NEW YORK – The U.S. Federal Reserve may be pressed in coming months to provide further liquidity to strained money markets as the financial system remains vulnerable despite rapid monetary easing over the past year.
But the Fed would like to stay within the parameters of the liquidity programs that were put in place after a credit crunch surfaced last August rather than take radical new steps.
“We will continue to review all of our liquidity facilities to determine if they are having their intended effects or require modification,” Fed Chairman Ben Bernanke told the Kansas City Federal Reserve Bank's annual conference in Jackson Hole, Wyoming last Friday.
The U.S. central bank last month took steps to offset the possibility of liquidity crunches at quarter-ends and the year-end, when fund demand is customarily high.
On Wednesday, the New York Fed conducted its first auction of awarding options where primary dealers can borrow U.S. Treasuries for less liquid assets, one of the new steps announced in July. The auction of the Term Securities Lending Facility Options Program (TOP) drew fairly good demand with a bid-to-cover ratio of 2.04.
“The Fed doesn't have a lot of cards left to play on the liquidity front, and needs to save its remaining balance sheet adjustments for the times when they will do the most good,” said Louis Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.
The Fed holds a little more than $300 billion in Treasury securities outright on its balance sheet, compared with some $800 billion before the credit crisis last fall.
Crandall said the Fed could use a similar tactic to the TOP for the Fed's Term Auction Facility, a program set up in December where banks can raise funds directly from the central bank via auction.
While the Term Securities Lending Facility is limited to the 19 primary dealers, who deal directly with the Fed, the TAF is open to all depository institutions.
The Fed could also ramp up the amount offered at the TAF auctions. The central bank held the credit outstanding under TAF at $150 billion even as it announced on July 30 that it would offer funds at some auctions for 84-day terms and not just the 28-day terms that were available earlier.
“The Fed has shown a high level of flexibility and are willing to tweak the arrangements by listening to the market,” said Zach Pandl, economist at Lehman Brothers in New York.
Another tool the Fed hopes to have soon is the ability to pay interest on reserves that commercial banks park at the central bank. That would allow the Fed to have more flexibility in providing funds without pressuring short-term rates lower.
Congress gave the Fed permission to pay interest on reserves in 2006, but the authority does not take effect until Oct. 1, 2011. However, earlier this year, the Fed asked for the ability to start paying interest this year.
Global central banks are also considering the use of foreign-denominated collateral in money market operations, a step urged in April by the Financial Stability Forum, a global grouping of central bankers and regulators.
A Group of Ten central banking source told Reuters on Thursday major central banks were working on such a step, which has the support of the Fed.
“It is possible that over time, major central banks could perhaps agree to accept a common pool of very safe collateral, facilitating the liquidity management of global banks,” Fed Vice Chairman Donald Kohn said in a speech on May 29.
Some also speculate the Fed could purchase mortgages from banks in a bid to shore up the ailing housing market.
Banks remain in dire need of cash. Borrowing at the Fed's discount window has remained near record levels. The latest data shows primary credit lending averaging $17.51 billion a day for the week ended Aug. 20, compared with roughly $1 billion from last August through March of this year.
(Editing by James Dalgleish)
