Fed capitulates: the central bank is broken

[FRED]

Fed capitulates: the central bank is broken

Or perhaps better, the entire banking system is broken.

For it appears that the US Federal Reserve has given up on the idea of easing stress on interbank and wholesale lending and is resigned to being the central bank-come-market-maker of last, first and every resort.
For some time now there’s been a debate about the direction of the Fed’s policy. Would we see target rates come down further? Quantitative easing? Massive T-Bill issuance in the open market?
__________________
From the Fed yesterday:

The Federal Reserve Board on Wednesday announced that it will alter the formulas used to determine the interest rates paid to depository institutions on required reserve balances and excess reserve balances.

Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6.

The Board judged that these changes would help foster trading in the funds market at rates closer to the FOMC’s target federal funds rate.

Why do such a thing? Michael Cloherty at Bank of America points out in a research note this morning that the move will cripple the Fed Funds market - that is, interbank lending:

The Fed is going to pay target flat for excess reserves rather than target less 35bps. This is likely to sharply reduce flows in the funds market. There is a staggering amount of excess reserves in the banking system– a normal level of reserves held at the Fed is $7.5bn, where last Wed there was $420bn. With that many excess reserves, funds should trade soft. Now, rather than lend to another bank at a sub-target rate, we should just see banks leave the $ in their account at the Fed. Volumes in the Fed funds market are likely to drop dramatically.

What that means is that the effective is likely to remain below target, and with volumes down, the effective will be even more volatle (unusual trades will have a larger impact on the average). This will make Fed funds futures contract even harder to trade.

The Fed isn’t supposed to work this way. The Fed is supposed to have a control over the monetary system; by which it can manipulate the rates at which banks lend to each other, and the rate at which banks lend to the economy. more...

[Chomsky]

Re: Fed capitulates: the central bank is broken

I posted this yesterday as The Bernanke Twist:

http://itulip.com/forums/showthread.php?t=6317

[Tulpen]

Re: Fed capitulates: the central bank is broken

Looks like it is finally time for the helicopters.

Long gold and oil and uranium.

[Mega]

Re: Fed capitulates: the central bank is broken

Ditto!
Mike

[rj1]

Re: Fed capitulates: the central bank is broken

I'm having a hard time understanding the article. It's a bit too wonkish for me.

I get the overriding point that we're heading full-on into a liquidity trap and the Fed governors are essentially crossing their fingers that nothing bad will happen as an effect.

[jk]

Re: Fed capitulates: the central bank is broken

the fed is now the central clearing house for interbank funds. it is every bank's counterparty; no bank need trust another bank, so any evidence of shakiness can be ignored. by the same token, no bank will be stigmatized by having to pay a higher rate for funds than any other bank.

[Jim Nickerson]

Re: Fed capitulates: the central bank is broken

the fed is now the central clearing house for interbank funds. it is every bank's counterparty; no bank need trust another bank, so any evidence of shakiness can be ignored. by the same token, no bank will be stigmatized by having to pay a higher rate for funds than any other bank.

jk, you are one smart dude if you deduced your post from what was posted above from ftalphaville. So what is the presumed, hoped for, expectation from the what Fed is doing? I have no idea if my life depended upon it.

[bart]

Re: Fed capitulates: the central bank is broken

The second part of my prescription is for the Fed to use its regulatory, supervisory, and lender-of-last-resort powers to protect and defend the financial system. In particular, alone and in concert with other agencies, the Fed should ensure that financial institutions and markets are well prepared for the contingency of a large shock to asset prices. The Fed and other regulators should insist that banks be well capitalized and well diversified and that they stress-test their portfolios against a wide range of scenarios. The Fed can also contribute to reducing the probability of boom-and-bust cycles occurring in the first place, by supporting such objectives as more-transparent accounting and disclosure practices and working to improve the financial literacy and competence of investors.3 Finally, if a sudden correction in asset prices does occur, the Fed's first responsibility is to do its part to ensure the integrity of the financial infrastructure--in particular, the payments system and the systems for settling trades of securities and other financial instruments. If necessary, the Fed should provide ample liquidity until the immediate crisis has passed.

