Doug H. wrote:
On Aug 18, 2007, at 2:09 PM, Marvin Gandall wrote:
Or is this all preparation for the
Fed going the next step and buying the MBS's outright? Is it
limited by law
as to what securities it can buy through open market operations or
accept as
collateral for loans through the discount window?
Could be the next step, and it's not unreasonable, is it? In any
case, the Fed is allowed to buy pretty much anything in open-market ops.
======================================
Actually, it now appears that the Fed will mop up a lot of those illiquid
MBS's and other asset-backed securities - but through the discount window
rather than open market operations. The following account of why the Fed cut
the discount rate rather the fed fund rate, which seemed to baffle many
pundits, seems plausible. I don't think non-banks like mortgage lenders,
hedge funds and the so-called "conduits" can dump their stuff off onto the
Fed through the discount window, but their creditor banks sure can, so this
may be the strategy.
A Fed Window Opens Wider
By GENE EPSTEIN
Barron's
August 21, 2007
THE STORM THAT FORMER FEDERAL RESERVE chairman Alan Greenspan bequeathed his
successor, Ben S. Bernanke, has defied the predictions of some (myself
included) by threatening the economic mainland. Odds are still good that it
will blow out to sea. But it has understandably forced Bernanke to resort to
preventive measures.
In the statement that accompanied its action Friday, Bernanke's Federal Open
Market Committee observed that "recent data suggest that the economy has
continued to expand at a moderate pace," but added that "the downside risks
to growth have increased appreciably." It was therefore "prepared to act as
needed to mitigate the adverse effects on the economy arising from the
disruptions in the financial markets."
As for the action it took to address those disruptions, Credit Suisse's
chief economist, Neal Soss, has been one of the few to call it an
"innovative move." The conventional move would have been to cut the
interest-rate target on federal funds, the rate at which banks borrow
overnight money from each other. But instead, the FOMC left the fed-funds
rate target unchanged at 5.25%, while unexpectedly lowering the discount
rate by a half-percentage point, to 5.75%.
The discount rate is the rate at which the Fed makes direct loans to banks.
These loans, as Soss notes, accept a broad range of collateral, including
some of the debt that the markets have recently become allergic to. Not that
good money will be thrown at bad debt. But there is plenty of debt,
including asset-backed commercial paper, that has been unfairly tainted by
the lack-of-confidence disease and cannot find a market. This debt might get
a fair discount at the Fed's discount window until confidence is restored
and it can find a market.
Banks eligible to borrow at the discount window might not be directly
saddled with this debt. But many of their institutional customers are. And
in a related move, the Fed sought to remove the stigma of discount borrowing
by permitting term financing of these loans for as long as 30 days,
renewable by the borrower.
THE USUAL ONE-PERCENTAGE-POINT spread between the discount rate and the
interest-rate target on fed funds has now been halved. It is, however, true
that the actual rate on fed funds has been averaging less than 5% ever since
the central bank began injecting liquidity into the system through
open-market operations. In its Friday morning announcement, the FOMC opened
the door to an easing in the fed-funds target itself.
But chances are that this discount-rate easing will be all the markets can
expect. The past week's battery of economic reports suggested that moderate
growth persists. In fact, the data revealed that second- quarter growth in
gross domestic product is due to be revised up from an annual rate of 3.4%
to more than 4%. The Fed's own July report on industrial production revealed
that the inventory cycle still has potential to boost growth.
But what if growth proves so moderate that the unemployment rate starts to
tick up from its currently low 4.6%? A jobless rate of 5% would probably be
more to the inflation-hawkish Ben Bernanke's liking.
Meanwhile, firms and individuals associated with the mortgage market will
lose a lot of money -- unsung victims of the easy-money policy pursued by
Bernanke's predecessor, Alan Greenspan.
