Why the Federal Reserve is pouring money into the financial system
ft.com
ft.com
1) Increase interest rates to attract new deposits
2) Sell assets — such as foreclosed homes now in the banks possession
With house prices at all time highs and interest rates at all time lows, both 1&2 sound great to me and absolutely have a direct impact on me.
I'm pretty sure you don't actually mean "printed money", since the Federal Reserve doesn't do that. No currency was created for this market operation, just balances in books kept by the Federal Reserve Bank of New York.
(This is all bad so I may be splitting hairs, but I would advocate for direct currency printing over this lending scheme if given the chance.)
Thats the difference I'm pointing out.
https://www.thebalance.com/is-the-federal-reserve-printing-m...
The fed is doing the same thing by stepping in and manipulating the overnight rate. Without the fed doing this, banks would have to plan ahead and make sure they have sufficient liquidity. This means maybe offering better interest rates to earn customer deposits.
With the major banks still calling 0.05% “high yield”, I don’t think it’s appropriate for the fed to continue to enable their incompetence. Furthermore, the banks hold a significant inventory of foreclosed homes on their books. They’ve been sitting on them for years. It’s time they sell that resource to people who need them.
But, yeah, if you are flush with cash and don't own a home but want to, #1 & #2 sound great if you consider only their first order effects on you.
#1, especially, is a huge brake on the economy (as is it's close relative #3). Which probably also has a negative impact on you, unless you are living entirely off of a pile of cash previously earned.
This book does nothing other than highlight common knowledge but does nothing to show why or how it is that way and what can be done to begin to change it.
Its the equivilant of saying well the reason the timing belt on your car breaks is it is too weak. So I made a 150kg gear system to replace it. "Wont that be too heavy for the engine to turn it?" , "Oh yeah you will have to replace the whole engine and transmission as well." Except in this instance it is all of society and humanity that would have to be changed or replaced.
On example: the reason duct tapers exist is that they handle the exceptions from really, really ,really, really difficult problems to solve that are already partially solved and working good enough.
Well, it would. Now, you can certainly argue that with an ideal distributional system (or even a far-from-ideal one that is still better than the one the US has, which aren't exactly rare in the developed world), we could have significantly lower total output and still equal or better overall well-being (and far better practical conditions for the lower 60-75% of the income/wealth distribution). And, sure, you'd be right. But we don't have such a system.
> If we broaden are thinking it could have an awesome impact long term.
Returning to a system that encourages positive-feedback economic crashes isn't broadening our thinking, it's just blindly throwing away beneficial progress.
Are there other economic friend that might eliminate the need for the current mitigation for that problem and be far better overall? Probably. Find and implement them first, though.
> Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to increase the money supply
When the central bank 'buys' securities, they do so with money they're creating in that purchase. In effect they're dumping new money into wherever they're buying securities from, but the 'dumping' isn't with dump trucks or dropping it from planes.
Now those bonds come due and the money is supposed to leave the system, but until then the velocity of money means there are knock on effects.
It's not the same thing as printing money and spending it and suggesting otherwise is either disingenuous or ignorant.
Think of this business opportunity.
Start a company where you imagine wealth into existence then loan it to others. Then you setup partner systems where you charge folks who use that wealth. A charge for each transaction.
Zero overhead with a profit layer...
It's not the same thing as printing money and spending it and suggesting otherwise is either disingenuous or ignorant.
That's it, that is the reason banks were bailed out in the first place. That's the reason they're being subsidised now (plus lots of cheap money pushes up the stock market and spurs investment and looks good at election time).
This isn't about economics. It's about politics.
The majority of boomers maybe own houses. Exclude them and your claim isn’t even close to true.
Regardless, this entire situation is a huge moral hazard. I think the majority of us wouldn’t approve of the fed deciding winners and losers.
Most of my parents' net worth is in either residential or investment real estate, and low rates are very much good for them.
Anyone with debt (e.g., mortgage, student loans) is advantaged from a future lower-value currency:
> If wages increase with inflation, and if the borrower already owed money before the inflation occurred, the inflation benefits the borrower. This is because the borrower still owes the same amount of money, but now he or she has more money in his or her paycheck to pay off the debt. This results in less interest for the lender if the borrower uses the extra money to pay his or her debt early.
* https://www.investopedia.com/ask/answers/111414/does-inflati...
