WASHINGTON (MNI) – The following are is the first part of excerpts
from the speech by Brian Sack, executive vice president of the New York
Federal Reserve, in Philadelphia Wednesday on the Fed’s asset purchase

Implementing Treasury Purchase Operations

A good place to start is with the distinction between the roles of
the FOMC and the Desk. The FOMC is responsible for making monetary
policy decisions, while the Desk is responsible for implementing those
policy actions on behalf of the FOMC. Thus, decisions about the broad
parameters of any asset purchase program, including the amount of
securities to be purchased and the duration of those securities, reside
with the FOMC, as those are the parameters that will govern the overall
impact on financial conditions and, ultimately, on the economy.

The role of the Desk is to determine how best to carry out the
purchase programs within those broad parameters. In doing so, the Desk
seeks to meet the policy intentions of the FOMC, while taking into
consideration two other objectives. The first objective is to obtain the
securities at competitive and appropriate prices for the Federal
Reserve, as doing so will ultimately benefit the U.S. taxpayer. The
second objective is to minimize any negative effects that the purchases
might have on the functioning of financial markets. As I noted in a
speech in October 2010, the liquidity and efficiency of the Treasury
market provide tremendous benefits to our economy, and the Desk was
intent on designing a purchase program that would not diminish those
benefits in any meaningful way.

To achieve these objectives, the Desk relies on a system in which
it purchases securities through reverse auctions with a set of
established counterparties called the primary dealers. The securities
that are eligible for each operation and an indication of the total size
of the operation are announced in advance. Dealers then submit offers to
sell those securities, either for their own accounts or on behalf of
their customers, over a 45-minute period on the morning of the
operation. Those offers are assessed by the Desk based on two criteria:
their proximity to market prices at that time, and an internal
methodology for comparing the relative value of the securities at the
offered prices. This process occurs over a proprietary trading system
called Fedtrade under the oversight of Desk staff, and the results are
typically finalized and published within a few minutes of the close of
the operation.

With this infrastructure, the Desk has been able to purchase large
volumes of securities in a rapid manner, as required by the policy
decisions made by the FOMC. Indeed, over the period since the FOMC’s
decision to expand the SOMA portfolio, the Desk has purchased about $300
billion of Treasury securities. That total includes about $220 billion
of purchases out of the intended $600 billion expansion of the
portfolio, and another $80 billion of purchases associated with the
reinvestment of principal payments on agency debt and mortgage-backed
securities. In terms of the monthly pace, the purchases so far have been
running at about $105 billion per month, consisting of roughly $75
billion in new investments and $30 billion of reinvestments. To meet
this pace, the Desk has been operating in the market on nearly every
available day.

The operations to date have gone well. Participation by the dealers
has been strong, with an average offer-to-cover ratio of about 3.5, and
the accepted offers have been allocated across a number of dealers and a
wide range of securities. Given the robust participation in the
operations, the Desk has received competitive and appropriate prices for
the securities obtained.

Moreover, our purchases do not appear to be causing significant
strains on the liquidity or functioning of the Treasury market. It is
unusual for the market to have such a large, persistent, and one-sided
participant, and we had to worry about how it would adjust to our
presence. However, the available evidence suggests that market liquidity
is decent at this time. Measures of liquidity, such as trading volumes,
bid-ask spreads, or quote sizes, worsened in December, but that pattern
appears to have been driven by year-end effects rather than our presence
in the market. These measures have recovered since the year-end, moving
back toward the levels observed before the start of the purchases.

In addition, we do not see signs that the market is facing unusual
scarcity of particular Treasury securities. To monitor this, we look at
the number of issues trading on special in the repo market and at the
amount and composition of the securities that the market borrows from
our securities lending facility. Both measures have increased some, but
we do not see their current levels as indicating notable strains.
Moreover, it does not appear that these patterns are more acute in
securities for which the SOMA portfolio holds a larger proportion of the

Our success at purchasing such large volumes of securities without
causing significant market strains reflects some of the operational
decisions that were made in the design of the program. One key issue was
determining an appropriate speed for purchasing assets. The pace of
purchases under the announced plan reflected a judgment by the Desk that
it could purchase as much as $100 billion to $125 billion per month
without significantly disrupting the functioning and liquidity of the
Treasury market. So far, that appears to be the case, given the evidence
just described.

Another important aspect of the operations is the flexibility in
terms of the securities that we purchase. As noted earlier, our
selection of the specific offers to accept at a given operation depends
on our assessment of their relative attractiveness. This process should
support market functioning. In particular, it allows the market to
determine which securities it is willing to sell on the most favorable
terms for us. If a particular security is scarce in the market, we will
presumably not be shown offers at attractive terms, and hence we will
not end up removing additional supply of that security.

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** Market News International Washington Bureau: 202-371-2121 **