1. Lesson 16 Crisis Related Liquidity Provisions
The History of a Powerful Paragraph
http://www.minneapolisfed.org/publications_papers/pub_display.cfm
Federal Reserve Liquidity Provision During the Financial Crisis
of 2007-2009, Michael Fleming, FRBNY Staff Reports # 563,
July 2012.
http://www.newyorkfed.org/research/staff_reports/sr563.html
Interest on Reserves and Monetary Policy, Marvin Goodfriend ,
FRBNY Economic Policy Review 2002
http://www.newyorkfed.org/research/epr/02v08n1/0205good.pdf
2. When Banks Borrow From The Discount Window
Bank Reserves Increase
Federal Reserve
assets
+Discount Loans
Banking System
liabiliies
+Reserves
assets
+Reserves
liabiliies
+Due to Fed
3. Eligible Collateral for Discount Window Advances
Marg ins for S ec urities
(as percentage of
C ollateral C ateg ory
2
U.S . Treas uries & F ully G uaranteed A gencies
B ill/Notes /B onds /Inflation Indexed
Zero C oupon, S TR IP s
B ills /Notes /B onds - U.S . D ollar D enominated
Zero C oupon - U.S . D ollar D enominated
G overnment S pons ored E nterpris es
B ills /Notes /B onds
C orporate B onds
A A A rated - U.S . D ollar D enominated
B B B -A A rated - U.S . D ollar D enominated
Municipal B onds
U.S . D ollar D enominated
A s s et B acked S ecurities
A A A rated
B B B -A A rated
C ollateralized D ebt Obligations - A A A rated
C ommercial Mortgage B acked S ecurities - A A A rated
A gency B acked Mortgages
P as s Throughs
C MO s
C ommercial L oans & L eas es
Minimal R is k R ated
7
8
Normal R is k R ated
C ommercial R eal E s tate L oans
Minimal R is k R ated
7
8
Normal R is k R ated
C ons umer L oans - Uns ecured
C ons umer L oans & L eas es (auto, boat, etc.)
C ons umer L oans - C redit C ard R eceivables
C ons umer L oans - S ubprime C redit C ard R eceivables
S tudent L oans
3
es timated fair market value)
D uration B uc kets
0-5
>5-10
>10
99%
98%
98%
97%
97%
96%
96%
95%
96%
95%
93%
96%
95%
86%
91%
93%
96%
96%
L oans
83%
82%
90%
92%
98%
98%
G roup D epos ited
95%
98%
89%
92%
97%
4, 5
94%
92%
98%
L oans
95%
97%
95%
Indiv idually D epos ited
96%
92%
95%
91%
98%
Marg ins for L oans
(as percentage of es timated fair market value)
95%
90%
87% to 96%
87%
63% to 95%
63%
78% to 96%
78%
57% to 95%
60% to 96%
76% to 96%
57%
60%
76%
59%
54%
83%
4
5. Prior to 2003
• Discount Rate was set below Fed Funds rate
• The Discount rate served as anchor on the Funds rate
• Banks were forced to borrowed from the discount window,
because the provision of nonborrowed reserves was below
the demand for combined demand for required and excess
reserves
• There were implicit costs of borrowing from the Fed, and
banks were generally reluctant to do so, unless the Fed
funds rate was elevated relative to the discount rate
• The larger the volume of forced discount window
borrowing the great the spread between the discount rate
and the Funds rate
7. Discount Rate Policy Prior to 2003
• During times of financial market stress, such as the
failure of Continental Illinois in 1984 the implicit costs
of borrowing from the Fed became more pronounced.
• The higher the implicit costs the larger the spread
between the Funds rate and the discount rate for a given
level of borrowing.
• The FOMC would establish “Borrowing Objectives”,
instructing the Open Market Desk to provide
nonborrowed reserves in such volumes as to force a
particular volume of discount window borrowings
• In effect the FOMC was attempting to foster a
particular spread between the funds rate and the
discount rate
8. The higher the level of Net Borrowed Reserves
(borrowed reserves – excess reserves), the higher the
Funds Rate trades above the Discount Rate
9. Beginning January 2003 The Discount
rate became a penalty rate
• The discount rate was set initially 1 percent above
the prevailing Fed funds target
• By having a penalty rate the Fed attempted to
remove any implicit costs of borrowing.
• Banks were no longer discouraged from
borrowing at the discount window
• This new approach to discount window policy was
thought of as putting a ceiling on the Fed funds
rate
10. In 2003 the Fed change the way the discount window operates. Henceforth, the
discount rate was set as a spread above the FF target…On August 17, 2007 that
spread was reduced from 1% to only ½%, and on March 16, 2008 the spread was
reduced to only ¼%.
