There seems to be an alternative to the discount stigma – is the liquidity problem too big for (orthodox) central banks?

The Federal Home Loan Bank System: Lender of Next-to-Last Resort?

Morten Bech, Federal Reserve Bank of New York

When we look at the FHLB balance sheet, we see a $746b surge in net lending to the banking system (at an annualized rate) in Q3. Is it true, then, that banks are suffering from an access to funding? If banks have been shy about tiptoeing to the discount window, they seem to have had no such bashfulness on their way to borrowing or securing advances from FHLB.

How, then, can any Fed official get in front of a microphone with a straight face and say we have a liquidity problem, best addressed by a TAF facility, which at the moment is scheduled to auction off a fraction of that which has already been loaned by FHLB to the banking system?

‘Liquidity’ for fed member banks is about price, not quantity. There is a ‘liquidity problem’ when the term structure of interbank rates isn’t to the fed’s liking.

Currently, the issue seems to be LIBOR – the fed wants the spread over fed funds to be narrower, particularly over year end. The ‘new facility’ should directly address this particular pricing issue.

There is another problem with this injecting liquidity story. If the Fed wishes to maintain the fed funds rate at the current target, assuming the demand curve for reserves remains stable, the Fed will have to remove as many reserves through open market operations as they inject through the TAF.

Yes. Not a problem. The TAF should function exactly that way to narrow spreads above.

If they don’t, the reserves will be in surplus, and the fed funds rate will fall below the target. In fact, the Fed’s balance sheet has been growing relatively slowly, even though they have been easing, especially when compared to the unprecedented expansion of FHLB balance sheet growth.

Yes, again, it’s all about price, not quanity.

The FHLB is acting as a broker – long with some investors/banks/etc and short with others.


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One Response

  1. On 12/16/07, Andrea Terzi wrote:
    >
    > It’s all about price, not quantity. We know this.
    > And the relevant ‘price’ is the stigma discount rate. I don’t understand
    > why member banks still feel the stigma, that was typical of the time before
    > 2002 when discount borrowing?

    From Warren Mosler:
    I have a small bank, and we called the fed about discount rate borrowing and they gave us a hard time. asked a lot of questions. told us they would do it but it’s only temporary, etc. someone needs to straighten those boys out!!!

    > Also, don’t you think FHLB loans are made useless by the ff target? (again,
    > price, not quantity!)

    From Warren Mosler:
    they should, but, as above, when the fed’s being difficult not much else to do. we wound up using the fhlb, for example.

    > It just seems that banks use fhlb instead of window at no avail! Price will
    > stay unchanged anyway! (fed will remove any reserves as necessary)
    > All seems to suggest fed is running out of options (as they insist in
    > keeping the discount penalty).

    From Warren Mosler:
    right, the overnight rate stays the same, but we use them for term funds which takes some ‘upward pressure’ off term rates.

    There’s also the Federal Financing Bank that does the same thing for other gov borrowers- allows them to go straight to the Treasury instead of going to the markets.

    Fact is, the media and leading financial and academic economists don’t get it, don’t understand monetary operations and reserve accounting, and sustain the counterproductive rhetoric that at best is fixed exchange rate/gold standard oriented.

    >
    >
    > On Dec 16, 2007 4:14 PM, Wray, Randall wrote:
    > > warren: yes; and this guy seems to think that “easing” means more reserves
    > and so he’s a little puzzled why fed’s balance sheet hasn’t grown much. As
    > we know, the fed funds rate can be driven down without adding any reserves.
    > It is all about price, not quantity.
    > >
    > > L. Randall Wray
    > > Research Director
    > > Center for Full Employment and Price Stability
    > > 211 Haag Hall, Department of Economics
    > > 5120 Rockhill Road
    > > Kansas City, MO 64110-2499
    > > and
    > > Senior Scholar
    > > Levy Economics Institute
    > > Blithewood
    > > Bard College
    > > Annandale-on-Hudson, NY 12504
    > >

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