I’m a little confused on the effects of open market operations. What’s the difference between pumping $200B into the market “for liquidity” vs actions taken to target a specific fed funds rate? Does the target rate not move when the Fed provides liquidity? Or does it, but just not much? Can someone help clear this up for me? Thanks
This is from Wall Street Journal: The Feb lends $200BN to wall street firms and receives equivalent MBS. This gives wall street firms comfort/liquidity in buying MBS from their own clients. Fed hopes this could lead to higher prices and thus lower yields on the mortgage-linked debt. A decline in those yields could help offer lower interest rates to prospective homebuyers. Correct my if I’m wrong: A more direct way to look at it is that increase in money supply (the $200BN) will lead to decrease in interest rate, but it also leads to higher inflation, which is also a problem now.
The target rate does not move. It is a fixed rate target that the Fed works hard to maintain. With open market operations (OMO), the Fed adds or drains liquidity into the banking system to try to stay at the target rate. The $200 Billion is not about the target rate, rather it is a way for the government to bail out the MBS’s market. When the MBS dealers receive the treasuries from the Fed in swap for the MBS’s, their liquidity increases, not the nation’s money supply. If the Fed wanted to increase money supply, they would have bought treasuries directly from the market. In this case, no additional reserves are added to the banking system. When the MBS dealers, holding the newly obtained treasuries, start selling them, they get money from other dealers, not from the Fed. If the Fed does not participate, no changes to money supply occurs. Feedback?
I think this means that the Fed just insured a bunch of MBSs. They’re essentially holding the MBS as collateral against cash that they’ve lent out. If the MBS’s turn to nice smelly toilet paper, the banks more or less walk away and leave the Fed with the collateral. Somehow this is supposed to make us feel better about buying MBSs and therefore produce lower rates on mortgages. It’s not as if I can just hand my MBS over to the fed if I get nervous.
They didn’t insure a bunch of MBS… they out right took on their risk and, by extension, is passing the bill of defaulting MBS loans back to the American taxpayer. That’s the bad part. The good part, as I see it, is that they have effectively averted what could have been a disastrous situation as brokers were no longer accepting AAA Agency and non-Agency securities as collateral for riskier holdings. Margin calls, or out right calls for more collateral, would have sent a good number of hedge funds and other large investors (and similarly large notional amounts or money) in to the toilet by not being able to convert their AAA bonds in to acceptable collateral. The way I see it, the really twisted thing here is that its the same organizations who are denying the validity of these AAA Agency and non-Agency securities as good collateral as the ones that created these structures in the first place. It’s like a cook refusing to eat his own food but having no problem selling it to the customer.