By Steven K. Beckner

CHATHAM, Mass. (MNI) - Federal Reserve Vice Chairman Donald Kohn said Thursday that prices of mortgage-backed securities are likely to fall when the Fed eventually begins selling MBS from its portfolio.

He gave no indication when that might be.

But Kohn, echoing earlier comments by New York Federal Reserve Bank President William Dudley, said the Fed may well avoid any losses on its asset holdings, as well as on its liquidity facilities.

"These programs may be unwound without loss," Kohn said, commenting from the audience at a Boston Federal Reserve Bank conference. He said the Fed entered the market "when prices were depressed by high premiums" and so "the Fed could finance without risk." That in turn will mean they can be "unwound without loss."

Kohn said that "the announcement was more important than the actual amounts" in terms of the impact of Fed credit easing programs, including its MBS purchases.

"We can have an effect there (in MBS) when markets are disruptive and premiums are high," he said. "We can affect prices in a crisis type situation."

Asked if this implied that the Fed could sell MBS without depressing their prices, Kohn acknowledged that selling "would drive down prices obviously," adding, "If (we) were to start selling them, prices would move right away."

But Kohn said "if we could sell at current market prices, there wouldn't be losses" for the Fed.

Dudley, who was moderating a panel that included former top New York Fed staffer Peter Fisher and a senior European Central Bank official, observed that the Fed's liquidity facilities are declining sharply and as intended. And he too said the Fed may well end up with no credit losses on its various liquidity facilities.

Fed credit outstanding in its various liquidity facilities has fallen from more than $1.6 trillion to $260 billion, noted Dudley, who did not talk about offsetting increases in longer-term Fed asset holdings.

The facilities, such as the Term Auction Facility (TAF) and the Primary Dealer Credit Facility (PDCF), are "running off very naturally, which was part of their design," he said.

Dudley said the Fed "may ultimately avoid any losses on the facilities."

He called it "serendipity" that, in doing the work needed to finance the takeover of Bear-Stearns, also did the necessary preparatory work for other non-banking institutions to borrow from the Fed through the PDCF.

Otherwise, he said the Fed "would have had difficulty" getting the PDCF ready in time to help other firms.

It was a point echoed by Peter Fisher, former head of the New York Fed's open market trading desk and also former undersecretary of Treasury. "Had (the PDCF) not already been set up, the events of September would have been much worse" -- an obvious reference to the panic that ensued after the Fed let Lehman Brothers fall last year.

Looking ahead, Fisher said the Fed and Congress are "going to have to rewrite the boundary for what is 'unusual and exigent'" -- the criteria for Fed lending to firms outside the banking industry. He said it will need to be determined who can borrow from the Fed and against what collateral.

"You can't go home again" in terms of going back to limiting Fed lending to depository institutions, said Fisher. "You've driven a fleet of Mack trucks through 13(3)" -- the section of the Federal Reserve Act which allows the Fed to lend to non-banks in an emergency that went virtually unused from 1933 until last year. "You can't go back."

Fisher, now managing director of BlackRock Inc., said the Fed lost its "bluff" that it would not lend to investment banks and said that in future all firms with "actively managed balance sheets," including securities firms, need to have access to the discount window. Money market funds should not have access, though, he said.

Fisher also advised the Fed, "you'd better keep the TAF going for awhile."

Francesco Papadia, chairman of the ECB's Foreign Exchange and Monetary Market Contact Group, noted that the ECB has always had a "broad" lending approach to different kinds of firms and said that it is not necessary to decide who can borrow and against what kind of collateral if the Fed broadens its lending scope. He said different "haircuts" (reductions in value) can simply be applied to different kinds of collateral.

Bank of America chief economist Mickey Levy told Dudley the Fed's liquidity facilities have been successful so far but need to be "measured a few years from now when you get to an exit strategy." To which Dudley responded, "I agree. Until we're done, it's incomplete."

** Market News International **

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