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The Fed’s New Policy Framework: A Major Improvement But More Can Be Done

Published by Anonymous (not verified) on Wed, 21/10/2020 - 9:45pm in

The Fed's new policy strategy of average inflation targeting is an unambiguously a positive step, but may not – under all circumstances – subscribe to a sufficiently aggressive make-up strategy when the zero lower bound is binding.

Citi’s Recidivist Rule-Breaking and Incompetence Shows Persistence of Too Big/Complex to Fail Problem

Published by Anonymous (not verified) on Mon, 12/10/2020 - 8:37pm in

Citi's latest run-in with regulators shows why comparing big banks "too big/complex to fail" problems to those of Big Tech is all wet.

Rana Foroohar and Mark Blyth: How Deep Will the Depression Get?

Rana Roroohar and Mark Blyth discuss the elections, tech, China, and Covid v. recovery with Paul Jay.

Trump Shoots His Campaign in the Head

Published by Anonymous (not verified) on Wed, 07/10/2020 - 9:10pm in

Trump is back to his usual self-destructive form.

Fed Study on Household Wealth Reveals Troubling Trends in American Inequality

Published by Anonymous (not verified) on Thu, 01/10/2020 - 3:51am in

Millionaires and billionaires hold a remarkable 79.2 percent of the United States’ household wealth. That is according to a newly released triennial study into consumer and household finances from the Federal Reserve. The report paints a picture of an unequal America, where a small minority of the rich control the vast majority of household wealth. 11.9 percent of American households have at least $1 million in wealth. Overall, mean family wealth declined by three percent across the country between 2016 and 2019. However, the study notes, wealthy and highly educated families saw their fortunes rise, but households where the main breadwinner had not achieved a high school diploma saw their wealth fall.

In some parts of the country, one million dollars might not seem like an unusual price for a home. However, nationwide, the median home value dropped to $247,000 in 2020, with much more expensive properties rarer. Those merely having a mortgage on a million-dollar home do not qualify as owning $1 million in household wealth.

At the same time, much of the country is living in serious poverty. Even before the COVID-19 pandemic, around 40 percent of Americans reported that they would be unable to cover a small $400 emergency such as a leaking roof or a car repair. In 2018, 14.3 million U.S. households were food insecure, meaning they had problems finding enough to eat. The coronavirus and the economic dislocation that it has caused has greatly exacerbated both poverty and inequality, meaning that the Federal Reserve’s study, based on data collected before the pandemic, is likely out of date and an underestimate of the problem’s severity.

In 2017, just three men — Bill Gates, Warren Buffet, and Jeff Bezos — held more wealth than the bottom half of America (164 million people). Since the pandemic began, all three have greatly increased their fortunes. Bezos, for example, has added over $73 billion to his since March alone. This is in stark contrast to tens of millions of people who lost their jobs, leading to a massive wave of de facto rent strikes across the country and a boom in demand for food banks.

The Trump administration has used the crisis to force through a number of reforms that amount to a giveaway to the country’s plutocrats. A nonpartisan congressional body found that 82 percent of the tax cuts hidden away in the government’s Coronavirus Aid, Relief, and Economic Security (CARES) Act went to those who earned over $1 million per year, with less than three percent going to the great majority of Americans who earn less than $100,000 yearly. Big businesses have been able to weather the storm far better than smaller ones and stand to be in a much stronger position when the dust settles. Data from business review site Yelp found that 60 percent of businesses that had to close during the pandemic are now permanently shut. Much of the suffering that the pandemic has caused, however, has been silent and invisible, with many quietly forced to live with relatives or staying almost permanently indoors.

Matt Bruenig from the People’s Policy Project also noted that the Fed’s report showed there are massive differences in wealth between racial groups. The mean white household is nearly five times wealthier than the average Hispanic one, and nearly seven times wealthier than a black one. Within each group, however, there are also enormous disparities, with the top decile controlling around 70 percent of all wealth, a small, comfortable, middle class, and a large mass of very poor people at the bottom. Indeed, 10-15 percent of the country not only has no wealth but is in debt.

