>
> (email exchange)
>
> On Wed, Feb 24, 2010 at 10:37 AM, wrote:
>
> It’s not worthy of any comment, other than to show that even the Fed doesn’t
> understand its own operations:
>
“These constraints will discourage institutions from lending their reserve balances as they continue to work to stabilize their operations.”
>
> Banks don’t lend from their reserve balances. That’s a fact. How can you take someone
> seriously when they get an elementary fact like that wrong? Banks DO NOT use reserve
> balances to create loans. They create loans and deposits simultaneously out of thin
> air. They use reserve balances to settle payments or meet reserve requirements ONLY.
> If a bank is short reserve balances for either of these purposes, the Fed provides an
> overdraft AUTOMATICALLY at a stated penalty rate, which the bank then clears via the
> money markets or the cheapest alternative. Whether banks in the aggregate hold $1 or
> $1 trillion in reserve balances, there operational ability to create loans is the
> same . . . infinite! (Though the creation of even 1 loan requires a willing,
> credit-worthy borrow in the first place, of course.)
>
Anybody know why they’re doing this:
http://www.ustreas.gov/press/releases/tg560.htm
What is the difference between this program and term deposits at the fed?
The term deposit program is prospective.
This program is the one they started with at the beginning of the crisis. It’s a second Treasury account at the Fed, whereby bills are issued to move bank reserves into this account.
My guess is they’re reactivating it to mop up any additional reserves created by what’s left of the MBS purchase program. In that case, it shows their heightened sensitivity to the market’s perception of further increases in excess reserves. As pointed out in this post, that’s a misdirected concern.
JKH,
Ive been
following the progress of the MBS purchases. the FRBNY has purhased 1.2T MBS but the H.4.1 only shows 1T on the books (200B diff). At first I thought that this difference was due to lengthy settlements for the trades, but lately Im starting to think that the MBS are being prepaid to the Fed(Saw FNMA CPR report of 23 last summer which I think means 23% of the component mortgages in the MBS should be prepaid within a year). So the Fed bought 1.2 with new reserves but has only 1 on its balance sheet, could this be related? It would seem that if the Fed was prepaid a mortgage balance, it would be a reserve drain, but usually the mortgage is re-financed. and also the GSEs are involved so Im having a hard time running this through…
Matt,
See comment by ‘jck’ (no relation) here:
http://www.econbrowser.com/archives/2010/02/treasury_supple.html
JKH, Thanks,
Looks like the 200B difference is a bit of both (prepayments & delayed settlements). 100B+ of pending MBS settlements, you know last year in March, they settled if I recall like 170B in one weeks reporting period (who knows maybe in one day) and the 10yr had the largest one day rally since 1960 or something. Maybe they dont want that kind of volitility and are being proactive by removing some before the lumpy MBS settlements come rushing in. Of course they could just not buy the MBS in the first place but they want to support the mortgage market as a separate policy and have committed to 1.250T. You know Bernanke said in his testimony yesterday that they would end up with the full 1.250T of MBS on their balance sheet, maybe he doesnt know about prepayments in MBS? they are used to treasuries at the Fed ie they are not “callable”…
I should have been more direct in my phrasing.
If they are using this to mop up reserves and using term loans, how is this qualitatively different than a term loan facility?
The fed issues some term paper that only banks can access, directed at “excess” reserves.
I am asking this question as I am only now learning the jargon – so it is a serious question, and not rhetorical.
Do you mean term deposits issued by the Fed? Or are you referring to assets on the Fed’s balance sheet, like the Term Auction Credit or Term ABS Loan Facility?
You seem to answer your own question, but:
There is a difference.
Term deposits will be restricted to use as a substitution device by banks. Banks will switch excess reserves at a floating rate IOR to term deposits at a fixed rate. Bank balance sheet levels stay the same as there’s no interaction with non-bank deposits.
Treasury bill issuance and redeposit at the government’s supplementary Fed account will drain both reserves and deposit liabilities if bills are sold to the non-bank public.
But the reason probably doesn’t relate to that difference. They haven’t started to use term deposits yet and maybe they don’t want to send the wrong signal about the timing of “tightening” by using them now.
Perhaps I don’t understand your exact question.
It seems they are preparing to raise interest rates. The reason I say this is because the current system doesn’t pay all participants an interest on excess reserves. That’s why they’ve been having so much trouble meeting their target fed funds rate with just the interest paid on reserve balances. Also consider the average maturity of the Fed’s US-Treasury portfolio has significantly increased from what it used to be in “normal” times. Even if the Fed sells all its US Treasuries, it won’t be enough to mop up all the excess reserves.
