- The Federal Funds market: banks borrowing from banks overnight to meet their reserve requirements.
- Federal Reserve has a target
- To raise the target, it sells Treasury bills for cash--and debits the reserve accounts at the Fed of the banks that hold the money of those to whom the Fed has sold the Treasury bills; the banks are then short of cash, and scramble for reserves.
- To lower the target, it buys Treasury bills for cash--and credits the reserve accounts at the Fed of the banks that hold the money of those from whom the Fed has bought the Treasury bills; the banks are then flush with cash, and scramble to lend it out overnight.
- Individual transactions throughout the day.
- In "normal" times, a few transactions at 7% per year--you find at 4 PM that your deposits are high or that your reserves are low, and scramble to find them before closing, and pay an extra 0.02 cents on the dollar, $200 on $1 million.
- In "normal" times, a few transactions at 4%--you find at 4 PM that you are flush with reserves and hasten to lend them out.
- Since mid-August, things haven't been "normal"
- Some banks can't borrow in the Fed Funds market.
- Some banks are borrowing at 6% when the target is 3%.
- Some banks are lending at 0%.
- Spread between Fed Funds (or LIBOR) and Treasuries: up from 0.2% to 1.6% or so.
- Assume that a "liquidity event" costs you 10% of the value of whatever you loaned, unsecured, to a big bank.
- Then a spread of 0.2% between Treasury and Fed Funds means that you think that the bank you are lending to will have an inconveniencing "liquidity event" once every fifty years.
- At a spread of 1.6%, it's once every seven years. * A chance of 0.3% that Big New YorK Bank simply will not open next week...
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