November 25, 2009 / 9:15 PM / 10 years ago

Fed told rule change could help with exit: source

NEW YORK (Reuters) - A handful of banks have told the Federal Reserve they could do more to support the central bank’s exit from its emergency cash infusions if a key accounting rule was changed, according to a person familiar with the situation.

The Federal Reserve building is seen with the Washington Monument and U.S. Capitol in the background in Washington November 24, 2009. REUTERS/Yuri Gripas

At issue are reverse repurchase agreements, a cash-draining tool, that the banks said could be used to a greater extent when the time comes if dealers did not have to record them on their balance sheets when they act as middle-men, the source said.

In its efforts to help the economy recover from a severe recession, the Fed cut interest rates to near zero last December, and this year further eased financial conditions by buying longer-term Treasuries and mortgage-related securities. The Fed’s balance sheet has more than doubled to $2 trillion in the process.

No decision has been made on what tools the Fed will use and in what order to eventually tighten monetary policy once the recovery picks up steam.

Reverse repurchase agreements are one option, but given the scale at which they might be needed, the Fed has said it could go beyond its usual primary dealer partners to tap cash-rich money market mutual funds.

In a reverse repo, the Fed sells assets for cash with an agreement to buy them back at a later date, thus draining extra cash from the system.

Dealers told the Fed they could play a bigger role as middle-men between the Fed and money market mutual funds if they didn’t have to record the assets in the reverse repo transactions on their balance sheets and could “net” them instead, the source said.

An accounting rule change that would enable dealers to net their positions would mean the dealers could be intermediaries on reverse repo trades without incurring the costs of having to hold additional capital against a bigger balance sheet, the source said.

A precedent for this is the netting of positions used between dealers in the Fixed Income Clearing Corp (FICC), but with money market mutual funds and the Fed on either side of the transaction, the source said.

If dealers act as middle-men between the Fed and money market mutual funds they would be expanding their balance sheets for little benefit, the source said.

“All the dealer community receives is a big balance sheet consequence,” the source said.

“And that is why dealers have made the point to the Fed that encouraging large balance sheet charges without positive economics will not serve as a strong foundation for a successful program.”

Any accounting rule change would have to be made by the accounting standard setter, the Financial Accounting Standards Board (FASB). The Securities and Exchange Commission can also provide accounting guidance.

A FASB spokesman said board was “unaware of any current accounting issues pertaining to repos”; the SEC was not immediately available for comment. The New York Federal Reserve Bank — the Fed’s operational arm on Wall Street — declined to comment.

Accounting rules would require banks to record assets on their balance sheets when they act as go-betweens if they take on credit risk in a transaction.

Direct reverse repurchase transactions between the Fed and money market mutual funds would likely prove more difficult than using dealers as intermediaries, because the Fed does not have existing relationships with these funds — and thus would have to craft new documentation, the source said.

The New York Fed said in a statement in October that it has been testing the mechanics of conducting tri-party reverse repos.

However, the New York Fed stressed that just because it was conducting tests to have its toolkit ready when needed, it didn’t mean it was about to use it.

Additional reporting by Rachelle Younglai in Washington; Editing by Leslie Adler

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