Results of the TAF Expose True State of the Money Markets

The Fed posted the results of the Term Auction Facility, the 28-day term loan it offered to dealers today. The stop-out rate was 2.87%. Eighty-three bidders submitted a total of $88 billion in bids for the $50 billion in loans awarded. Demand continues to exist for financing from the Fed for unwanted collateral, as the rate is significantly higher than the fed funds target of 2.25%. However, the results were about 2.5 basis points lower than one-month libor, which is currently at 2.895%. This indicates that dealers consider trading with the Fed a privilege rather than a stigma. Although conditions in the credit markets have improved significantly in the past month, as evidenced by a reduction in swap spreads, the persistently high spread between libor and fed funds points to significant fears of hidden credit problems that have yet to be exposed. If banks were not afraid to lend money, they would be closing the gap between libor and fed funds by putting on massive arbitrage positions. If you told a bank a year ago that it could borrow at 2.25% and lend at 2.90% short-term, without taking any interest rate risk, it would've responded with "How many trillions of times can I do that trade?" These types of anomalies have never existed for such a prolonged period of time. It's just too juicy of a trade to go unexploited. So what is the story behind the persistence of this wide spread? I can only hazard a guess: Banks are still very nervous about the next shoe to drop.