The Fed, as we know, has a real sticky wicket to get through: it knows that it's gotta find some way to, as the pundits are saying, "drain the swamp" and not let all the positively, massively, completely insane amount of money they've printed out into the wild for good, or else we'll be reprising the German hyperinflation. But, similarly, we've got such a vast debt-deflation hangover that they can't just jack up interest rates, as that would kill off any nascent recovery. They've been kicking around the idea of doing reverse repos for a while (where you sell T-Bills from them and they have to buy them back in the near future); that plus paying interest on reserves would allow them to incent lenders to keep their money on the sidelines, but it's rather limited.
The new idea is to allow not only their primary dealers network, but also money-market funds, to trade treasuries with them. The beauty of this scheme is two-fold. First-off, the primary dealers are fairly limited in what they can absorb at any one time, whereas there's a ton of domestic money-market demand sloshing around. Secondly, and here's the genius of it, the money-market funds would likely not be allowed to trade those T-bills with anyone else (which would infringe the primary dealers) -- thus they get a mechanism by which to handle their duration risk by floating treasuries that by definition cannot escape out into the wild.
... and, when you consider the embedded profits of getting treasuries via a primary dealer that a money-market fund would be able to avoid paying, this would provide a minor boost to the rates they could provide, too.
... and thinking about it, the only way for the money-market fund to profit from the T-bills is either price speculation against only the Fed (an illiquid market -- not so nice) or by banking the coupon payments. This might eventually end up not as actual treasuries (with their unpleasant maturity dates), but as a floating-rate perpetual bonds whose yields are set via the normal auction process (I'm *really* speculating here).
I'm impressed.
7 comments:
And I'm confused. Why on EARTH would anybody in the money markets go for this?
Perceived risk; the Fed is less likely to default than a lot of the other high-rated munis and commercial-paper investments that money-markets invest in. Also, they buy a lot of T-Bills, but do so on the secondary market where they pay a service premium to other market-makers -- they'd be able to get them from the Fed more cheaply.
Perceived risk is indeed right.
Say....would it be a good idea for the Federal Reserve to be the organization giving loans to businesses since banks won't do it, or is that outside the organization's charter?
but their liquidity would be effectively zero... that's like walking into a little box and saying "I'm here, own me" to the Fed...
Depends on how it's structured -- there's already an existing market, so it might be structured so that the Fed would have to use the market rates (which would actually be in its interest).
Axl: it technically already has the right to do so under emergency provisions, but that would lessen what little independence it already has. Boondoggle waiting to happen....
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