Patrick
http://www.InvestorKnowledgebase.org

A further advantage of the auction facility is the liberal rules regarding the types of assets that the discount window folks will accept as collateral — including certain CDOs.

Such securities are not purchased by the Open Market Desk as it supplies non-borrowed reserves.

The difference in the type of securities that the Fed will accept at the Window and at the Desk perhaps answers which choice banks make.

We know that the TAF is designed to target reserves toward those who need it. It’s an extension of the discount window. We also know that the collateral is the same as acceptable discount window collateral.

The amounts involved here are tiny in comparison to the balance sheet size of the banking system.

The reserve setting is a discipline that facilitates the Fed’s targeting of the fed effective rate. The amounts involved normally are tiny anyway.

Friday, December 21, 2007
Why Fed auctions are not inflationary
Independent accountant has argued in comments that the Fed’s auctions are inflationary. I don’t agree.

Even as the Fed injects liquidity via the auction it has used open market operations to remove a countervailing amount from the money supply. The Slosh report is the easiest way to see what is going on with open market operations. (Alternatively you can go to the NY Fed website and construct the numbers yourself.) As you can see on December 20, the same day that the first auction amount was injected more than $23 billion was removed by failing to replace maturing open market transactions.

Furthermore, the Fed has announced that on December 27, when the second auction enters the system, it will allow $14 billion in Treasuries to mature without replacement. Presumably this means that the Fed will not have to effect a $20 billion open market withdrawal on the same day.

We can all agree that lowering the Federal Funds Rate dramatically is an inflationary action. But as long as the Fed is providing liquidity to the banking system without allowing the FFR to drop significantly, the Fed’s liquidity provision is not inflationary.

1. Treasury sloshing has dropped from 18.8 to 3.5, Agency slosh has increased from 2.3 to 8.75 and MBS slosh a year ago was 0.2 and now around 20.69.

Now, why would that be, perhaps because rates are going down and maybe something to do with too many MBS chasing too few Treasuries?

Help Im lost, we need more vodka

Note also there was a very big ratchet down the two weeks before the big fall in the last two weeks. The seasonally adjusted reserves fell to less than a quarter of their former level, and again, the absolute value being that low in unprecedented.

>>>Have any of you looked at The Slosh report in regard to this?

http://www.gmtfo.com/reporeader/OMOps.aspx

You can run reports to look at slosh, which is entertaining, like watching witch doctors toss chicken bones into pots of boiling goo. The MBS sloshing is always interesting!

Found this link on Mish’s site:
http://www.federalreserve.gov/releases/h3/Current/

Here you will find that negative number you were looking for in the nonborrowed reserves.

Thanks for the post, I did write down the amounts for the adjusted reserves that I had originally observed on the Federal Reserves’ site as human memory is stubbornly unreliable. Actually the adjusted reserves have been altered downward from an even 200m to 199m, so I don’t actually think there has been an attempt to hide the figures. It was the negative number in the unadjusted reserves that shocked me and prompted me to write you.
Since I sent you that email I have learned somewhat more about what has occurred but I want to stress that my understanding of the workings of the Fed are rather rudimentary. It does appear that the TAF was used to lend the reserves (about 40Bn) to banks in need (and maybe somewhat to banks that took advantage of the low rate) in an effort to break the credit crunch. That effort was at least partly successful in restoring some of the commercial paper trade between the banks. It was also successful in avoiding serious liquidity problems in individual banks that took advantage of the TAF system. I’m pretty amazed that the Fed managed this in the space of a couple of weeks. Quite a feat in my opinion and worthy of a well done to the Governors and employees of that fine institution. In essence, I think that the action of the Fed has averted a number of bank failures. I could, of course, be wrong about all of this, as I said my understanding of the Fed’s inner workings is incomplete.
The banks of course are still in trouble whether they know it or not as they have gone into capital preservation mode and that is going to seriously reduce future earnings due to great reductions in lending activity. The Fed has it’s work cut out for it, again in my humble opinion.
Thanks for looking into this and I will continue to try to make sense of this peculiar point in the economic history of the United States as I am sure you will and will keep in touch.