The FED's recent open market operations - The Alternative Bailout

This morning the Federal Funds rate was 7%. Doesn't sound so bad, huh? Well, the problem is that the Fed Funds target is 2%. What does this mean? The cost of US banks lending to each other was 5% higher than it should be. If the spread between the actual and target rates persists, banks become very reluctant to lend to each other and to consumers. Draw this out over weeks and the flow of money (lending) will be hindered and the economy will slow down considerably (more than we want).

But the Fed has not been sitting idly by. In order to reduce the Fed Funds spread, the Fed pumped $20b into the money markets at 9:40am today. In fact, over the last 30 days, the Fed has injected $530b into the US financial system. And the problem isn't just with US banks. We are in the middle of a worsening global credit crunch, with one of the indicators being the TED spread (a measure of illiquidity).

The open market operations in which the Fed is engaging is the ongoing bailout, or aka The Alternative Bailout. Granted, we're not talking about a $700b blank check. But the Fed's operations are just as risky, if not more. The assets that the Fed purchases ARE returned to the owner and the loan IS repaid with interest to the Fed, but repayment in the current market is not a given. The assets that the Fed is now purchasing, thanks to temporary policy changes announced on 9/14, are not just Treasuries and MBS (allowed in 2007) but a broad range of asset types such as equities, junk bonds and subprime mortgage bonds.

Fed takes fresh steps to battle credit crisis (AP, 09/29/2008)
"Under one new step, the Fed will boost the amount of 84-day cash loans available to U.S. banks. The Fed is increasing the amount to $75 billion, up from the current $25 billion starting on Oct. 6. Banks bid on a slice of the loans at an auction. That move will triple the supply of 84-day loans to $225 billion, from $75 billion, the Fed said. Meanwhile, the Fed will continue to make $75 billion worth of shorter, 28-day loans available to banks. All told, the total amount of cash loans — 84-day and 28-day — available to banks will double to $300 billion from $150 billion, the Fed said. Moreover, the Fed will make a total of $620 billion available to other central banks, expanding ongoing currency "swap" arrangements with them where dollars are traded for their currencies. That's up from $290 billion previously in such arrangements."

The Fed's balance sheet is $800b, which leaves approx. $200b in lending ability. This is not a good debt-to-high credit limit ratio.

I don't think we have much leftover for Hedge Funds.