…if banks are able to obtain 25 basis points by simply placing their funds at the Federal Reserve why would anyone be willing to lend another bank fed funds (deposits at the Fed) unsecured at less than 25 bps? The answer is actually very simple. The GSEs, consisting primarily of Fannie Mae and Freddie Mac, maintain accounts at the Federal Reserve but do not receive interest on their balances since they are not depository institutions. So Fannie Mae and Freddie Mac are the primary suppliers of funds to the banks at rates below the “floor”. Since their return on idle reserves is zero, they are willing to lend to banks at less than 25 bps while the banks are more than willing to pick up a margin on their intermediation of GSE “loans” to the Fed.
That is Peter Stella. There is more here (pdf), which leads to an interesting (but technical) discussion of how the Fed will unwind its current positions. The original pointer was from FTAlphaville blog.