Here is another post from Ahha that needs to be read, he knows money and the mechanics of the system better than anyone else. And....because we are not afraid of the truth, he called the low, when no one else on SI did. The following post is educational, bandwidth expanding by way of understanding the nuance of what is really causing contradictions in the minds of all players.
To: rich evans who wrote (9768) 8/18/2007 10:26:02 PM
From: ahhaha of 9769
It seems that the Fed reducing the discount rate would be symbolic only
More than that. FED is trying to encourage member banks to go to the window if they get squeezed in non Treasury reserves like MBSs where the biggest stress seems to be occurring. Thus FED is trying to be specific in their accommodation.
as the market has already reduced the rates based on your statements that the Fed had to transact RPOs at a very low rate below 5.25 to get banks to take the cash.
The market is tied to FED's apron strings and doesn't have a real identity as a market. The market was fully in charge between Sept. '79 and Aug '82 as FED targeted non-borrowed reserves, a money supply targeting rather than a price targeting. Gradually FED obviated the market with their intervention under AG. By 1995 there was no free market. Since then the market has followed the FED. I've emphasized this in the past.
Over the last several years FED has maintained a fixed rate and this prevents anyone from knowing where the risk lies, that is, where the true fed funds rate should be. The market, as it were, just goes along with whatever FED posts. The fixed rate enables inventive financiers to lower their effective rate below fed fund target using everything from terms on re loans to yen carry trade. FED knows all about this, but condones it because it alleviates them from adding money to the system. Problem is, when no one knows the true intrinsic rate which is discovered by the infinitesimal and instantaneous pricing mechanism of free markets, disruption of orderly borrowing can develop. Then lending freezes in fear. Demand for loanable funds falls and the available supply is too large causing the cost, the rate, to fall. That occurs in the public market of Treasuries, etc. Meanwhile, certain sectors of the private market where origination of loans is based on public reserves but which can be stretched to extremes by the inventions and machination of clever guys, are starving for funds. Starvation comes from the freeze up.
So in effect banks could get cash from FED Funds or discount window if I understand this correctly. The difference is that banks at the discount window can come at their initiative while RPOs are at the fed initiative.
Banks can and do borrow reserves from each other in the overnight interbank "fed funds" market on their own initiative. The going rate is always something at or above the FED's target rate under normal conditions. Why? Because if it varies due to bank impatience or need to comply with reserve requirement, FED can buy or sell in order to get it back in line with the monetary policy motivated target. FED can operate in scale almost without limit, so why take "fed funds", reserves, from another bank when FED, NY Fed, can give them to you cheaper? And, other banks can't lend you reserves which aren't properly designated, that is, can't lend you the kind of money, say, mortgage money that has a bank under a squeeze. Simply put, a bank can go to the window to get mortgage money.
And the Fed funds rate is basically below 5.25% also if the FEd is having to do a transaction as low as 3.55%. So it seems this whole CNBC talk from all the commentators is just that ,talk and not reality.
Always true, but like any myth, has an element of fact. The commentators are right about two things: fear freezing the desire to lend, over extension of all types in the re market. You'd know all about that through the endless howls on re crash thread over the last several years, and there have been plenty of similar comments on CNBC for years.
Except that this talk/perception seems to move the market a lot judging from Friday.
It's a complex subject. Bottom line, FED is trying to assuage the situation. I don't know that it's necessary for them to do that except as you have pointed out, it's important for them to show their presence. Individual banks are already very busy cooking up solutions that employ time and terms to resolve these issues where stress is occurring. I've noted several of these actions, for example, in Canada. The problem arose in a private market and should and can only be solved there. FED was only trying to assure people that they won't allow the private problem to develop into a public one.
But it would also seem that if a bank can get money from Fed at 5.75 , this would limit the interbank rate.
The interbank rate for reserves sought to meet reserve requirement are established by the FED's fed funds fixed target as mentioned above. Why get reserves at 5.75 when you can get them cheaper either from FED in size or from other banks? Exercising the window merely seeks more specific assistance than can be rendered quickly through the usual reserve system.
Is the interbank rate way below the discount rate also?
Recently, it has as you noted. Heller, on Friday, said FED was way too tight with window rate at 6.25 and target ff at 5.25. Of course, the re fiasco proves that Heller is exactly wrong. The free market would have priced fed funds maybe as high as 8% assuming the same conditions could evolve that brought about the re fiasco.
I guarantee that that couldn't occur under a free market. Quite the opposite. Fed funds would rarely rise above 2.5% because all the punishment and fear associated with changing perceptions of risk would be priced in every day at the margin as delivered by the "invisible hand", the invisible hand of all those greedy and fearful individuals operating in the market trying to scratch a buck out of what they do. It is this apparent mystery that FED economists can't accept. Think of it! All those screamers on the floor totally in charge! We can't have that here. We demand the order and safety of BIG, posting a fixed rate, and don't confuse the issue with all the crashes that causes.
This is all confusing stuff and no wonder the market is so volatile with such confusion.
It is solely caused by FED's absurd and easily modified operating procedure of fixing a rate. I ask you, as I have asked many pseudos at the universities, how can you have a free market with a fixed price? No one ever answers.
Grace has expressed an interest in CIT. Yawn. |