11. Cutting the discount rate usually doesn’t impact on
the funds rate, only if banks are already borrowing
heavily from the window
12. Onset of Current Crisis: Term Funding Rates (1-mo
Euro$) exceeded the discount rate early in the crisis
13. Crisis Related Adjustments to
Discount Window Policies
• The Fed’s first crisis related action was to reduce the spread
between the funds rate target and the discount rate from 1% to .
50%. This resulted in a drop in the discount rate from 6-1/4% to
5-3/4%.
• Later following the the unwinding of Bear Stearns in March 2008
the discount rate spread was reduced to only .25%.
• Initially the Fed also extended the term of borrowings from
overnight to up to 30-days, after Bear Stearns this was increased
to 90-days.
• The intent was to encourage borrowings so that stress in the interbank funding markets would ease
• Banks still would not go to window because of a perceived
stigma
14. Why a Stigma in borrowing at the
discount window?
• Banks were concerned that if it became known
that they were accessing the discount window they
would be perceived as suffering liquidity
problems
• Banks feared depositors might withdraw deposits
• Banks feared that other creditors, such as banks
lending Fed funds, would pull back credit
• Banks also feared that speculators would “short”
their stock, causing a rumor related plunge in their
stock price.
15. Why was the Fed concerned about the
lack of borrowing?
• The Fed was hoping that the stress in the term
interbank funding market would encourage
discount window advances, recall the purpose of
setting the discount rate above the funds rate was
to provide a ceiling on the funds rate, and related
interbank financing costs. If banks borrowed
from the window the stress in the markets would
be relieved.
16. What Did the Fed Do to Increase
Liquidity of Financial Institutions?
• Eased Terms at Discount Window – Lower
Discount/FFR Target Spread, Longer Borrowing Terms
• Term Auction Facility (TAF)—Instead of banks coming
to the window, the Fed auctioned credit. Banks bidding
successfully in the auction won credit at costs below
market term funding rates
• Fed opened the Primary Dealer Credit Facility (PDCF)
to ensure liquidity to dealers with appropriate collateral
• Fed activated Currency Swap Lines providing dollar
related credit to foreign central banks to enable a relending of these dollars to banks outside the US
18. Under Section 13(3) of the Federal Reserve Act the
Fed provided credit to systemically important
institutions such as AIG
19. The Various Liquidity Programs Enacted During the
2008/2009 Period Caused Bank Reserves to Rise
20. The Rise in Bank Reserves Associated with these
Liquidity Provisions would have resulted in a Fed
funds rate plunge to zero, if not for payment of
interest on reserves
21. By paying Interest on Reserves (IOR) the Fed could expand its
balance sheet without having the funds rate fall to zero. The thinking
was that IOR would put a floor on the funds rate, even when there
was an abundance of excess reserves in the banking system.
22. Fed Pays 0.25% Interest on Reserve Balances, lifts
floor on funds from zero to 0.25%
23. Why Does the Funds Rate Trade Below the Floor? Answer: Not all
deposits at Fed pay interest. GSEs don’t earn interest on deposits and
therefore have incentive to sell these deposits (reserves).
24. Fed will move towards managing the Fed funds rate within
a “corridor” sometime in the years ahead
The demand curve has a downward-sloping portion because banks want to
hold more reserves when the federal funds rate is lower
25. The Supply Curve for Bank Reserves: Discount Rate
serves as a theoretical ceiling on the funds rate
The supply of reserves is vertical when ffr is less than the
primary discount rate and horizontal when they are equal
26. The IOER serves as a theoretical floor on the funds rate
When ffr exceeds the Fed’s target, the Fed engages in purchases in the amount
of ∆R and equilibrium ffr will equal the target
27. Together the IOER and the Discount Rate define a
“corridor” for the Fed Funds Rate
When ffr exceeds the Fed’s target, the Fed engages in purchases in the amount
of ∆R and equilibrium ffr will equal the target
28. A Shift in the demand for reserves does not
cause the funds rate to trade above ceiling
If demand for reserves is D2 instead of D1, ffr will rise to equal the
discount rate
Notas do Editor
There was a stigma by the Fed. Instead of borrowers coming to the Fed to borrow, the fed instead went to them and said you can bid for the money. This way they didn’t have to bid in the Eurodollar market which cause the Libor rate to come down
Under this special section the Fed can lend money to people like us. Maiden Lane was the bad balance sheet that Bear Stearns collapsed under and the Fed used this section and lended money to this T account. Jp Morgan also lended money.
The supply curve before the liehmann brothers collapsed. Then the fed starts doing stuff and then shifted to S2 and the funds rate becomes 0. The fed didn’t really want to do this as to having the feds fund rate 0.
By giving interest on the reserves the feds funds rate increased as it can be seen by the black demand line. Also the amount of excess reserve you may want to hold will increase because the fed is now paying you interest for keeping a reserve.