Source is Bernanke speech:
http://www.federalreserve.gov/boardd...15/default.htm

[jk]

Re: Fed capitulates: the central bank is broken

jk, you are one smart dude if you deduced your post from what was posted above from ftalphaville. So what is the presumed, hoped for, expectation from the what Fed is doing? I have no idea if my life depended upon it.

i think it makes it easier for the fed to stuff more reserves into the system- quantitative easing - while ensuring the banks earn a return on these new reserves. if the fed stuffed in new reserves otherwise, the return on these reserves would tend to zero in the interbank overnight market, or would just be held stagnant by the banks themselves.

the fed paying at the funds rate guarantees bank earnings. so the fed can swap treasuries for bank-held toxic waste, stuffing the banks with new reserves, then pay interest on those reserves, helping recapitalize the system and - at some point - hopefully encouraging the banks to lend to entities somewhat riskier than the fed itself.

[i am no expert on the banking system, so i may have misrepresented or distorted some or all of this. perhaps someone more knowledgeable can chime in and tell me if this sounds right.]

[c1ue]

Re: Fed capitulates: the central bank is broken

What we're seeing here is classic mission creep.

The Fed is now taking over even the interbank lending role within the US.

To some extent, this also will apply to some of the international banks - if not now then certainly soon.

However, the unintended consequences are coming.

I can see one already: without a need for international interbank lending, a major stabilizing influence in the forex market is removed.

All currencies at the edge of this Fed/not Fed boundary will see much higher swings than previously.

The result will be significant falls in international trade - it doesn't take too many forex related losses for companies to just pack it in.

If Hawley-Smoot was a hammer on the glass table of international trade in the Great Depression, this might be a medium sized paper weight dropped from 5 feet.

[Starving Steve]

Re: Fed capitulates: the central bank is broken

What we're seeing here is classic mission creep.

The Fed is now taking over even the interbank lending role within the US.

To some extent, this also will apply to some of the international banks - if not now then certainly soon.

However, the unintended consequences are coming.

I can see one already: without a need for international interbank lending, a major stabilizing influence in the forex market is removed.

All currencies at the edge of this Fed/not Fed boundary will see much higher swings than previously.

The result will be significant falls in international trade - it doesn't take too many forex related losses for companies to just pack it in.

If Hawley-Smoot was a hammer on the glass table of international trade in the Great Depression, this might be a medium sized paper weight dropped from 5 feet.

Yes, in recent days, I have noticed that the beaver buck has become extremely volatile, moving as fast as a penny U.S. in 10 minutes. When I think about this, no business can conduct foreign trade with this chaos.

Again, we get back to the main problem: WHAT IS MONEY WORTH, ANY MONEY, FROM ANY COUNTRY, WHEN THERE IS NOTHING WHATSOEVER BACKING IT? And the more the central bankers try to bury this issue, the more this issue confronts us, front and centre.

[grapejelly]

Re: Fed capitulates: the central bank is broken

i think it makes it easier for the fed to stuff more reserves into the system- quantitative easing - while ensuring the banks earn a return on these new reserves. if the fed stuffed in new reserves otherwise, the return on these reserves would tend to zero in the interbank overnight market, or would just be held stagnant by the banks themselves.

the fed paying at the funds rate guarantees bank earnings. so the fed can swap treasuries for bank-held toxic waste, stuffing the banks with new reserves, then pay interest on those reserves, helping recapitalize the system and - at some point - hopefully encouraging the banks to lend to entities somewhat riskier than the fed itself.

[i am no expert on the banking system, so i may have misrepresented or distorted some or all of this. perhaps someone more knowledgeable can chime in and tell me if this sounds right.]

Why is there a point in the banks' lending when they can buy govt. bonds that pay, say, 3.8% interest, and pay the Fed close to 1%?

[kingcopper]

Re: Fed capitulates: the central bank is broken

Why is there a point in the banks' lending when they can buy govt. bonds that pay, say, 3.8% interest, and pay the Fed close to 1%?

Assh*les just waiting for the greater fool! What a joke. I can just see Bernacke all grey in 10 years still waiting for the greater fool and still paying zombie banks 2.5%.