Mr. Neel Kashkari
Interim Assistant Secretary of the Treasury for Financial Stability
and
Mr. Timothy F. Geithner
President, Federal Reserve Bank of New York
Subject: New Alternatives for Funding Collateral at the Federal Reserve
Corporate America is being stifled by the lack of debt financing alternatives. Banks are reluctant to lend, the
commercial paper market is not functioning, and secondary bond trading has diminished sharply. Clearly, the
corporate debt market is in crisis, and the primary cause is lack of funding in the capital markets.
Currently, the conduit through which investment institutions can access financing of investment grade
corporate bonds is not functioning. While member banks can pledge corporate bonds to the Federal Reserve as
collateral to borrow money, they are not passing this ability through to corporate bond investors via the repo
market. Rather than acting as a conduit for investors, the member banks are charging very high borrowing rates
and imposing very large haircuts to reverse repo corporate bond collateral. Compounding this problem is the
fact that reverse repo-ing from customers and then repo-ing to the Federal Reserve has the effect of grossing
up the dealer balance sheet, which the dealers cannot do without affecting capital ratios. This is especially true
for high risk-weighted assets, such as corporate securities. Investors, therefore, are denied effective access to
the Federal Reserve facility. This reduces investor demand for corporate bonds and limits the ability of high
quality corporations to issue debt at reasonable rate levels in the capital markets.
There are at least 3 possible ways the Federal Reserve and/or United States Government could provide
immediate relief:
- GSE DIRECT REPO. Use the GSE (FNMA and FHLMC) former repo matched books to reverse repo securities from collateral providers and to repo securities to cash providers. The GSEs are government-guaranteed until December 31 2009, and the government can provide them balance sheet.
- FED DIRECT REPO. Have the Federal Reserve transact both repo and reverse repo with other creditworthy cash providers and collateral providers, in addition to primary dealers, which have dropped in number to 17.
- FED SUPPORTED DIRECT REPO. Encourage primary dealers to transact reverse repo with collateral providers and then repo or pledge those securities to one of the many existing Federal Reserve liquidity programs by giving the primary dealers balance sheet relief. We would expect, under this pipeline, that primary dealer balance sheet usage would be zero for any securities they reverse repo from collateral providers if those securities are then pledged to the Federal Reserve under one of its programs.
This does not put an additional burden on the Federal Reserve, nor would it increase costs beyond that to which the Federal Reserve is currently committed. Further, these changes would insure the orderly operation of the corporate capital markets. Investors could buy more bonds, and issuers would be able to issue debt at far more attractive interest rates.