So, the only way they know how to raise rates is to mop up excess reserves by using the Treasury Supplementary Financing Account to absorb excess reserve funds. What they should do is change the rules on who is eligible to receive interest on excess reserves.
Zaid,
So who isn’t eligible for the IOR? Could the Fed change the eligibility rules unilaterally, or will Congress have to amend the law? FInally, and a bit off point, for Tsy to overdraft its reserve account, would that also require a new Fed regulation and/or Act of Congress?
Hi Beowulf,
Depository institutions like commercial banks, credit unions, etc are eligible. Other institutions like GSEs, Federal Home Loan Banks, etc are not.
As far as I know, overdraft powers have not been granted, but there is nothing operationally to prevent them from doing so. The near zero funds in the US Treasury General Account is not an issue because the US government also has claims on reserve balances that are transferred into its account at the Fed as needed. And these initial funds are all that is needed to begin the cycle of government spending creating the funds used to purchase government debt.
On your second question, they can probably do it unilaterally as they have done with their decision to pay interest on excess reserves.
Thanks for the explanation!
JKH,
This is funny. They introduced it because the Fed was defending a non zero interest rate without paying an interest on reserves. Now that they have started paying an interest, I don’t know why they are doing that.
My only guess is that it is a buffer against any “crash from quality” (opposite of “flight to quality”). It will have more control on the yields. If the bond yields rise, they’ll refuse to auction etc … An alternative to passing a law to remove the previous law “no overdraft at the Fed”… wild theory!
Ramanan,
That’s a good theory. You may be right.
And/or they don’t want to grow excess reserves much more and they don’t want to start doing reverses, etc. to drain any growth. Either could cause market jitters. Bond traders may be the only group on the planet that misunderstands reserves as much as neoclassical economists.
🙂
Every bond trader I have ever met is neoclassical or austrian. It is like fish in water – they don’t even notice it.
JKH,
Minor issues with the econbrowser guy.
1. The difference in amount is I guess not just prepayments but the monthly coupons paid as well – “Paydowns”
2. The Fed won’t “reinvest” – the payments (paydowns) to the Fed just reduces its liabilities.
3. There is some “dollar roll” complication which I do not understand. http://www.newyorkfed.org/markets/mbs_FAQ.HTML
Ramanan,
Not sure, but I believe from an accounting perspective the value of each upcoming coupon payment would accrue to Fed earnings and equity, starting with the preceding coupon payment. There is an increase in the value of the MBS asset and an offsetting increase in equity. Then, when the coupon is paid, the value of the coupon is dropped, the corresponding value of the MBS reverts, and reserves are debited. The net effect is that, other things equal, Fed equity increases while reserves decline and the payment of coupons doesn’t affect the principal value of the MBS reported.
“Other things equal” may be the thorny assumption here. I’m not familiar enough with MBS prepayment accounting to understand the full detail there.
Which raises the question of marked to market versus book accounting for Fed reporting purposes. Have you seen anything on that? (I’m not even sure how the treasuries work in that sense. Do you know? I assumed they were carried at book, but maybe not. It’s reasonably important, and I’ve never investigated it.)
“Dollar roll” looks like portfolio switches to provide liquidity to and absorb liquidity from the market, keeping outstanding MBS holdings about the same.
JKH,
I guess what I am saying is that the Fed will let the MBSs mature plus they will not reinvest the inflows unlike a fund manager who will very likely reinvest the inflows by buying more MBSs
An analogy is that the Fed buys more Treasuries from the Treasury when they mature, typically. Plus they will buy more Treasuries from the market when there is a coupon payment. So you see the Treasuries value at about the same level in a non-crisis situation and slowly increasing in value depending on how liabilities increase. For MBSs’ however, the assets side will keep dropping in value as will the liabilities, though of course not will equal values.
I don’t have an idea on how they do the accounting .. MTM/book. My guess is mark to market because a month back I saw a report which said that when the Fed raises rates, the value of the assets will fall and it may have a negative net worth and blah blah on independence(!)
i’ve been suggesting to sr officials there that they could offer term deposits rather than issue ‘fed bills’ or something like that, should they run out of repo collateral.
the concern was those deposits ‘count’ as ‘reserves’ so they wouldn’t be ‘reducing reserves’ even though they agreed it was all functionally the same- repo, issuing secs, term deposits, overnight deposits, etc.
seems they worry far too much about ‘managing expectations’ of ‘know nothing monetarists.’
The Atlanta Fed repeats Bernanke’s message about reserves in its 13th Feb post. See here:
http://macroblog.typepad.com/
See para starting “Here’s the way I think…” about one third the way down.