In a stunning move of fiscal prudence (cough CME cough), the Federal Reserve said it will hike (not lower) margins on current coupon MBS with its 2221 Primary Dealers "in a move that would be aimed at securing an extra layer of protection against settlement risks with its counterparties" the Wall Street Journal reported. But, but, the CME lowered margins in a time of "major market upheaval" to raid said margins of 40% of all equity protect itself clients: how can the Fed do something as radical as actually protecting investors by hiking margins? Surely this is some travesty. Apparently not: the WSJ explains: "The measure would be a blow to dealers as it would raise their trading costs. But the move could provide an extra layer of protection for the Fed against the risk that a dealer bank goes belly up. That risk became apparent with the collapse of MF Global Holdings Ltd., an investment bank that until its bankruptcy filing two weeks ago was listed as a primary dealer." But, but, the CME is also exposed to lack of liquidity among its client base: shouldn't it also be hiking margins to protect everyone else, not just help itself to millions of margin dollars from orphaned onboarded MF accounts? And speaking of, is the CME still keeping initial margins low? Wasn't it just a "temporary measure" - surely all MF Global accounts have been properly raided analyzed by the CME at this point and there is nothing else to transfer over. We are confident the CME will hike initial margins any. second. now. You know: to protect everyone else and stuff.
More on why the Fed is now apparently more prudent than the Chicago exchange from WSJ:
Several people familiar with the matter said the central bank conveyed the idea during a conference call earlier Tuesday with the primary dealers—a group that trades directly with the Fed and serves as the central bank's major counterparty in monetary policy operations.
A transaction in so-called current coupon MBS, the most liquid securities in that market and the target of the Fed's policy-driven buying, is typically settled a month forward. Under this arrangement, known as a forward MBS agreement, the securities are delivered one month after the transaction takes place. That is where the counterparty risk arises for the Fed. Over that time, the value of the MBS can fluctuate and if the price were to rise, the central bank would have to pay a higher cost to replace them if a dealer failed to make delivery.
The requirement may begin next Monday, according to the people familiar with the matter. One person said the Fed may pose a 2.5% initial margin on the dollar amount of the mortgage-backed securities transactions from the dealers. That means a dealer may need to put up $25 million in cash collateral for an MBS transaction of $1 billion.
"The Federal Reserve Bank of New York informed its primary dealers today that it will require dealers to margin against their outstanding agency MBS forward transactions with the NY Fed," said a New York Fed representative in an emailed statement Tuesday afternoon. "Dealers are required to post collateral in a number of other types of operations with the NY Fed."
So the next time someone says Initial-Maintenance margin = 1 in a time of unprecedented market stress, just ask the Fed what that means, and skip the CME... At least if you want to keep your money.