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"Haircuts"

While newly instituted collateral values are generous for International Agency, Student Loan,
Municipal Bonds, Corporate Bonds, and Money Market Instruments, they are quite low for
Treasuries, Agencies, and all types of Mortgage Backed Securities. It is particularly of note that
the Treasury will not take its own paper at 100% of market value, a practice normally followed
by the repo market.

If repo customers demand more margin than market, the rate is sometimes adjusted to reflect that
fact. The same should be true of TT&L deposits, particularly since both the existing and
proposed arrangements require banks to keep excess collateral to allow for deposits coming in on
any given day as well as the collateral margin.

Rate of Interest

Calculation of Overnight Repurchase Agreement Rate

It would be important to include the portion of the repo market that consists of transactions of $1
million and less in the rate calculation, since a fairly large portion of TT&L payments are in this
category. Typically, those transactions earn a rate at least 25 to 50 basis points less than that paid
to competitively traded investments. If the repo rate calculation used by the Federal Reserve
Bank of New York mirrors the Fed funds calculation, none of the small, low rate transactions
will be included in the calculation. The dealers that I surveyed in preparing this do not want a
daily repo rate published by the Federal Reserve Bank because they think their customers
receiving 25 to 50 basis points under the market will want to know why they're not being paid
Fed New York's repo rate.

In fairness to the banks, the size of an average TT&L transaction more closely mirrors the size of
the smaller, direct repo trades, which is one reason to ensure that they are included in the
average. Whether or not these smaller transactions are included would have an impact on the
rate and on the willingness of banks to continue in the program.

Other Rate Considerations

If this change is instituted as proposed and the rate calculation is as indicated, there will be no
reason for large institutions currently using Treasuries, agencies or mortgage-backed securities as
collateral to continue keeping TT&L balances, since banks could finance these securities more
cheaply in the repo or Fed funds markets. This is particularly true if the institution has good
traders; pegging funding to an average cost is less attractive to institutions whose traders can beat
the average. The additional haircut, excess collateral required for TT&L balances, and
operational inefficiencies involved in maintaining collateral pledged to a ceiling level plus daily
float will ensure that any reasonable institution will no longer accept substantial Treasury
deposits.

Other Solutions
If the Treasury wants the advantage of the higher rate, it should hire traders to invest the majority


of the Treasury's funds in the repo market and eliminate a large portion of the existing TT&L
arrangement. Banks and dealers could deliver securities to the U.S. Treasury's account at Fed
New York. Standard market haircuts could be used. This process would pass on not just the
higher rate to the Treasury, but also the cost of doing the transaction, which is currently borne by
the banks, and any fail and credit risk. The practice of refusing to take securities that were
reversed in by the counterparty should disappear, as well. A small portion of the existing TT&L
program, that for "A" and "B" banks and up to a limited ceiling for "C" banks, might be left
intact.

Conclusion

This institution is currently a note option bank with a ceiling of $650,000,000 and ranks in the
top 10 banks in its Fed district for accepting TT&L deposits. We would drop the ceiling to
$25,000,000 under the new proposal. Under current conditions, we have little interest in the
fixed maturity proposal. That aspect of the proposal might be viewed slightly more favorably
under different market conditions.