Provisos:
> Inflation can help lenders in several ways, especially when it comes to extending new financing. First, higher prices mean that more people want credit to buy big-ticket items, especially if their wages have not increased – new customers for the lenders.
Broadly speaking, it's a position of weakness and servitude. It's a similar suggestion that if you're deep in debt, you "win" if you get hit in the head with a baseball bat. Sure, you enjoyed spending the money and now you're mentally deficient so you got away with not having to pay it off, but you've still been beaten over the head with a bat.
But ultimately, even if my view is an inaccurate description of reality, what you're saying is true, but I'd argue it's still a net loss. The end-goal over a lifetime of earning is to be in the black, not red. It's difficult to lose your way to the top. Wages don't track inflation (contrary to those 2% raises a year, because salaries are suppressed from downward pressure on wages). So the relatively short time someone is in debt doesn't outweigh the time spent out of debt thus the advantage you speak of isn't worth it.
All that said, debt is not inherently bad.. but that's another discussion and not in the context of this discussion.
(This may not sound causal until you consider the larger feedback loop that has gotten us to here in the first place.)
"...Analysts say these two things alone should not cause the deep cracks in the repo market that we have seen this week. The underlying issue is more structural.
The Fed has been reducing the size of its balance sheet, letting the Treasuries and mortgage bonds it bought following the financial crisis roll off. In turn, that reduces the amount of cash reserves banks hold at the Fed... 'We have had tax payments in the past. What is different this time is that it has followed a period of quantitative tightening,' said Jon Hill, an interest rate strategist at BMO Capital Markets. 'Companies sucking cash from the market was just the tripwire that brought things falling down.'”
I'm somewhat skeptical that the reduction in Fed balance sheet is the impetus for the recent surge in repo rates, especially since the Fed ended its balance sheet unwind in August.
From August 2014 to January 2018, the Fed held $4.4 trillion in assets [0]. From 2014 to 2016, overnight repo rates remained stable and low [1]. In December 2015, the Fed began its hiking cycle. From this point onwards, repo rates began drifting up, consistent with an increasing fed funds rate [2]. It would appear that the changes in repo rates were not driven by Fed balance sheet during this period.
Starting in January 2014, banks held $2.4 trillion in excess reserves at the Fed, peaking at $2.7 trillion in August 2014 [3]. By January 2018, excess reserves held at the Fed had fallen to $2.1 trillion, independent of any change in the size of the Fed's balance sheet. In 2016, repo rates remained steady, despite a $400 billion decrease in excess reserves. In 2017, overnight repo rates drifted up, despite an increase in excess reserves of $200 billion. Here, repo rates do not exhibit any obvious impact from fluctuations in excess reserves.
As Fed balance sheet declined by $700 billion in 2018, excess reserves declined by roughly the same amount. However, even as Fed balance sheet continued shrinking in 2019, repo rates held fairly steady, corresponding to the stable level of the effective fed funds rate.
Given all this, it doesn't look like reductions in Fed balance sheet have been the sole driver of declining excess reserves, nor does it appear that the quantity of excess reserves correlates strongly with overnight repo rates. Furthermore, the Fed announced an August 2019 conclusion of the balance sheet unwind in July's FOMC statement. Finally, excess reserves held at the Fed are now 1000x greater than they were in 2007.
In short, the recent spike in repo rates happened despite a massive overhang of excess reserves and in the absence of a shrinking Fed balance sheet. I wonder if the decline of the interbank loan market, which serves as a source of short term funding for banks, is related. At the time the Fed discontinued reporting interbank loan volume (2018), volumes had declined ~75% from precrisis levels [4]. Such low volumes were last seen in 1979. This, in part, explains the large amount of excess reserves held by banks. If they do not have confidence they will be able to borrow when they need to, they must maintain such reserves.
[0] https://www.federalreserve.gov/monetarypolicy/bst_recenttren...
[1] https://tradingeconomics.com/united-states/repo-rate
[2] https://fred.stlouisfed.org/graph/?g=URW
Not quite 2/3 of collateral at the Fed operations has been treasuries the rest mortgage paper with a tiny amount of agencies.
