As I’ve said all along, it needs to be in unlimited quantities with a set interest rate.
It’s a pricing mechanism, not a quantity mechanism.
They also need to relax collateral requirements to include commercial and residential whole loans, and all other legal bank assets of solvent banks.
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I’ve been recommending the following for the Fed for quite a while (see Proposals for the Fed):
Failure to implement the above shows a failure to understand fundamental monetary operations.
These policy changes would alleviate critical liquidity issues, and not, per se, alter net bank reserve demand (not that the size of the bank reserve ‘matters’).
Part of the current crisis is due to the failure to implement the above changes that would have:
The Fed is slowly moving in that direction, but, unfortunately, not proactively to ‘fix’ a flawed institutional structure, but reactively as things fall apart in no small part due to lack of action:
Federal Reserve lowers standards for collateral from primary dealers
The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.
The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.
These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.
Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.
The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.
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>
> On Tue, Jul 29, 2008 at 4:05 AM, Andrea wrote:
>
> In case you haven’t seen this yet: A Fed study that finds that
> Taf has lowered Libor.
>
> http://www.newyorkfed.org/research/staff_reports/sr335.html
>
>
right, thanks, as if they needed to fund a study to figure that out!
It’s like doing a study that shows the repo rate goes down when the fed lowers its ‘stop’ on repo.
(Too bad they didn’t use this study to show they should set a rate for the TAF and let quantity float, instead of setting a quantity and having an auction.)
It’s this kind of expense that gives govt. a govt. spending negative connotation.
all the best!
warren
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Hardly need a study to figure that out!
This paper from the NY Fed was just released:
The Effect of the Term Auction Facility on the London Inter-Bank Offered Rate
Summary: This paper examines the effects of the Federal Reserve’s Term Auction
Facility (TAF) on the London Inter-Bank Offered Rate (LIBOR). The particular question investigated is whether the announcements and operations of the TAF are associated with downward shifts of the LIBOR; such an association would provide one indication of the efficacy of the TAF in mitigating liquidity problems in the interbank funding market. The empirical results suggest that the TAF has helped to ease strains in this market.
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“Inflation is a problem,” she said. Yet the problem isn’t excessive demand, rising wages, or a tight labor market, but “negative supply shocks.” Once the shocks wear off, the inflation rate can’t be sustained in the long run without a pick-up in wage growth, she said.
“There’s no textbook answer to what monetary policy should be doing at this time,” Yellen added.
Yes, there is – the mainstream says quite clearly ‘don’t add to demand during a negative supply shock. Or a triple negative supply shock. That will monetize the price increases and turn a relative value story into an inflation story.’
The FF rate is now below the year over year headline and core CPI; so, it’s easy for the Fed to now make the case the ‘real rate’ is negative and cutting it any could adversely alter long term employment and growth given the balance of risks between market functioning, inflation, and the output gap.
They also think they know that if markets are expecting a 25 basis point cut they need to do less than that to get a positive inflation response.
And, as before, they need to set a rate for the TAF and accept any bank legal collateral to be able to more effectively target LIBOR as desired.
The larger point is that ANY assets banks are allowed to hold already have to be on the regulators approved list, and banks in any case can fund all their (legal) assets with with govt insured deposits.
So why should another arm of government, the Fed, not always provide funding for the same govt approved assets that the govt already provides funding for? Why did it take them so long to come up with the TAF and now with the security lending facility?
And even now only with partial measures?
Clearly they are still in the dark on the workings of monetary ops and reserve accounting?
You may recall my proposal back in August (long before that, actually):
Drop the discount rate to the FF rate and open it up to any bank legal assets.
This should have always been the case.
The Fed’s ‘job’ is to administer interest rates, and that’s how you do it.
It’s about price, not quantity. Fed operations don’t materially change any of the monetary aggregates, as many who should have known all along have been ‘discovering.’
Yes, in good times the system did function reasonably well, but the risk was always there that in a crisis it would break down.
My other proposals remains equally valid:
Let government agencies fund via the Fed Financing Bank (at Treasury rates). They exist for public purpose, shareholders remain at risk for default losses, and lower interest rates would get passed through to the housing markets.
The Treasury should open it’s lending facility and lend Treasury securities in unlimited size to primary dealers.
Lastly, this is a good time to get the Treasury out of the capital markets and limit them to the issuance of 3 month bills. This would lower long-term rates, which is the investment part of the curve.
Forgot to include the influence of the 8,000 lb gorilla I’ve been advancing for the last few years!
The Fed is aware rate cuts don’t do much for near term financial disruptions. For example, the FF/LIBOR spread was first addressed with FF cuts, but little or nothing changed until the TAF was introduced to address and normalize that spread.
Along the same lines, Bernanke has recently met with the President and Congress to coordinate a fiscal package, and today’s cuts were preceded by Paulson talking about what Treasury is doing for the financial crisis.
The Fed knows they pay an inflation price for each cut, but also believe they need to get the current financial crisis behind them first, and then address any residual inflation issue. Nor does Congress want to go into the election with a weak economy.
The incentives are in place for a credible fiscal package.
And with core inflation indicators now moving up, the Fed would very much like this rate cut, along with the pending fiscal package, to ‘work’ and be the last one needed.
♥
(from Patrick Doyle)
Below is a table of the results of the last 3 TAF auctions
Of note is the spread to OIS (FF’s) which is inside the historic LIBOR / OIS spread. There were less participants in this round as well
This all bodes well and is showing the easing of pressure in the funding markets.
| Jan. 15 2008 |
Dec. 21 2007 |
Dec. 19 2007 |
|
| Stop-out rate: | 3.95% | 4.67% | 4.65% |
| Total propositions submitted: | $55.526 Bil. | $57.664 Bil. | $61.553 Bil. |
| Total propositions accepted: | $30.000 Bil. | $20.000 Bil. | $20.000 Bil. |
| Bid/cover ratio: | 1.85 | 2.88 | 3.08 |
| Number of bidders: | 56 | 73 | 93 |
| Term | 28-day loan | 35-day loan | 28-day loan |
| Settlement Date | Jan. 17, 2008 | Dec. 27, 2007 | Dec. 20, 2007 |
| Maturity Date | Feb. 14, 2008 | Jan. 31, 2008 | Jan. 17, 2008 |
♥
(an interoffice email)
On Jan 14, 2008 10:29 AM, Warren Mosler wrote:
> thanks, continued tafs will get it to wherever the fed actually wants
> it. it’s a policy rate they can administer at will.
>
>
>
>
>
>
> On Jan 14, 2008 10:16 AM, Pat Doyle wrote:
> >
> >
> >
> > Today you can say that the spread has narrowed significantly between LIBOR
> > and FFs. The spread on the indices has been above 60 (with a few
> > exceptions) since August. Aug 7th it was 12bps and was over 100 at times.
> > NOW THE SPREAD IS 43.
> >
> >