These sorts of disparities are not limited to the United States alone but are seen across the West and most of the world. A new report in Scotland, for instance, found that the richest 20 families have as much wealth as the bottom 30 percent of the population. Professor Danny Dorling of Oxford University has argued that this kind of global inequality, where houses are regularly bought and sold for $1 million, is completely unsustainable, merely because if it continues for a lot longer the rich will own literally everything.

The November election presents the United States with a stark choice between two candidates on many issues. Yet on the economy, the Democrats and the Republicans do not differ wildly. Biden began his campaign for president promising his ultra-wealthy donors at a ritzy New York fundraiser that “nothing would fundamentally change” if he were president and that he “needed” them greatly. The New York Times recently published an investigative report into Trump’s finances and taxes. Despite the fact that it showed he barely paid any taxes for years, many Democrats chose to attack him on the grounds that he wasn’t a “real” billionaire after all, suggesting this was the major scandal the report exposed. Thus, whoever wins in November, it is unlikely that this problem will get better quickly.

Feature photo | A man is seen at a homeless encampment that sits under Interstate 110 near Ramirez Street in downtown Los Angeles, May 21, 2020. Mark J. Terrill | AP

Alan MacLeod is a Staff Writer for MintPress News. After completing his PhD in 2017 he published two books: Bad News From Venezuela: Twenty Years of Fake News and Misreporting and Propaganda in the Information Age: Still Manufacturing Consent. He has also contributed to Fairness and Accuracy in ReportingThe GuardianSalonThe GrayzoneJacobin MagazineCommon Dreams the American Herald Tribune and The Canary.

The post Fed Study on Household Wealth Reveals Troubling Trends in American Inequality appeared first on MintPress News.

Expanding the Toolkit: Facilities Established to Respond to the COVID-19 Pandemic

Published by Anonymous (not verified) on Tue, 22/09/2020 - 9:00pm in

Anna Kovner and Antoine Martin

LSE_2020_covid-series_martin_series1_460

First of three posts

The Federal Reserve’s response to the coronavirus pandemic has been unprecedented in its size and scope. In a matter of months, the Fed has, among other things, cut the federal funds rate to the zero lower bound, purchased a large amount of Treasury securities and agency mortgage‑backed securities (MBS) and, together with the U.S. Treasury, introduced several lending facilities. Some of these facilities are very similar to ones introduced during the 2007-09 financial crisis while others are completely new. In this post, we argue that the new facilities, while unprecedented, are a natural extension of the Fed’s toolkit, as they operate through similar economic mechanisms to prevent self-reinforcing bad outcomes. We also explain why these new facilities are particularly useful as part of the response to the pandemic, which is an economic shock very different from a financial crisis.

An Overview of the Facilities

The distinction between new and old facilities loosely maps to a commonly used description of facilities as “liquidity” or “credit” facilities. Liquidity facilities include the Primary Dealer Credit Facility (PDCF), the Commercial Paper Funding Facility (CPFF), and the Money Market Mutual Fund Liquidity Facility (MMLF). These facilities support financial intermediaries, such as primary dealers and money market funds, or money markets, such as the commercial paper market. In addition, they provide short-term support, generally less than one year. "Credit" facilities include the Municipal Liquidity Facility, the Main Street Lending Program, the Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF), the Term Asset‐Backed Securities Loan Facility (TALF) (introduced during the 2007-09 crisis) and the Paycheck Protection Program Liquidity Facility (PPPLF). They support corporations, states, and municipalities more directly and the terms of the loans are longer. All these facilities were established under Section 13(3) of the Federal Reserve Act, with approval of the Treasury Secretary.

Regardless of the label used to describe these facilities, they all serve a similar purpose, to ensure that American businesses and households have access to credit. Moreover, we argue that they do so through a similar economic mechanism; stepping in to ensure that, when there are multiple possible economic outcomes, the U.S. financial system is positioned to facilitate the best possible outcome for the U.S. economy.

How do Federal Reserve facilities help the financial system?

Liquidity provision by the central bank can break the vicious cycle that makes panics self-fulfilling. For example, in a bank run, if a bank can borrow from the central bank to repay its depositors, it will not have to sell its assets at a loss. This means that the bank will have enough resources to repay the depositors that are not withdrawing immediately, which reduces or eliminates the incentive to do so. This is an example of multiple equilibria—a situation with multiple outcomes. By acting according to Walter Bagehot’s advice to the Bank of England to lend freely and vigorously against good collateral, the Fed can prevent or mitigate run dynamics.

