Interest Rate Roundup

Friday, August 22, 2008

Bernanke focuses on strengthening the financial system's inner workings in comments today

Fed Chairman Ben Bernanke's comments at the Kansas City Fed's Annual Economic Symposium in Jackson Hole, Wyoming were recently released. The comments recap recent Fed actions, explaining why they have been taken. Not much of that part is forward looking, as near as I can tell. More of the comments are focused on strengthening the financial system's "hardware" and "software." An excerpt:

"An effective means of increasing the resilience of the financial system is to strengthen its infrastructure. For my purposes today, I want to construe "financial infrastructure" very broadly, to include not only the "hardware" components of that infrastructure -- the physical systems on which market participants rely for the quick and accurate execution, clearing, and settlement of transactions -- but also the associated "software," including the statutory, regulatory, and contractual frameworks and the business practices that govern the actions and obligations of market participants on both sides of each transaction. Of course, a robust financial infrastructure has many benefits even in normal times, including lower transactions costs and greater market liquidity. In periods of extreme stress, however, the quality of the financial infrastructure may prove critical."

Regarding some early conclusions of the Fed's research into stablity, Bernanke talks about some of the problems in the derivatives and repo markets:

'More generally, although customized derivatives contracts between sophisticated counterparties will continue to be appropriate in many situations, on the margin it appears that a migration of derivatives trading toward more-standardized instruments and the increased use of well-managed central counterparties, either linked to or independent of exchanges, could have a systemic benefit.

"The Federal Reserve and other authorities also are focusing on enhancing the resilience of the markets for triparty repurchase agreements (repos). In the triparty repo market, primary dealers and other large banks and broker-dealers obtain very large amounts of secured financing from money funds and other short-term, risk-averse investors. We are encouraging firms to improve their management of liquidity risk and to reduce over time their reliance on triparty repos for overnight financing of less-liquid forms of collateral."

Meanwhile, in the markets, we're seeing a reversal of recent trends -- swap spreads are coming in, Treasury prices are down, stocks are up, commodities are down, and the dollar is rallying. That all signals some lessening in risk aversion. All I can say is that if you're not seasick by now, you're not paying attention!


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