of reserves in excess of what is required. A bank that ends up with extra reserves would find it advantageous to loan Federal Reserve deposits overnight to a bank with a deficit in what is called the federal funds market. The interest rate on these overnight loans is usually very sensitive to the quantity of excess reserves in the system, so the Fed could change this rate by adding or subtracting deposits through open market operations. The Fed simply announces the rate it intends to maintain, with the current target being 525%, and the announcement is credible because all participants know that the Fed will be adding or draining reserves as necessary to keep the rate near the target. Not all loans will take place exactly at the target rate, however. These loans are unsecured, and though their very short-term nature makes the risk small, it is not zero. Small banks will often pay a slightly higher rate to borrow fed funds than will big banks, and an individual bank will have a maximum amount it is willing to lend to any given other bank. If a bank has a really big outflow of reserves, or its usual sources for borrowing short-term funds dry up, it may need to offer a rate well in excess of 525% in order to maintain a positive level of reserves. some trades at 6%, some 75 basis points above the rate that the Fed has declared it will defend. So, the Fed used open market operations in the form of repurchase agreements to create new reserves, evidently in the amount of $38 billion. One can put this number in perspective with the following graph of what Federal Reserve deposits usually turn out to be over a two-week period. severe disruption from the physical destruction of a large number of the key institutions that make these markets. Again this week it seems that banks suddenly desired a huge volume of reserves in excess of the amounts they are required to maintain. Some analysts have interpreted the Fed's action as "bailing out the banks", and are particularly troubled by the fact that the assets purchased by the Fed through the open market operations apparently involved mortgage-backed securities. Calculated Risk that since the reserves were injected in the form of a 3-day repurchase agreement, unless the banks go under in 3 calendar days, they will pay the loan back with 3 days of 525% interest. William Polley: A lot of entities holding mortgage backed securities needed liquidity. They were willing to borrow at a higher overnight rate to get that liquidity as evidenced by the spike in the funds rate early in the morning. The Fed, quite understandably, did not want the funds rate to spike, and so they loaned these banks reserves accepting mortgage backed securities of the highest quality as collateral (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. The agreement is that on Monday the banks get their securities back and the Fed takes back the reserves. The bottom line is that the Fed was doing exactly what it needed to do. But the fact that this was needed is a very troubling development. Que sucedi en el mercado monetario from GurusBlog En el blog Economists View (haciendo referencia a un artculo de Jim Hamilton) encuentro una buena explicacin de lo que sucedi la pasada semana en los mercados monetarios con la intervencin de varios bancos centrales inyectando liquidez e.. Tracked on August 11, 2007 at 02:49 PM Comments groucho says... "This kept anyone from unloading good quality assets at fire sale prices just to get liquidity. Since agency MBS pricing has been based on the same faulty mark to model and fraudelent appraisal process as private MBS, how could the MBS the FED purchased be considered "good quality"? This is the same MORAL HAZARD policy that has been creating the ponzi asset boom/bust episodes we repeatedly see around the world. Long term, todays fire-sale prices will prove to be too high anyway. Does the gov't really want to experience another Japanese style drawn out malaise? I need some money fast and somebody is willing to lend me boatloads of money using the bucket of crap as collateral (it *is* worth something after all I guess). The interest rate of the loan is lower than the going rate. "unless the banks go under in 3 calendar days, they will pay the loan back with 3 days of 525% interest. But if they don't pay it back -- the Fed gets stuck with overvalued mortgage-backed securities. Then the Fed sells these securities at a loss -- less money for the treasury -- more taxes for the little guy. There is simply no concern about a failure to repay eoityh interest a Federal Reserve liquidity extension, nor is there danger of the Fed holding overvalued mortgages. The root of the situation appears to be that no one is willing to pay the current MBS holders' asking price for the securities, due to "the market" suddenly realizing that they have no clue about the actual value. What secret information does the Fed have that, if stuck with the securities, the loaned amount was "correct"? The value of a mortgage package offered as collateral for liquidity is easily understood because the package will be short term in duration and the mortgages involved of minimal default risk and further secured again real property. Notice how easily Vanguard values bond funds nightly, with bond packages of varying duration in a given portfolio and the most limited duration packages essentially available as immediate collateral or even cash. There is simply no threat to the Federal Reserve in holding mortgages as overnight collateral. The question that should be asked is why Vanguard bond portfolios as so long expected have held no difficult mortgage debt but not so for Goldman Sachs portfolios? I asked the guy who did the Fed tour yesterday why the Federal Reserve hadn't been requiring stricter underwriting on bank originated mortgages and maybe something akin to reserve requirements on them. He said that in the past the Fed had had a lot of problems with regional banks failing due to local housing slumps -- he cited Texas as a particularly bad example-- and MBS was actually a pretty good way of spreading that risk around. Hamilton's chart gives a good idea of why this caused such a furor-- it wasn't what happened, but the size of it that was unusual. Also, since MBS are relatively new and the Fed's acceptance of them in repos even newer, lots of people were caught by surprise and many at first thought that something really unprecedented had happened. I must say to be taking macroeconomics and have a trip to the Fed scheduled at this particular moment was a huge piece of luck! I can't imagine a more exciting introduction to what can be a pretty dry subject. "There is simply no threat to the Federal Reserve in holding mortgages as overnight collateral." in the short term the FED isn't threatened because they are legally allowed to monetize a variety of assets that congress has spelled out in their charter. And if they have their way they will try to monetize anything and everything not nailed down, including that "bucket of crap" that ponzi is trying to sell (with little luck). The FED tried (and failed) to reflate the productive parts of the US economy. The hole they thought the US was entering is now much, much deeper. Will the FED move to outright purchases of MBS going forward? While it's still too early to know what Bernanke will do, we do get some clues from Bush's strategy in Iraq. Will Bernanke copy Bush's playbook and hope for a miracle with a quick surge in outright MBS purchase in hope of putting a floor under their price? We shall soon find out................................... Sarah: "Also, since MBS are relatively new and the Fed's acceptance of them in repos even newer, lots of people were caught by surprise and many at first thought that something really unprecedented had happened." Interesting comment, but though the Federal Reserve acceptance of mortgages as collateral dates to 2001 why do you write mortgage backed securities are relatively new?... |