Money Markets and the Federal Reserve

The Federal Reserve addressed lingering liquidity issues in the money markets prior to the release of the labor data this morning. The Federal Reserve has increased swap lines with the European Central Banks and has increased substantially the size of the TAF program. It has also expanded the range of eligible collateral at the TSLF.

I spoke with a money market trader of long acquaintance. He notes that transactional issues remain in the money markets, and that with funds to one month Libor at 70 basis points money is not changing hands in a normal way. He notes that there is a problem but he described the problem as “not grievous” in contrast to the extreme conditions extant last August and September.

He believes that the FOMC has probably finished slashing the funds rate and will now devote itself to seeking operational devices which will normalize the Libor markets. In his opinion, we are in the early stages of the end of the mess. This trader sits at a reasonably large house with a familiar name and he notes that there has been a sentiment shift over the last month. In particular, small second tier A and AA European bank names which have been tarred with the same brush as some of their profligate relatives have begun to see increasing interest from institutional investors. So, whereas in an earlier time these institutions could only raise overnight and very short dated money, there is now increased interest in lending to these entities for three months and six months.

That process has been incremental but ongoing and in this traders opinion represents the first signs that the logjam is beginning to break.

Comments

[Coelacanth]

I agree there's been an easing in the credit markets but am not as sanguine about negatives surprises to come. I think the collective sigh of relief heard around the investment world that we seem to have avoided financial collapse was palpable. In many ways it's what helped to improve appetites for risk.

That said, with losses mounting on mortgages and other consumer debt it may not matter that the Fed has provided extra liquidity, as banks hoard cash anyway to maintain liquidity reserves in the face of rising defaults. It's not by mistake commercial banks are still bucking up to the TAF while investment banks have largely stopped. All this in the face of declining real wages, rising food and energy prices and stagnanat retail sales the past 3 months.

Investors (here and abroad) have come back to risk because the financial system seems to be churning again but they don't IMO appreciate how the slow burn of a very weighed down and increasingly thrift minded consumer will translate into negative earning surprises 3 to 9 months down the road.

[warren mosler]

hopefully the fomc figures out the liability side of it's member banks is not the place for market discipline

there is no reason for the fed not to accept ANY member bank collateral- it's all eligible for fdic insured funding anyway, and the occ and others carefully regulate/monitor capital ratios, etc. for compliance.

and the fed should accept said collateral in unlimited quantities, as net lending to the banks remains the same in any case. loans 'create' deposits which means the banking system as a whole is necessarily entirely 'funded' without the fed, and intervention is limited to 'offsetting operating factors' as a matter of accounting (as i'm sure you well know from your days at the fed?)

as a point of logic there is no reason for any interbank/ff trading- the fed can clear it all as other cb's have done without ramification beyond avoiding interbank trading issues such as the current ff/libor spreads.

the case can be made that interbank funding issues of the last 8 months are entirely due to the FOMC's lack of understanding of actual monetary operations.

and the fact that the TAF is for limited quanties and limited collateral alone indicates this is still the case?

moslereconomics.com

[venividivici]

Very good posting Coelacanth, much better than the article itself. I want so much to be positive about the furture because you'll never make money with a negative mindset but it so hard to forget the incredible greed and stupidity that seems ingrained in the world's biggest financial companies and caused all of these problems in the first place.