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FDIC Takes Aim at Bank Arbitrage Profits

Photo: iStockphoto

The Wall Street Journal reports that a recent rule change as part of the Dodd-Frank bill has led to a shortage of Treasurys available in the last few days. An FDIC rule that went into effect April 1 has made it more expensive for banks to participate in the overnight repo market, where they post Treasurys as collateral in order to borrow short-term.
By last Friday, some $40 billion of Treasury collateral was pulled from the market, leading to a shortage so severe that on Monday, some investors desperate for Treasurys actually accepted negative yields, meaning they paid banks to take their money.
The FDIC has since defended its action, saying the new fee on banks will in the long-term have a positive impact on the credit markets. In a statement it released on Tuesday, the FDIC appeared to be targeting the elimination of overnight arbitrage as a primary motive for the change: “A direct effect of the new assessment base is a reduction in arbitrage profits for a few large banks, profits that do little to help the real economy,” said the FDIC in the statement. “This change may have a positive impact on credit availability as resources are directed elsewhere.”
The overnight arbitrage game is relatively simple, and risk-free. Big banks borrow in the Fed funds market, posting Treasurys as collateral, and then deposit that cash with the Federal Reserve over night, earning a few basis points. The Financial Times estimates that since late 2008, overnight arbitrage may have earned banks as much as $200 million in profits.