Federal Reserve 'purchases' mortgages backed securities ?
Q. Over the last couple of days the Times and other publications
have reported that the Federal Reserve has injected $68 billion
into the equities markets and that foreign central banks, such
as the ECB, have pumped even larger amounts of capital into
their markets.
Could you tell me precisely how this is done? Are the central
banks simply printing money to purchase the CDO’s other debt
instruments that nobody else wants to touch? If so, isn’t this
just a way of socializing the costs of bad investment through
inflation? Finally, didn’t this whole mess begin with too much
liquidity and reckless lending practices?
The Fed injects money into banks by lending dollars on the
security of high quality assets held by banks. Under the
rules central banks now follow, this is almost an automatic
action.
The Fed sets a target on the federal funds rate — the rate
on loans between banks. If the market rate rises above that
rate, it is a sign that demand for funds is greater than anticipated,
and the Fed meets the demand. Similarly, it withdraws loans if
the rate falls below that level. There was an interesting twist
on one day, in that the Fed asked that the security for loans be
mortgage securities, but those are of the type issued by Fannie
Mae and Freddie Mac, not the ones that are now questionable.
Because the Fed is not lending against bad securities, it is not
bailing out anyone. But that move enables banks to lend to
customers who own securities that cannot be sold right now.