The Federal Reserve has taken an unusual step this week. To my knowledge the action is without precedent. There was no prior announcement or discussion preceding the new measures. By itself, this is atypical for Bernanke's Fed. Ben doesn't like to surprise markets. He did this time (I'm sure he personally approved the move). Some details and thoughts on what it might mean.


For years the NY Fed has conducted "Dollar Rolls" of MBS securities with the Primary Dealers. These transactions provide liquidity to the MBS market. The Fed's description:


Still confused? So am I. My conclusion is that this is benign. The Fed is just providing order and a degree of predictability to an important capital market. I also don't know how much of this is going on. This Reuters article suggests that it is a Trillion dollar market. (Would love some help on the #s?)

Why would the Fed establish a new margin requirement on something that has been going on fine without one for years? Why now? The answer is easy. It's the fallout from MFG.



The Federal Reserve said it will be increasing collateral requirements on 21 primary-dealer banks in transactions dealing with mortgage-backed securities, in a move that would be aimed at securing an extra layer of protection against settlement risks with its counter parties.

Random thoughts:

* What kind of message does this send? (It was communicated to the PDs via a conference call!) It sends a very mixed message in my direction. Essentially the Fed is saying, "We're not so sure we can trust all of you". Of course this position is justified given that MFG (an ex PD) went into the tank in a matter of days.


We've looked very close. MFG was the only bad apple. It won't happen again. We're comfortable with our counter party risk. No need for changes in margins or haircuts.

But they didn't say that. In fact they have said/done quite the opposite. So to me, it sends an ominous message.



* I don't think this is all that profitable of a business for the PDs. It's just part of the grind of financing Agency MBS paper. This is a slap in the face of the PDs.


*I'm making a big deal of this. I think it may prove to be important. Anytime that the Fed does something unanticipated it's worth noting. There is always something more than meets the eye. The timing is odd. The optics are terrible. The Fed is making credit harder to get (very big numbers involved in MBS land) at what may prove to be exactly the worst moment.
