More Liquidity from the Fed: Welcome to the Roach Motel

The Federal Reserve announced earlier today a series of measures to enhance and improve the current set of tools it uses to deal with the unique liquidity problems which have threatened financial stability since about this time last year.They have extended the Primary Dealer Lending Facility and the term Security Lending Facility through January 2009.

They will introduce auctions of options on $50 billion of draws on the TSLF.

They will introduce an 84 day TAF to complement the 28 day TAF.

They will increase their swap lines with the ECB to $55 billion from $50 billion.

This will not be the last time these facilities will be extended. They will be rolling repo with dealers for a very long time. They are in the infamous roach motel. There is no exit. They can not unwind their trade. Time heals all wounds and that is the solution to the problem. I would venture to say that the Fed will be lugging this stuff around on its books in January 2010 as well as January 2009 because circumstances will remain “unusual and exigent”.

Central bankers parse and choose words very carefully. I think there must be something in their DNA which makes them very precise. When I worked there three decades ago I was castigated for using the verb “catapulted” to describe the price action in the bond market. My editors preferred the more mundane and lifeless “moved sharply higher”.

I mention this because to me it is very instructive to note that in the body of the release on the changes to the various liquidity facilities the Federal Reserve describes “continued fragile circumstances on financial markets”. That is not the phrasing of a body about to embark on some path of financial restraint. It indicates to me that the funds rate will remain at the current 2 percent level for a very long time and in my opinion suggests a less than bellicose communication from the FOMC on Tuesday.

Why did the Federal Reserve add an 84 day TAF? I think they have heard the complaints of the street regarding the elevated level for three-month Libor and for the steep yield curve from one month to three months along the Libor curve. That spread was about 33.5 basis points today and will probably flatten a couple tomorrow.

The problem I see is that the longer facility is for just $25 billion. It is a start but it will not put a significant dent in the problem. My guess is that in several months they will return to upsize the 84 day facility.

Comments

[TraderMark]

Agree 100%. It's all a farce. They should just say, give us your tired, your pool, your useless for 3 years and then get back to us in 2011. That's what it's going to end up being.

2008 Jul 30 09:16 PM

[naturalsol]

fascinating

2008 Jul 30 10:23 PM

[Moral Hazards Amok]

Thanks, John. Your perspective is always informative.

2008 Jul 31 12:25 AM

[phdinsuntanning]

foreign currencies will be “catapulted” soon

2008 Jul 31 08:25 AM

[peterthepainter]

it the 'flation man. some think it IN some think it DE. Me ahm leanin toward DE an ah thinks the fed is too! but wadda I know?

2008 Jul 31 08:37 AM