In the 2007-09 financial crisis, the liquidity facilities were established to help prevent run dynamics in financial markets, just as the Fed has done through the discount window for banks since its founding, thus avoiding the bad equilibrium that could follow from inefficient fire sales of assets. Many of these facilities have been reinstated to respond to the severe market dislocations and run risks that emerged in response to the coronavirus pandemic.

Are "credit" facilities a new role?

At first glance, the "credit" facilities appear new to the central bank’s tool kit, targeting businesses and localities directly rather than providing liquidity to banks and financial markets. When the cause of lack of access to credit is fundamental uncertainty about the real economy, we argue that, just as the Fed steps in to lend to solve the multiple equilibria facing banks in a run, the "credit" facilities help solve a multiple equilibria problem facing the real economy. In this way, the facilities are a natural evolution of the toolkit adapted to the current circumstances.

A growing literature in economics theorizes about the possibility of multiple equilibria in the real economy. For example, if households and firms have pessimistic views about the future, they are likely to be reluctant to consume and invest. This will in turn depress economic activity. Conversely, if households and firms have optimistic views about the future, they will be willing to consume and invest and this will in turn stimulate economic activity (see, for example, this Liberty Street Economics post). This literature also suggests that in models with multiple steady-states, a self-reinforcing negative outcome is likely to happen only in unusual circumstances, for example, following an unusually large shock (as in Benigno and Fornaro). This possibility of multiple equilibria is also explored empirically in Adrian, Boyarchenko, and Giannone. They estimate forecasts in a framework that allows for negative feedback between ever-tighter financial conditions and slowing growth. The authors apply this estimation in a recent blog post and show the prospect of two possible outcomes, a more benign outcome and a very negative one in 2020. The possibility of multiple equilibria is rare in their framework but was also evident in 2008.

Why now?

It is important to recognize that the coronavirus pandemic is of a different nature than the 2007-09 financial crisis. That crisis was primarily a financial shock that amplified what may have otherwise been a reasonably small macroeconomic shock. By contrast, the pandemic is primarily a large macroeconomic shock arising from measures taken to contain it. The shock to the economy created by the pandemic has created unusually high uncertainty about the possible macroeconomic outcomes, affecting companies and localities that rely on capital markets. This can arise when financial markets assign too much weight to negative outcomes that good policy can avoid. As a result, market prices will diverge from what they would be under the better equilibrium. Since the multiple possible economic outcomes affect mainly the real economy, and are driven by uncertainty about the prospects for the post-shutdown economy rather than financial institutions, the Fed had to adapt its tools to address this new problem.

The multiple equilibria argument does not mean that these facilities are a free lunch—costlessly leading the U.S. economy to the better outcomes. Interventions could raise concerns, particularly about moral hazard, as we discuss in a later post.

A Joint Effort

As noted by Fed Chair Jerome Powell during a Brookings webinar, the Fed is providing “credit to households, businesses, state and local governments as we are directed by the Congress.” In theory, if the Fed knew with perfect certainty the length of the COVID-19-related disruptions and the state of the better equilibria for the economy, no capital would be required to extend these facilities. However, in practice, given their unconventional natures, and the scale of the required intervention, the facilities have been established in partnership with the U.S. Treasury. To provide a large-enough backstop at reasonable prices, the Fed in particular relies on the equity that the U.S. Treasury provides to protect it from losses on the "credit" facilities as mandated in the CARES Act and in Section 13(3) of the Federal Reserve Act. In addition, Section 13(3) requires that the Secretary of the Treasury approve any Section 13(3) facility established by the Fed.

The Fed plays two important roles in this partnership. First, it leverages the capital that Treasury is putting toward helping the real economy. This means that the amount of support available to households, businesses, state and local governments is larger than it otherwise would be. Second, the Fed provides technical and operational expertise to help set up these programs as fast as possible so that relief is available quickly to those who need it.

