Fed to Add Government-Sponsored Entities as Counterparties
May 24, 2011, 2:09 PM EDTBy Liz Capo McCormick
(Adds analyst comments beginning in fourth paragraph.)
May 24 (Bloomberg) -- The Federal Reserve Bank of New York is seeking to expand its counterparties to include government- sponsored enterprises for use when policy makers begin to drain the record amount of cash they added to the financial system.
Government-sponsored enterprises such as Fannie Mae and Freddie Mac must apply to the New York Fed by June 3 for the designation. If they’re approved, that will expand the central bank’s counterparties for reverse-repurchase, or repo, operations from the Fed’s primary dealers and domestic money funds, which were added last year.
The criteria for the added counterparties include being a “consistent” cash investor in the tri-party repo market and being able to confirm and arrange settlement of a “significant volume” of transactions with the New York Fed, according to the statement on its website. The proposal comes as the U.S. seeks to wind down the mortgage companies Fannie Mae and Freddie Mac for their role in the collapse of the housing market during the economic crisis of 2008.
“This will further enlarge the number of counterparties the Fed can do reverse repos with and will allow them to do more transactions than they could otherwise,” said Ray Stone, principal at Stone & McCarthy Research Associates in Plainsboro, New Jersey. “The GSEs are lending about $150 to $175 billion a day in the fed funds and repo markets, and much of that could be redirected to the Fed.”
Policy makers are debating how to withdraw emergency stimulus programs without disrupting financial markets or bank liquidity as the economic recovery gains strength. Fed officials have said they may use reverse repos, pay interest on excess bank reserves and sell securities directly to investors to withdraw or neutralize cash in the banking system. They also oversee the overnight bank lending rate.
Reverse Repos
In a reverse repo, the Fed lends securities for a set period, draining cash from the banking system. At maturity, the securities are returned to the Fed, and the cash to the primary dealers. In a tri-party repo, a clearing bank acts as a third party to make sure there’s adequate collateral behind the repo and that it conforms throughout the life of the transaction to the investor’s requirements.
The central bank’s 20 primary dealers, which trade directly with the New York Fed’s markets desk and are obligated to bid at U.S. debt auctions, include BNP Paribas SA, Bank of America Corp. and Goldman Sachs Group Inc.
Target Rate Gap
The addition of GSEs as counterparties in the Fed’s reverse repos may help narrow the gap between the fed funds rate traded in the market and the central bank’s target rate for overnight loans, which matches the interest rate it pays banks on excess reserves, according to Stone.
While the Fed promises to pay banks 0.25 percent to keep excess funds on deposit at the central bank, the so-called fed effective rate, or market rate, has averaged 0.09 basis point this month. Fannie Mae and other government-sponsored enterprises that are ineligible to deposit money at the Fed “have pulled down” the fed funds rate by selling funds in the market, New York Fed researchers said in a paper published in December 2009.
“This will almost be the same as paying interest on reserves to the GSEs, which the Fed can’t do without Congressional approval,” said Stone. “If the Fed did reverse repos with the GSEs that may mop up some of their liquidity, which may otherwise find its way into the fed funds market. That will probably provide for a better alignment between the funds rate and the interest rate on reserves.”
Fannie Mae and Freddie Mac have been in conservatorship since 2008 and have received more than $160 billion in government support.
--Editor: Dave Liedtka, Paul Cox
To contact the reporter on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net
To contact the editor responsible for this story: David Liedtka at dliedtka@bloomberg.net
