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Term Deposit Facility? Oh, now I get it

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December 28, 2009 – Comments (6)

The Fed is going to sell CD's to banks as a new tool to drain liquidity. At first blush, I was planning to be sarcastic and derisive about this idea, but now I am beginning to understand the financial subtlety of it all (that can't be a good sign).

See, the Fed already has several traditional tools it can use to fight liquidity and inflation:
**stop propping up FRE and FNM securities and dump the MBS' it already has
**raise the reserve requirement
**jack up the Fed funds rate
problem is that all of these will raise the interest rates on mortgages, hurting the residential real estate recovery.

That is where this TDF comes in. There is $1T+ in free cash on deposit at the FED: its movement out into the financial system raises the specter of hyperinflation. So, the TDF promises to lock down this cash under the control of the FED, rather than under the individual banks' control. This is a new idea, and the question is: will it work as advertised? Will banks buy TDF's offering a paltry rate of return if they would really rather withdraw it and toss it back into their coffers?

6 Comments – Post Your Own

#1) On December 28, 2009 at 11:05 PM, rd80 (98.29) wrote:

Interesting. 

Unless the TDF goes at a higher interest rate than a T-bill, I don't see any reason a bank would buy one over a similar term Treasury.  A T-bill is extremely liquid and a well understood instrument. The TDF - not clear there would even be a secondary market.  Even if there was a market, it certainly wouldn't have the liquidity of a T-bill. 

If the ceiling rate is set higher than a comparable T-bill, this will effectively put the Fed in competition with Treasury, possibly drying up one source of Treasury funding and driving those rates higher.

This begs the question -  what does a TDF get the Fed that they can't achieve with the other tools they already have?

Fed press release

 

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#2) On December 28, 2009 at 11:15 PM, AbstractMotion (53.15) wrote:

Publicity apparently...

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#3) On December 28, 2009 at 11:31 PM, cthomas1017 (95.35) wrote:

Permission to continue operations?

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#4) On December 28, 2009 at 11:37 PM, cthomas1017 (95.35) wrote:

oops... re #3... I meant to say that the banks will have to purchase TDFs to get permission to continue operations.

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#5) On December 29, 2009 at 6:27 AM, starbucks4ever (96.89) wrote:

And what happens as the "CD"s mature?

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#6) On December 29, 2009 at 8:39 AM, russiangambit (29.27) wrote:

FED is getting more devious by the minute. You know, it is like a sci-fi robot invented for the greater good, which take the life of its own.

My initial understanding was that to mop up liquidity FED would have to get the cash it lent and return the trashy collateral to the banks. Or even, gasp, sell some of MBSs they hold.

Apparetnly, they cannot find fools to buy whatever junk they hold at whatever prices they paid. So, they invented those deposits to get the cash out of the system. And they will be paying interest on them (right?), while still holding all the junk they bought, which is a couple trillion in the hopes of the juink becoming more valuable with time.

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