To Sum Up

A central bank’s toolkit must adapt to the circumstances it faces. The Fed has established a number of facilities, in partnership with the Treasury and at the direction of the Congress. These facilities play a similar role to that played by the facilities introduced during the 2007-09 financial crisis, helping to prevent self-reinforcing bad outcomes. The "credit" facilities are particularly helpful to respond to the macroeconomic shock created by the uncertainty associated with the coronavirus pandemic. Of course, the facilities are only one aspect of the official sector’s response to the pandemic. In tomorrow’s post, we consider interventions by the official sector more broadly, including institutions like the Treasury and Congress, asking whether, during the pandemic, they should extend support to insolvent businesses.

Anna Kovner

Anna Kovner is a policy leader for financial stability in the Federal Reserve Bank of New York’s Research and Statistics Group.

Antoine Martin

Antoine Martin is a senior vice president in the Bank’s Research and Statistics Group.

How to cite this post:

Anna Kovner and Antoine Martin, “Expanding the Toolkit: Facilities Established to Respond to the COVID-19 Pandemic,” Federal Reserve Bank of New York Liberty Street Economics, September 22, 2020, https://libertystreeteconomics.newyorkfed.org/2020/09/expanding-the-tool....

Related Liberty Street Economics reading

Market Failures and Official Sector Interventions


The Official Sector’s Response to the Coronavirus Pandemic and Moral Hazard




Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Tom Ferguson: Biden Blurring Almost Everything

Political scientist Tom Ferguson juxtaposes the factions around Biden with how Roosevelt eventually stared down banks and corporatists in the second phase of the New Deal

Explaining the Puzzling Behavior of Short-Term Money Market Rates

Published by Anonymous (not verified) on Mon, 24/08/2020 - 9:00pm in

Antoine Martin, James J. McAndrews, Ali Palida, and David Skeie

Since 2008, the Federal Reserve has dramatically increased the supply of bank reserves, effectively adopting a floor system for monetary policy implementation. Since then, the behavior of short-term money market rates has been at times puzzling. In particular, short-term rates have been surprisingly firm in recent months, despite the large increase in reserves by the Fed as a part of its response to the coronavirus pandemic. In this post, we provide evidence that both the supply of reserves and the supply of short-term Treasury securities are important factors for explaining short-term rates.

Money Market Rates in a Floor System

During the 2007-09 crisis the Fed sought to stabilize financial markets by greatly increasing the supply of reserves through lending facilities, subsequently, post-crisis, shifting to large-scale asset purchases to stimulate the economy. The Fed was able to maintain control of interest rates despite the large supply of reserves because Congress gave it the authority to pay interest on reserves (IOR) in October 2008. Ever since, the Federal Open Market Committee (FOMC) has influenced the level of the effective federal funds rate, which the Fed targets for monetary policy, primarily by adjusting the level of interest it pays on reserves.

Theory suggests that IOR should act as a floor for overnight rates, such as the fed funds rate. In practice, due to a variety of frictions, those rates can be below the level of IOR, as was the case between 2009 and 2018. Early research aimed at understanding this disconnect focused on the role of bank balance sheet costs and the supply of reserves (see, for example, this paper). Because reserves created by the Fed must be held by banks, an increase in reserves must, all else being equal, expand the aggregate balance sheet of the banking sector. Crucially, banks face costs that are proportional to the size of their balance sheet, such as a leverage ratio requirement and the Federal Deposit Insurance Corporation fee. If an increase in the supply of reserves raises those balance sheet costs, then we should expect bank deposit rates, and in turn other short-term money market rates, to decrease below IOR.

This theory—that short-term rates are guided by the rate of interest paid on reserves and that a larger supply of reserves depresses rates—was put to the test in 2018, when the Fed began reducing the supply of reserves. Consistent with the theory, short-term money market rates started to increase relative to IOR.

More recently, a puzzling inconsistency emerged. Earlier this year, as part of its policy actions to combat the economic and financial disruptions caused by the coronavirus pandemic, the Fed greatly enlarged its asset holdings and extensions of credit. Those actions more than doubled the supply of bank reserves, from approximately $1.5 trillion in March to more than $3 trillion in June. Yet, even with such a large increase in reserves, money market rates have proven surprisingly firm relative to the IOR rate. What explains this puzzling behavior?

