Fed Adds Most Reserves Since 9/11 as Banks Hoard Cash

Sept. 15 (Bloomberg) — The Federal Reserve added $70 billion in reserves to the banking system, the most since the September 2001 terrorist attacks, to reverse a surge in borrowing costs sparked by the collapse of Lehman Brothers Holdings Inc.

Fed funds traded as high as 6 percent, or 4 percentage points above the central bank’s target rate for overnight loans between banks, according to ICAP Plc, the world’s largest inter- dealer broker. The margin was the greatest since Bloomberg began tracking the data in 1998. The rate dropped to as low as 0.5 percent after the Fed added the temporary reserves.

The central bank uses repurchase agreements, or repos, to buy or sell Treasury, mortgage-backed and so-called agency debt for a set period, to help maintain enough money in the system to keep overnight interest rates close to the target. They don’t signal a policy shift. Futures show traders boosted odds to 68 percent that the Fed will cut rates when policy makers meet tomorrow to offset financial market turmoil.

Demand for short-term funds “dramatically increased,” said Michael Darda, chief economist for MKM Partners LLC in Greenwich, Connecticut. “If the Fed puts enough liquidity in the system, the funds rate will come down. It may actually trade below target for a while.”

The so-called effective funds rate was 2.1 percent on Sept. 12, or 10 basis points over the target rate. The Federal Reserve Bank of New York reports daily, for the previous trading session, the effective funds rate. It is a weighted average rate of unsecured overnight lending transactions. A basis point is 0.01 percentage point.

Expanding Collateral Options

The Fed widened the collateral it accepts yesterday for loans to securities firms in an effort to help Wall Street weather Lehman’s bankruptcy.

The Fed added $50 billion in temporary reserves to the banking system when it arranged overnight repurchase agreements, or repos, at 11:50 a.m., after providing $20 billion earlier.

“It is rare that overnight operations exceed $15 billion,” Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co., wrote in a note to clients. “There is a longstanding pattern in which the funds rate falls in the afternoon, as banks scramble to unload their excess monies onto other banks, lest they get stuck with excesses earning nothing.”

SOMA Lending

When the Fed added the reserves at 9:40 a.m., federal funds, the overnight lending rate between U.S. banks, traded at 4.25 percent, above the central bank’s target rate, according to ICAP. The rate was at 6 percent at the time of the second open market operation. Fed funds opened at 3.5 percent today.

A total of $5 billion in repos matures today. Wrightson, an ICAP research unit specializing in U.S. government finance, had expected the Fed to add about $15 billion in repos. Dealers submitted $270.1 billion in bids for the repurchase agreements.

Fed funds’ weighted average was 2.1 percent on Sept. 12 after trading between 1.75 percent and 2.9375 percent, according to the central bank.

The Fed also accepted $25.8 billion in collateral as part of its daily System Open Market Account, or SOMA, securities lending program, the largest amount this year, according to Fed data tracked by Stone & McCarthy Research. Dealers submitted $29.8 billion in bids.

The Fed offers specific Treasury securities held by SOMA for loan to dealers against Treasury general collateral on an overnight basis. Dealers bid in a multiple-price auction held every day at noon. The securities lending program is separate from the Fed’s Term Securities Lending Facility, or TSLF, one of the three liquidity measures the Fed initiated since the credit crisis ensued last year.

The TSLF offers Treasury general collateral held by SOMA for maturities longer than overnight in a single-price auctions with dealers who program-eligible collateral.

Bloomberg | Liz Capo McCormick | Monday, September 15, 2008