MNI EXCLUSIVE: Moral Hazard A Risk For Fed's Standing Repo

By Evan Ryser

     SAN DIEGO (MNI) - The Federal Reserve remains uncertain about the

practicalities of how to implement a standing repo facility, which it has

identified as a possible mechanism for keeping control of short-term interest

rates but which some officials fear might prompt moral hazard and feed balance

sheet volatility at the central bank, current and former officials told MNI

     Concerns include the danger that some institutions could take on excessive

liquidity risk in the knowledge that the Fed could provide funds if necessary,

said former Fed Board senior special adviser William English. Policymakers must

also decide parameters for who can access the facility, as well as its rate and

collateral requirements.

     "If you want to have a small footprint then you say just primary dealers,

just Treasuries, and a high rate," English, now a professor at the Yale School

of Management, said in an interview on the sidelines of the American Economic

Association's annual conference. "But if you want to have a greater chance to be

more effective then you may want to include banks, may want to have a lower

rate, and may even want to accept a wider range of collateral."

     "These are really hard decisions for the Fed."

     English likened the discussion, ongoing for close to a year but made more

urgent by the September repo market spikes and the Fed's subsequent

half-trillion dollar liquidity injections, to the 2014 debate over use of an

overnight reverse repo facility,

     "There certainly was a sense, for a lot of them, they didn't want to be too

big a player, or play too big a role, in the operation of the repo market,"

English said, "That is probably still true with a standing repo facility."

     "There is a lot of ambivalence."

     --COST-BENEFIT ANALYSIS

     If the Fed were to finally decide not to establish such a mechanism, which

would allow it step in whenever needed to supply banks with reserves, then it

would consider operating with a larger amount of reserves and also stand ready

to intervene temporarily to add reserves if needed, English said.

     Cost-benefit analysis regarding a potential facility continues, said

another source familiar with the matter, who asked not to be identified. Chair

Jerome Powell told the post-FOMC press conference in December that a standing

repo facility would "take some time to evaluate."

     Dallas Fed President Rob Kaplan said last week that he had not yet come to

a conclusion on a facility, but that his "objective for policy should be that we

have the smallest possible balance sheet in an ample reserves regime."

     Meanwhile, Chicago Fed President Charles Evans said on Friday the Fed

"could decide to make a judgement to put a standing facility in place" but

decisions have not been made on the offer rate. Former Fed Bank of New York's

President Bill Dudley on Monday spoke in favor of a facility, which should be

open to a broad set of counterparties and accept Treasury and agency

mortgaged-backed securities as collateral.

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]