Accounting for the Role of the Supply of Treasuries

In a Staff Report updated last year, we showed that the theory focusing solely on reserves and balance sheet costs isn’t sufficient to explain the behavior of short-term rates. In reality, it is also important to consider how the supply of Treasury securities affects rates. Specifically, our model showed that short-term Treasury securities and reserves have opposing effects on short-term rates.

Putting aside model details, the intuition for this result is as follows: as would be expected, increases in reserves lower short-term rates through the mechanism described by the balance sheet cost theory. More reserves raise banks’ balance sheet costs, which leads to lower bank deposit rates. However, wholesale bank deposits are not the only investment option for institutions seeking to invest in short-term instruments. Money market mutual funds (MMFs) offer an investment alternative to bank deposits and hold a large amount of short-term Treasury securities as assets. When the supply of Treasury securities increases, everything else being equal, Treasury yields tend to increase to attract investors. MMF shares become more attractive than bank deposits and investors reduce the amount of such deposits they hold. (Greenwood, Hanson, and Stein provide evidence of the substitutability of short-term Treasury securities and bank deposits in this paper.) This reduces the size of banks’ balance sheets (banks may reduce, on the asset side, their investments in repos, for example), and induces banks to raise their wholesale deposit rate to remain competitive.

Since MMFs can only hold assets with a maturity of up to one year, it is this segment of the Treasury market that we expect to be an important determinant of money market rates. This segment includes Treasury bills that have been issued with maturities of up to one year, as well as outstanding Treasury notes and bonds that have less than a year remaining until maturity.

To test our theory, we present empirical analysis focused on the fed funds rate. This particular money market rate provides a good representation of the overnight interbank interest rate as well as the rates earned by wholesale depositors in large U.S. banks and their overseas affiliates. Our regression aims to explain the spread between the fed funds rate, as our dependent variable, and the IOR rate. The key explanatory variables are the changes in the outstanding amount of Treasury securities with less than a year to maturity, which we dub as “short-term Treasuries,” and the changes in the outstanding amounts of bank reserves issued by the Fed. We posit that changes in short-term Treasuries tend to have a positive effect on the interest rate spread, and changes in reserves a negative effect. The empirical specification is discussed in detail in Section 5 of this Staff Report. For this post, we extend the time period over which we conduct the estimation through June 2020.

The actual and fitted fed funds rates from our regression are displayed in the chart below, which shows the fed funds rate relative to the IOR rate. The chart also displays the FOMC’s target range for the fed funds rate fits relative to the IOR rate. Our estimation shows that a trillion dollars of additional reserves tends to reduce the fed funds rate by 8 basis points relative to the IOR rate, while an additional trillion dollars of Treasuries with less than a year to maturity tends to increase the fed funds rate by about 3 basis points, confirming the opposing effects these two variables impart on short-term rates.

Explaining the Puzzling Behavior of Short-Term Money Market Rates

The model is particularly useful in explaining money market rates over the last year. While the reserve supply has increased since September 2019, dramatically so since March, rates have remained firm throughout the period. However, as shown in the next chart, the amount of Treasury securities with less than a year to maturity was rising as well, partially offsetting the depressing effect of higher reserves on interest rates. This highlights the importance of the simultaneous issuance by the U.S. Treasury of trillions of dollars of Treasury securities, many of them Treasury bills.

Explaining the Puzzling Behavior of Short-Term Money Market Rates

The model also provides clarity on the need for technical adjustments in the last couple of years. These adjustments lowered IOR compared to the top of the fed funds target range, shown with red lines in the first chart above. In that time period, while reserves were falling, short-term Treasuries were rising, leading to surprisingly firm market interest rates. Lowering the IOR relative to the target range of the fed funds rate made it possible to maintain the fed funds rate within the target range.

To Sum Up

In this post, we showed that the quantity of short-term Treasuries, in conjunction with the quantity of reserves, assists in explaining the evolution of short-term rates such as the fed funds rate. In particular, by enriching our understanding of how short-term rates are determined, we are able to explain why these rates have remained elevated in recent months, despite the Fed’s very large increase in the supply of reserves. Put another way, whether reserves are scarce can only be judged in relation to the amount of short-term Treasuries. Because Treasury issuance of short-term securities is expected to remain high, upward pressures on the federal funds rate are likely to continue in the coming months, even in the face of a large supply of reserves.

