Thank you very much. Are there questions for the staff? Okay. If there are no questions, I would like to make a couple of comments, just giving you my impression of this work, and then I would like to ask for a go-round and have people comment on the proposals. There are really two proposals: There is a TAF, term auction facility, and then there is a swap. Obviously, they are complementary as well.
Brian was correct when he said that this is not primarily a liquidity issue we have; it is a credit and valuation issue. But we have all been following the markets, of course, and I do believe that liquidity is playing a role in the pressures that we are currently seeing. In particular, the normal providers of liquidity—such as banks, as Bill Dudley pointed out, but also money market mutual funds (we see what is happening to the Florida state fund), other relatively unsophisticated funds, or funds that are driven by retail investors—have withdrawn significantly from these markets. The result is that getting funding, particularly term funding, has become quite difficult.
This has, I think, important costs. The fact that it is very hard to get funding more than overnight creates a lot of uncertainty and risk around the funding process. We are seeing elevated rates like LIBOR, which in turn is a reference rate that affects other contracts. Perhaps most important, if funding rates remain elevated, the risk of fire sales increases with knock-on effects in the rest of the system. Of course, as always, in proposing liquidity measures there are the usual moral hazard issues and so on. In my view, at this point, the imperative of trying to help markets function more normally and, therefore, support normal economic functioning is the stronger.
As the staff described, we looked at a number of options for addressing this problem. One set of options relates to somehow expanding or extending the discount window—lowering the primary credit rate, for example. The fundamental issue there is that it is very hard to know how far to lower the rate. If you don’t lower it far enough, you don’t get any borrowers. If you lower it too much, you may get too many in the sense that a large amount of unplanned or unexpected borrowing creates significant problems for the Desk’s management of the federal funds rate. So to hope to achieve a significant scale, we need some method that will help us plan and give us some warning, some advance knowledge, of how much credit is likely to be extended. One possibility, incidentally, would be to use the discount window but to require advance notice or put other restrictions on the amount borrowed. We thought about that, but in the end, once the discount window is hedged about by all kinds of restrictions, it is not obvious that it is better than just going ahead and auctioning credit.
So I do think, after much discussion with staff and colleagues, that the term auction facility is probably our best hope to try to improve, at least on the margin, the liquidity situation. By construction, it will lead to a predictable amount of lending. We know what the limit will be as we set up an auction, and we can take the view that, if in fact we are undersubscribed, that we will plan to use regular term repo operations to make up the difference. And so, again, we will have good knowledge of how much to account for. The question of the stigma is basically unknowable, but the fact that the reservation price will be low suggests that some banks may be able to justify coming to this auction facility as an economic measure and perhaps will reduce the stigma, although I certainly can’t guarantee that. We would announce this as a temporary measure. However, I would point out that other central banks do have facilities that are similar to this one. It may be, depending how well this works, that we may wish to make it a more normal part of our tool kit. If we were to do that, we would go out for comment and get the public’s reaction, but this does have the advantage that we can either keep it or take it back; or if it is particularly successful and demand is high, we can also scale it up because, again, if we can forecast the borrowing, we can account for that in our monetary policy implementation.
Let me say a couple of words about the international aspect of this. With all of the work that we did—and I should say that the Reserve Banks were extremely helpful in the feedback and in doing some practice runs and analysis—I think we made the proposal a lot better from the last time we talked about it. But we have been talking about it strictly in terms of a domestic operation. You may recall that the last time we discussed this possibility we were considering a joint operation with the ECB and perhaps also with the Swiss National Bank. There is a problem with dollar funding in Europe. There is a shortage of dollars there early in the day, which often leads the funds rate to open high. It creates problems for our monetary policy implementation. It creates problems in other markets, like the foreign exchange swap market. We have believed for some time that it would be helpful if the ECB would enter a swap agreement with us to use the dollars to address some of those needs. They were unwilling to do that except in the context of some kind of broader operation, and they were willing, therefore, to do this joint operation that we described at the earlier meeting. For both technical and optical reasons, we are not proposing to include any other central banks in this auction. This would be a U.S.-only operation. However, as we went around and we informed other central banks about what we were planning, the ECB, which met today, came back to us and said that, even though they wouldn’t be part of the auction, they would be interested in a swap arrangement that would give them dollars as part of this overall effort to try to improve liquidity in dollar term funding markets.
I think this is a positive step. Again, it would not create any significant operational problems for us. I think it would have greater impact in the marketplace, and so I would support that as well. We may also hear from the Swiss National Bank. We may have the Bank of England announce separately some sterling operations, which would be unrelated; but by announcing at the same time, we would be essentially conveying to the market that the major central banks are in communication and that we are working together to try to address some of these problems. This may not work. I don’t want to oversell it. We may not get a full bid. The amount may be too small to affect the markets. But I do think it is worth trying. I think it will send a good signal, and particularly I think the international cooperation aspect of this would be well received. But I don’t know for sure. If we do it, we are just going to have to give it a try and see what happens.
Have you been taking names, Ms. Danker? Let’s start with President Hoenig.