The financial system/world runs on repo and it is troubling this is happening at all. My gut is Mnuchkin knew this would happen and is trying to force the Fed into backdoor easing through another round of QE before gradually releasing the cash back into the system by slightly lower than expected issuance of new debt.
edit: more questions. As I understand it, the "repo market" is broader than only banks. Why is it that the Fed performing repo operations will alleviate the liquidity issue in the repo market, unless it is some such bank borrowing in the repo market that is the cause of the problem? And given the point about the size of excess reserves, and the low yield they earn, is there any way for the repo rate to have spiked unless there were some bank that weren't able to muster adequate collateral?
The rate spiking is indeed reflective of someone needing collateral quickly and being willing to pay up for it.
Now the fact that it spiked doesn’t mean Armageddon, just check out Chinese interbank stats to get a sense of how much they can move.
That being said looks like a narrative has formed that it must mean reserves are “too low” and so, I guess we should print more.
Another perspective is we had a decent amount of monetary tightening, and tightening are designed to reduce liquidity, especially on the front end.
This is a sign that, that tightening, combined with regulatory pressure on banks to get out of this market, have indeed reduced liquidity.
Now, no one really wants to make levered entities go under because randomly repo liqidity dries up, so the answer is clearly to just print more money.
What’s being missed though is that this illiquidity is not a bug, it’s a lagged feature of monetary policy decisions from 2014-2018.
But yep! I agree with you 100% on this being a result of all the monetary policy decisions taken over the last 4 years.
https://www.stlouisfed.org/on-the-economy/2019/march/banks-d...
Regarding high quality liquid assets, wouldn't the collateral one would receive in a typical repo transaction qualify as such?
Here's the link (it's also available on Apple Podcasts)- https://www.bloomberg.com/news/audio/2019-04-12/why-foreign-...
edit: It's a little heavy on content, so if you don't know much about the money market (like me when I first listened to it), I'd recommend having a pen and paper on hand to take notes.
I'm not sure if it was actually recorded or not.
They're not getting along well: https://news.ycombinator.com/item?id=19828317
It worked fine for me on Firefox(Android and Windows), no containers.
[0]:https://support.mozilla.org/en-US/kb/enhanced-tracking-prote...
FED will have always more trouble to handle that. What will happen is hard to say, maybe some crazy inflation, or liquidity crisis... or something I don't care about. What I care about is that economy and money will be broken for a while which will make people move away from the Dollar.
Why though?
No country in the world can run a $1 trillion deficit or 5%(?) of their GDP every year and not have consequences. This might be "okay" now, but this will create an effect that when people finally start to move away from the dollar, things will run completely out of control in America.
Reserves are simply a low pass filter, making it very unlikely that high frequency events (routine events) will cause a crisis. But they still allow low frequency events to potentially cause problems.
Since the "cutoff frequency" of the "filter" is determined by the political process, then to answer the question about whether reserves are adequate we must consider how effectively the political process addresses these sorts of issues in general.
Consider the PBGC, the government coordinated insurance system for pension funds. It is dramatically under-funded, and if more than one or two large firms with big pension obligations went under, so would the PBGC. What this means is that it would be up to the political system to bail it out.
Underwriting capital (reserve capital, or capital that is generally kept idle) is useful for financial contracts because it is far more reliable than the uncertain outcome of the political system. It is also much faster to access pre-arranged underwriting capital than it is to wait for the political system to resolve an issue.
We learned in 2008 that underwriting requirements were too low, and the policy response was actually to reduce them further, allowing firms to use riskier assets for underwriting and the government buying some of those assets (QE).
From the perspective of a politician, the response to the 2008 crisis was superb. The Fed and Treasury teamed up to prevent more widespread insolvency of financial firms and even automakers. This led to both industries being increasingly beholden to politicians and the political process in general.
But imagine if the underwriting levels prior to 2008 had actually been adequate to prevent the cascade of insolvency. There would simply have been no crisis.
From the perspective of an insurance company or banker, reserve capital is sitting idle and going to waste. If the US requires more reserve capital, this gives a competitive advantage to foreign firms whose governments require less caution. So reducing underwriting requirements is a view supported by economic nationalists.
So considering that most policy discussion these days is dominated by the political class and by economic nationalists, of course the conclusion is that everything is being done in a very smart, sensible way.
In the past, before bailouts were so commonplace, we could expect the firms' selfish interests to moderate their appetite for risks to the firm's solvency, but this check is not really a factor anymore.
The facility is being extended and will run daily through October 10.
https://inflationdata.com/Inflation/Inflation_Rate/CurrentIn...
https://www.forexlive.com/news/!/lets-talk-about-the-repofun...