Antoine Martin
Antoine Martin is a senior vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

James J. McAndrews is the CEO and Chairman of the Board of TNB USA Inc, a senior affiliate at Coherent Economics, and a senior fellow at the Wharton Financial Institutions Center.

Ali Palida is a postdoctoral researcher at MIT Sloan School of Management.

David Skeie is a professor of finance at Warwick Business School.

How to cite this post:

Antoine Martin, James J. McAndrews, Ali Palida, and David Skeie, “Explaining the Puzzling Behavior of Short-Term Money Market Rates,” Federal Reserve Bank of New York Liberty Street Economics, August 24, 2020, https://libertystreeteconomics.newyorkfed.org/2020/08/explaining-the-puz....




Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Market Function Purchases by the Federal Reserve

Published by Anonymous (not verified) on Thu, 20/08/2020 - 9:00pm in

Kenneth D. Garbade and Frank M. Keane

Market Function Purchases by the Federal Reserve

In response to disorderly market conditions in mid-March 2020, the Federal Reserve began an asset purchase program designed to improve market functioning in the Treasury and agency mortgage-backed securities (MBS) markets. The 2020 purchases have no parallel, but there are several instances of large SOMA purchases undertaken to support Treasury market functions in earlier decades. This post recaps three such episodes, one in 1939 at the start of World War II, one in 1958 in connection with a poorly received Treasury financing, and a third in 1970, also in connection with a Treasury financing. The three episodes, together with the more recent intervention, demonstrate the Fed’s long-standing and continuing commitment to the maintenance of orderly market functioning in markets where it conducts monetary policy operations—formerly limited to the Treasury market, but now also including the agency MBS market.

The 2020 Market Intervention

The Federal Reserve’s System Open Market Account (SOMA) holdings of U.S. Treasury and agency MBS expanded at an extraordinary pace beginning on March 13, 2020, with purchases totaling more than $100 billion on some days (see chart). Severe disruptions in Treasury market functioning, discussed here, and in the agency MBS market, discussed here, triggered the interventions. Cumulative purchases between March 13 and July 31 amounted to $1.77 trillion of Treasuries and $892 billion of agency MBS. The purchases were undertaken by the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York, acting on instructions from the Federal Open Market Committee (FOMC) to make purchases “in the amounts needed to support [and subsequently sustain] the smooth functioning of [the Treasury and agency MBS] markets.”

LSE_2020_market-function_garbade_ch1-01

The manager of the Open Market Account, Lorie Logan, recently commented on the “unprecedented scale and speed” of the March purchases. Logan observed that, “in early to mid-March, amid extreme volatility across the financial system, the functioning of Treasury and agency MBS markets became severely impaired” and that “continued dysfunction would have led to an even deeper and broader seizing up of credit markets and ultimately worsened the financial hardships that many Americans have been experiencing as a result of the pandemic.” She further noted how the responsiveness of the Desk’s interventions to evolving market conditions contributed to meeting the Committee’s objectives.

Origins of Federal Reserve Concern with an Orderly Treasury Market

Whether the Federal Reserve System has some responsibility for maintaining an orderly market for U.S. Treasury securities was first discussed in the December 21, 1936, FOMC meeting, where, as recounted in the minutes of the meeting:

... it was brought out that, in addition to its operations to serve general credit policy, the Reserve System had some responsibility for the maintenance of an orderly money market, and that in recent years the government security market had become so large a part of the money market that the general responsibility for the money market involves some measure of responsibility for avoiding disorderly conditions in the government security market.

In an April 1939 memo to the president of the Federal Reserve Bank of New York, written in anticipation of a war in Europe, Allan Sproul, the First Vice President of the Bank and interim manager of the Open Market Account, observed that “we have an obligation ... to facilitate an orderly adjustment of [the Treasury] market to new conditions.”

The September 1939 Intervention

World War II began on Friday, September 1, 1939. The onset of war was not unanticipated—Britain had suspended gold payments a week earlier and Treasury bond prices had fallen about two points since mid-August—but nevertheless converted what had been a likely prospect into a concrete fact. Treasury bond prices fell another 4½ to 6½ points during the first three weeks of September.

