US Fed tries to fill the liquidity pool and avoid a drought

Yesterday's pronouncements by a global consortium of central banks demonstrated how serious the current liquidity drought is.

The US Fed has further relaxed it's market intervention policies and to offered to accept triple-A rated private label mortgage backed securities (MBS) as collateral in exchange for lending primary dealers up to $200bn in Treasury securities for 28 days at a time.

The following example should helps explain how this helps
It is the recycling of funds that keeps the financial system working and on which the economy depends. Hence, the Fed's effort to oil the recycling system.

Notably, this move doesn't transfer ownership of the credit risk of MBS, which an outright purchase of the MBS by the Fed would do. This remains with the hedge fund in the example above. As I discussed here, falls in the price of MBS assets related to a loss of confidence that the MBS issuer can repay its' loans or make repayments as a result of losses of the underlying mortgages will hit the hedge fund and begin a vicious spiral. It is for this reason that commentators are wondering whether the Fed might ultimately need to actually begin buying the MBS, at which point the Fed [read US Govt] would bear the credit risk and shift lending from the private to public sector.

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posted by John Wilson @ 9:17 AM Permanent Link newsvine reddit



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