ETFnerd

Is Bernanke Hinting Something About the Fed's Rate Plans?

Reinko said: "This is also one of the ways to avoid down writings; when it is temporary gone as collateral and is on the balances of the FED, it is not marked to market value."

Collateral does not leave the balance sheet when it is pledged to a lender. When collateral is pledged on an overnight (or a 28 day) borrowing, you'd better believe that it is mtm daily. In the case of the tri-party repos when the Fed is borrowing, the third party prices the collateral and make margin calls on deficiencies.

www.newyorkfed.org/abo...

There are two main types of settlement methods for repos: triparty and “delivery vs payment” or DVP. Fed repos are done via triparty settlement, which means that the Fed and the primary dealers use a triparty agent to manage the collateral. In a triparty repo, both parties to the repo must have cash and collateral accounts at the same triparty agent, which is by definition also a clearing bank. The triparty agent will ensure that collateral pledged is sufficient and meets eligibility requirements, and all parties agree to use collateral prices supplied by the triparty agent.

The Desk selects winning propositions on a competitive basis. Each dealer is requested to present the rates they are willing to pay for the agreements versus various types of collateral. The three types of general collateral, or GC, the Fed accepts are marketable U.S. Treasury securities (including STRIPS and TIPS), certain direct U.S. agency obligations, and certain agency “pass-throughs” (or Mortgage Backed Securities, often called MBS).

The significance of the “GC” designation on the collateral is that GC collateral is fungible. That is, the Fed is not looking for specific securities; rather it is looking for any of the eligible securities that do not have scarcity value. As such there are a number of securities that would satisfy the requirements, and neither the dealer nor the Fed needs to know which specific security or securities are going to ultimately be pledged to a winning proposition. The Desk establishes relative values across the three collateral types, and then uses these values to selects the best bids presented.

The New York Fed makes payment for the securities by crediting the reserve account of the dealer's triparty agent, a commercial bank. This act of crediting the bank's account actually creates reserve balances. When the repo matures, the dealer returns the loan plus interest, and the Fed returns the collateral. The return of funds to the Fed extinguishes the reserves that were originally created by the repo.