In an effort to buffer the price decline and maintain an orderly market, the Desk purchased $800 million of Treasury securities during the first two weeks of September. The purchase program was the largest to date, exceeding both a $157 million purchase program in the fall of 1929 and a $640 million program in the spring of 1932. The selling abated at the end of September and prices thereafter rose to the end of the year, recovering all but about a point of the losses incurred since mid-August.

The July 1958 Intervention

Following the Treasury-Federal Reserve Accord of March 1951, the FOMC examined how it could best move on from its wartime and post-war policy of fixing upper limits on Treasury yields (discussed here) and recapture control of bank reserves. In March 1953, the Committee voted to limit its operations in the Treasury market to short-term securities, except when intervention in longer-term markets was necessary to correct a disorderly market.

On Thursday, July 17, 1958, Treasury officials announced an exchange offering of 1-year certificates of indebtedness to refinance $16.2 billion of maturing securities. (In an exchange offering, investors paid for new securities by tendering maturing securities on a par-for-par basis. Cash purchases were not allowed.)

At midday on July 18, Robert Rouse, the manager of the System Open Market Account, received a call from Under Secretary of the Treasury Julian Baird. Prices in the Treasury market were “drifting lower,” Baird said, and “a condition was developing which the Treasury could not, in its opinion, hope to deal with.” Baird thought the problem “was a responsibility of the Federal Reserve System.”

Shortly thereafter Rouse suggested, in a conference call with FOMC members, that while trading was not disorderly, the Committee should nevertheless “authorize purchases of bonds for the [Open Market] Account ... in order to steady the market.” Al Hayes, the president of the Federal Reserve Bank of New York, thought the market was pretty close to disorderly and, in view of Treasury’s concern with the “incipient failure of its financing,” backed Rouse’s recommended course of action. The minutes of the meeting state that Chairman William McChesney Martin supported Rouse’s proposal “reluctantly.” Other Committee members went along as well and the Committee authorized the purchase of up to $50 million “of government securities at the discretion of the manager of the System Open Market Account … wherever the manager deemed it appropriate in order to stabilize the market.”

Barely an hour later the Committee was back in session. As recounted in the minutes of the meeting, Rouse explained that “selling in the government securities market was increasing…. Bids were disappearing and about the only bids were those put in by the Desk. Indications were that volume was getting to be considerable.” His colleague, John Larkin, elaborated on the deteriorating situation:

At the conclusion of the last Committee meeting the [Desk] was informed by several leaders in the business that there were almost no bids .... Until recently, the selling seemed to be mostly speculative-type selling. However, with prices falling and dealers withdrawing their bids, there were reports of increasing institutional selling.... Dealers were reporting that the market was tending to feed on itself.

Rouse told the Committee that “he would now have to call the market disorderly” and that the $50 million authorized earlier was no longer adequate. Watrous Irons, president of the Federal Reserve Bank of Dallas, agreed that “means must be taken by the System to restore stability.” Martin proposed that the Committee give Rouse “maximum discretion to handle the situation in the way he thought best.”

Following a unanimous vote to authorize “purchase for the System Open Market Account in the open market, without limitation, government securities in addition to short-term government Securities,” the Desk bought $32 million of securities before the close of trading. The intervention reversed the earlier price decline and the market closed unchanged on the day. Bankers hailed the action as “a necessary move to meet a market situation with which the Treasury was unable to cope.”

Subscription books for the exchange offering opened on Monday, July 21. Although market prices were generally firm, large secondary market offerings of the maturing securities soon appeared. The sellers were turning down the opportunity to exchange the securities for the 1-year certificates that the Treasury was offering, choosing instead to reinvest in higher yielding intermediate-term issues. Attrition (from securities not tendered for exchange that would have to be redeemed with cash) seemed likely to be quite high, potentially creating a cash flow problem for the Treasury.

During an 11 a.m. FOMC conference call, Larkin pointed out that “the situation was not one which would encourage the exchange of maturing securities.” Relying on the Committee’s Friday authorization, he said the Desk intended to support the Treasury offering, fearing that the refunding “could turn out to be the worst failure in the history of Treasury financing.”

