May 24, 2011 / 2:26 PM / 8 years ago

Fed to widen counterparty list for exit strategy

NEW YORK (Reuters) - The Federal Reserve is looking to add another group of big players to round out its roster of counterparties that will participate in its exit strategy when it is ready to end its ultra-loose monetary policy.

A guard stands at the door for the Federal Reserve Bank in New York, May 2, 2011. REUTERS/Brendan McDermid

On Tuesday, the Federal Reserve Bank of New York laid out the criteria for Fannie Mae, Freddie Mac and other government-sponsored entities, or GSEs, to become counterparties it could tap to help drain the $1.5 trillion in excess reserves from the banking system.

The Fed, through reverse repurchase agreements — known as reverse repos — with GSEs, primary dealers and money market funds, could remove some of the excess reserves by exchanging them for Treasuries it owns.

Tuesday’s announcement is not a signal on the timing of the central bank’s move to tighten policy. But it is seen as one of the last steps for the Fed to prepare reverse repos as part of an exit strategy that paves the way for an increase in the federal funds rate sometime next year.

“The Fed has established a deep bullpen with nearly three dozen counterparties. The reverse repos will be beneficial in draining liquidity due to the ongoing demand,” said Sean Simko, senior portfolio manager at SEI Investments Co in Oaks, Pennsylvania.

The inclusion of GSES, in particular Fannie Mae and Freddie Mac, would also help stabilize the federal funds rate, which the Fed would look to increase whenever it tightens policy.

The possible role of Fannie and Freddie in the Fed’s exit strategy comes at a time when lawmakers are looking for ways to reduce the firms’ role in the $10.5 trillion U.S. home loan market.

The federal government took control of Fannie and Freddie in September 2008 due to growing losses from the housing bust and the ensuing credit crisis. It has spent billions to cover the losses from bad loans on their books.

“The question of appropriateness not only has to do with solvency but also public policy that is still on the table and is still undecided,” said Joseph Mason, a professor at Louisiana State University in Baton Rouge, Louisiana, and a principal at Navigant Economics.


Fannie Mae and Freddie Mac have been heavy lenders of overnight loans in the fed funds market, often at levels at the low end of Fed’s current zero to 0.25 percent target range.

Unlike banks, the two mortgage finance giants are not eligible to deposit cash with the Fed and earn interest.

If the two companies were to engage in large-scale reverse repos with the Fed, this would help to bring the fed funds rate closer to where the Fed wants it to be, analysts said.

Stone & McCarthy Research Associates said the inclusion of Fannie Mae and Freddie Mac would enable the Fed to do another $100 billion to $150 billion in reverse repos a day.

Other GSEs such as Farmer Mac are not big enough to meet the Fed’s counterparty requirements, while the Federal Home Loan Bank system is not seen as an active lender in the fed funds market.

The Fed can conduct $50 billion to $100 billion in reverse repos with primary dealers and $500 billion with money market funds, according to the firm.

The New York Fed on Monday added 32 new money market funds to its roster of counterparties. The new funds include the Federated Capital Reserves Fund, BofA Treasury Reserves and the JPMorgan Liquid Assets Money Market Fund.

Fannie Mae, Freddie Mac and other GSEs must apply with the New York Fed by June 3 to become an eligible reverse repo counterparty.

Freddie Mac spokesman Mike Cosgrove declined to comment, while a Fannie Mae spokesman contacted by Reuters could not immediately comment.

(For the current list of eligible reverse repo counterparties, see: here)

Editing by Dan Grebler and Leslie Adler

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