Concerned that overnight interest rates could soar late this year because of fears in the financial markets of potential year-end computer glitches, the New York Federal Reserve Bank today announced a series of actions it hopes will help keep rates under control.
One step, affecting mortgage-backed securities issued by government-sponsored agencies such as Fannie Mae, could help head off a potential spike in mortgage rates.
A number of financial analysts said the changes would help the markets function more smoothly as the new year approaches. Meanwhile, the announcement had an immediate impact on some types of securities that mature in December or January. In one instance, the interest rate on a type of contract committing someone to make money available in December fell by more than a quarter of a percentage point, which underscored the level of apprehension in the market.
"This is a doozy," said F. Ward McCarthy of Stone & McCarthy Research Associates, a financial-markets research firm. "The Fed is pulling out all the stops to both calm market anxieties and provide the . . . tools necessary to allow the money markets to continue to function through the fourth quarter and early 2000."
Overnight rates often shoot up at the end of a year as many major banks, brokerages and investment-banking firms seek to improve the look of their balance sheets by shedding even modestly risky assets. This year, with all the concern about potential year-end computer problems, the pressures could be enormous, though no one is sure that will happen.
Market conditions could prove to be a headache even for the New York Fed, which is responsible for keeping overnight rates close to the target set by the central bank's policymakers as part of their effort to keep the U.S. economy on a stable path.
The New York Fed tries to hit the chosen target for the federal funds rate--the interest rate financial institutions charge one another on overnight loans--by adding and subtracting cash from the U.S. banking system virtually on a daily basis. Its most frequent action is to add cash by lending money to 30 large financial firms known as primary dealers. As collateral, the companies typically give the New York Fed U.S. Treasury securities to hold until the loan has been repaid.
But when the calendars in computers around the world turn over from "99" to "00" on Jan. 1, some older ones may treat the new date as 1900 instead of 2000 and fail to operate properly.
The impact of the year 2000, or "Y2K," problem on financial markets later this year is hard to predict. But to reduce the possibility of losses that might occur if something goes wrong, many large firms have already borrowed or arranged to borrow large amounts of money so that they won't need to do so later this year.
With so many financing arrangements already being wrapped up, and many financial market participants shying away from anything that looks risky, there is concern that markets won't function normally in December. For instance, there could be a shortage of Treasury securities available for use as collateral in the New York Fed's daily interventions in the money market.
At a news conference this morning, Peter Fisher, the bank's executive vice president in charge of those operations, said Fed policymakers voted at an Aug. 24 meeting to expand the list of acceptable collateral to head off a shortage. For the first time, he said, the mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac--all government-sponsored agencies that help finance the nation's mortgage market--will be eligible. Other types of collateral also have been added to the list.
In addition, to help ensure that cash will be readily available in private financial markets, Fisher said the Fed will auction option contracts to the primary dealers that will give the firms the right to call on the Fed to provide them with loans, in exchange for collateral, even if the Fed wouldn't be doing so to meet its own needs. The interest rate charged on such loans would be at least 1.5 percentage points higher than the federal funds target, currently 5.25 percent.
The Fed earlier announced a separate financing facility though which financial institutions can borrow money for extended periods to meet any unusual customer needs for cash. The interest rate on those loans would also be 1.5 percentage points above the target for the funds rate.
"Our objective here is to assure the dealers that financing will be available so they can meet the needs of their own customers," Fisher said.
"The best outcome is that we provide this kind of backup insurance, and the dealers don't need it," Fisher said. And he emphasized, "We are doing this in part to make sure our own operations go smoothly."