Fed Makes Biggest Reserve Addition Since 9/11 « naked capitalism

Monday, September 15, 2008

Fed Makes Biggest Reserve Addition Since 9/11

The Fed made a $70 billion reserve injection today in two operations in response to a sharp increase in the Fed funds rate, indicating bank reluctance to lend to each other. One reader informed us the rate was 3.75% mid-morning after the first, $20 billion addition (versus the 2% target level) and according to Bloomberg reached as high as 6% before the second Fed move.

From Bloomberg:

The Federal Reserve added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, to keep bank borrowing costs low after the bankruptcy of Leman Brothers Holdings Inc.

Fed funds traded as high as 6 percent, or 4 percentage points above the central bank’s target rate for overnight loans between banks, according to ICAP Plc, the world’s largest inter- dealer broker. The margin is the greatest since Bloomberg began tracking the data in 1998…

The central bank uses repurchase agreements, or repos, to buy or sell Treasury, mortgage-backed and so-called agency debt for a set period, to help maintain enough money in the system to keep overnight interest rates close to the target. They don’t signal a policy shift. Futures show traders boosted odds to 68 percent that the Fed will cut rates when policy makers meet tomorrow to offset financial market turmoil.

“If the fed funds rate closes high today, I would be really worried as it would mean that there really is no money out there to be lent,” said Stan Jonas, who trades interest- rate derivatives at Axiom Management Partners LLC in New York.

The so-called effective funds rate was 2.1 percent on Sept. 12, or 10 basis points over the target rate….

The Fed added $50 billion in temporary reserves to the banking system when it arranged overnight repurchase agreements, or repos, at 11:50 a.m., after providing $20 billion earlier.

“It is rare that overnight operations exceed $15 billion,” Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co., wrote in a note. “There is a longstanding pattern in which the funds rate falls in the afternoon, as banks scramble to unload their excess monies onto other banks, lest they get stuck with excesses earning nothing.”

When the Fed added the reserves at 9:40 a.m., federal funds, the overnight lending rate between U.S. banks, traded at 4.25 percent, above the central bank’s target rate, according to ICAP. The rate was 6 percent at the time of the second open market operation. Fed funds opened at 3.5 percent today.

A total of $5 billion in repos matures today. Wrightson, an ICAP research unit specializing in U.S. government finance, had expected the Fed to add about $15 billion in repos

2 Comments:

Anonymous says:

September 15, 2008 at 3:57 pm

where did the Fed get that $70 billion from. if they “printed” it that means the cost of living was just raised.

Anonymous says:

September 15, 2008 at 4:53 pm

It’s worth remembering that in the pre-Federal Reserve era, the overnight call money rate (which was essentially a free-market interbank rate) would soar into double digits during panics. I seem to recall in the Panic of 1907 that overnight call money went to 50% or 100%.

Economic central planning by the Federal Reserve has inverted that relationship. Now in financial panics, the Fed Funds rate perversely plunges.

Obviously, as today’s unprecedented spread of effective Fed Funds over the target indicates, the natural tendency is still for rates to soar when there’s a whiff of fear. When lending has suddenly become more risky, any intelligent lender will demand more inducement to do so. As a result, when panic strikes, banks withdraw from supplying funds at the controlled, unattractive rate, and the Fed steps in with massive injections to make up the funding gap so as to maintain the target rate.

The question is, why do they feel it necessary to fight nature this way? If a hurricane is expected to produce a ten-foot storm surge, should we build giant pumps to suck the water down, proclaiming that “even storms shall not change the sea level”?

Central planning simply does not work. Former Cleveland Fed Guvner Hoskins was on Bloomberg Radio today, inveighing against a rate cut tomorrow. He accused the Fed of trying to micromanage GDP, rather than keeping inflation in check. Yet he knows full well that the Fed has an impossible dual mandate of maintaining both growth and price stability.

Funny, the Fed’s fatally-compromised dual mandate resembles Fannie and Freddie’s structural ambiguity, as “Congressionally chartered” entities which were serving public purposes for private gain. Et tu, Ben Bernanke? With your junk-loaded balance sheet and your Canute-like determination to fight the tides of market-set rates, it appears that your forlorn institution may be the next bailout candidate. And current management may have to go. Good thing you’ve got a helicopter to escape from the roof when the peasants with pitchforks assault the Eccles Building.

As one of those peasants (though an articulate one), I’d like to see Dirty Ol’ Lizard Greenspan lynched from a yardarm, while thousands cheer from the forecourt. Justice! Justice, I cry! Lynch the Lizard!

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