The Desk began buying certificates on a when-issued basis on Monday afternoon when, in Larkin’s estimation, “the atmosphere got worse.” By the time the Committee met by telephone at 11 a.m. on Tuesday, the Desk had purchased more than $78 million of the certificates. Purchases exceeded $100 million before the meeting was over and exceeded $500 million on the day.

The Desk continued buying through Wednesday, July 23, the last day the subscription books were open. By the end of the day the Desk had bought, in aggregate, more than $1 billion of the certificates, $110 million of the maturing securities, and $65 million of other notes and bonds.

The May 1970 Intervention

On Wednesday, April 29, 1970, Paul Volcker, the Under Secretary of the Treasury for Monetary Affairs, announced the terms of the May refunding: a fixed-price cash subscription offering of $3.5 billion of 18-month notes and an exchange offering of 3-year and 6¾-year notes for $16.6 billion of maturing securities. Subscription books for the cash offering would be open for one day only, on Tuesday, May 5. The books for the exchange offering were set to close on May 6.

In a televised speech to the nation on April 30, President Richard Nixon announced that ground combat forces had crossed over from South Vietnam into Cambodia in a large-scale operation aimed at eliminating Communist sanctuaries. By Monday, May 4, anti-war protests had erupted at dozens of colleges, four students had been killed by National Guard troops at Kent State University in Ohio, and (in the words of the Wall Street Journal) “the bond markets were battered.” Treasury yields were 25 basis points higher and the refunding was in danger of failing.

On Tuesday, May 5, the Desk entered the market, buying what was described by the Wall Street Journal as “large quantities” of Treasury bills. The New York Times reported that “the Federal Reserve System was forced to make ‘massive’ purchases of securities in the open market to prevent the Treasury’s $3.5 billion sale of notes … from failing ….” The Desk purchased $1.5 billion of Treasury bills during the week ended May 6 and lent $1.2 billion on repurchase agreements.

Summing Up

The magnitude of the Desk’s purchase program in 2020 “to support the smooth functioning” of the Treasury and agency MBS markets marked those purchases as highly unusual. From an operational perspective the speed and size of the program were unprecedented, yet as a policy response, as the three episodes discussed here show, it was not unique. There may be other ways to forestall or mitigate the appearance of a disorderly, illiquid market, such as primary market auction sales of Treasury debt (which in the 1970s replaced the fixed-price offerings at the root of the 1958 and 1970 episodes) or improved clearing and settlement systems (which have been suggested in the wake of the 2020 purchase program), but the infrequency of Federal Reserve intervention suggests that relying on the Fed on those rare occasions when markets are in extremis has not materially exacerbated moral hazard.

Expanded and footnoted versions of the three episodes recounted in this Liberty Street Economics post will appear in "After the Accord: A History of Federal Reserve Open Market Operations, the U.S. Government Securities Market, and Treasury Debt Management from 1951 to 1979," by Kenneth D. Garbade, to be published by Cambridge University Press next winter.

Garbade_kennethKenneth D. Garbade is a senior vice president in the Research and Statistics Group of the Federal Reserve Bank of New York.

Keane_frankFrank M. Keane is a senior policy advisor and a vice president in the Federal Reserve Bank of New York’s Markets Group.

Related Reading on Liberty Street Economics:

How the Fed Managed the Treasury Yield Curve in the 1940s (April 6)

Treasury Market Liquidity during the COVID-19 Crisis (April 17)

MBS Market Dysfunctions in the Time of COVID-19 (July 17)

How to cite this post:

Kenneth D. Garbade and Frank M. Keane, “Market Function Purchases by the Federal Reserve,” Federal Reserve Bank of New York Liberty Street Economics, August 20, 2020, https://libertystreeteconomics.newyorkfed.org/2020/08/market-function-pu....




Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

“Savings Glut” Fables and International Trade Theory: An Autopsy

Published by Anonymous (not verified) on Wed, 12/08/2020 - 4:55pm in

Debunking Bernanke's pet excuse for the global financial crisis, the savings glut hypothesis, which of course exculpates the Fed.

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