The latest edition of the Federal Reserve Bank of New York’s Current Issues in Economics and Finance, Alternative Arrangements for the Distribution of Intraday Liquidity, is available.
Author James J. McAndrews examines alternative funding arrangements that would enable government-sponsored enterprises (GSEs) to efficiently meet their payment obligations to investors once the Federal Reserve ends its provision of free daylight credit to the GSEs on July 20, 2006.
As part of its role in the nation’s payments system, the Fed processes the principal and interest (P&I) payments made through banks to investors in GSE-sponsored debt- and mortgage-backed securities, payments that average $30 billion a day and on some days can go significantly higher. Two years ago, the Board of Governors of the Federal Reserve System announced its new policy to process the GSEs’ P&I payments only when the issuers’ Federal Reserve accounts contain sufficient funds to cover these payments. Thus, the Fed will no longer continue its practice of advancing funds to the GSEs at the start of the day.
Noting that the private sector has been given a two-year interval to prepare for this change, McAndrews reviews a number of alternative arrangements by which the private sector could meet the GSEs’ need for funds early in the day, including the potential use of lines of credit, early-return fed funds and repurchase agreements.
The author anticipates that the elimination of the Fed’s early-morning extension of credit to the GSEs will require some changes in the pattern of payments. He suggests that the speed of payments on Fedwire® may be somewhat slower as the GSEs, seeking to finance their principal and interest payments, reckon with the costs of obtaining funds from commercial banks earlier in the day than they currently do.
McAndrews proposes a test of the efficiency of the alternative funding arrangements as Fedwire® participants adapt to the new policy. He suggests that if the speed of payments made on Fedwire® is the same on days of high GSE P&I payments as on days of low GSE P&I payments, the market will have adapted well to the policy change.
James J. McAndrews is a vice president in the Payments Studies Function of the Bank’s Research and Statistics Group.