Re: fed’s action

>     On Wed, Mar 12, 2008 at 8:40 PM, Davidson, Paul wrote
>     Warren:
>     Don’t you think it was a strange open market operation —
>     where the Fed was moving Treasuries from their balance
>     sheets to private balance sheets (even temporarily) —
>     while accepting as collateral the highest grade mortgage
>     backed securities? Usually open market operations involve
>     Treasuries going one way and bank deposits (not
>     collateral) going the other way.

Hi Paul,

It was a ‘securities lending operation’ and was probably done that way to be in compliance with existing Fed regulations regarding interaction with the dealer community.

The Fed probably already had authority to lend securities to the primary dealers from their portfolio, and either get cash in return or other securities rated AAA or better (govt, agency, etc). So they offered to loan their tsy secs and accepted the dealer’s securities as collateral for the transaction.

Note that the dealers remain as beneficial owner of the securities pledged to the Fed in return for the tsy secs, and so the Fed is not assuming that risk. The dealers do get tsy secs which they can then in turn use as collateral for loans in the market place at much lower rates than loans vs the collateral they gave the Fed.

So the end result is the dealers get to borrow at the lower rates.

No ‘money’ is added to the system by the Fed. The Fed just sets rates as is always the case.

However, this is not to say they didn’t have other reasons for doing it this way. They continue to display a very limited knowledge of monetary operations and it’s not always clear why they do what they do.

Best to Louise!