Fed Testing Clearing Banks In Tri-repurchase Agreements With Primary Dealers to Drain Excess Liquidity

October 9, 2009 by · Leave a Comment
Filed under: Policy News 

I have two simple questions after reading this extensive article on this subject.   First, how is the clearing banks going to be funded?  Is is going to be funded from the Treasury or will the Federal Reserve fund this itself and if so, where and what will that capital come from?  Second, why would we consider the Federal Reserve and a “zero-counter-party risk” institution.   I assume they are referring that the Fed could just print money to meet its obligations but is that okay for our central bank to devalue our currency with its counter-parties whenever it deems it necessary?

Bloomberg,  New York – The Federal Reserve is considering accessing money market funds through clearing banks or creating a facility to drain the record amount of cash added to the financial system, according to people familiar with the plans.

Those methods may help conserve the capital of the 18 primary dealers that act as counterparties for open market transactions as the Fed removes some of the more than $1 trillion the central bank pumped the economy, said the people, who declined to be identified because no decision has been made.

Dealers would face constraints on capital if they were the sole counterparties on all the so-called reverse repurchase transactions while they’re still repairing balance sheets after booking losses and writedowns in the aftermath of the worst financial crisis since the Great Depression. In a reverse repo, the Fed sells securities for a set period, temporarily decreasing the amount of money available in the banking system.

“One of the goals could be that the Fed is trying to distribute paper without encumbering dealers’ balance sheets while utilizing existing distribution channels” to expand the transactions to money markets, said George Goncalves, chief fixed-income rates strategist in New York at primary dealer Cantor Fitzgerald LP.

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