"The best solution is the simplest: forcibly reunite money market funds and banks" That mechanic is already occurring naturally through the FHLBs. Why did RRP significantly drop 3/9 -> 3/14? Because FHLB issued a couple hundred bil of debt (to fund advances to probably mostly smaller banks looking to replace fleeing deposits). MMFs bough…
"The best solution is the simplest: forcibly reunite money market funds and banks"
That mechanic is already occurring naturally through the FHLBs. Why did RRP significantly drop 3/9 -> 3/14? Because FHLB issued a couple hundred bil of debt (to fund advances to probably mostly smaller banks looking to replace fleeing deposits). MMFs bought that debt (at the expense of RRP). Of course RRP has risen again since due to the inflows of new deposits/reserves into MMFs (117b last week) overwhelming any reallocation from RRP to FHLB debt
Mechanics aside.... I heartily disagree that there are too few aggregate reserves in the system, even when you just look at bank reserves (excluding RRP). Before SVB and the deposit runs on smaller banks there were 3T in bank reserves (~3.4T today). In Sept of 2019, when system legit snapped imo due to lack of aggregate reserves (given regulatory intraday liquidity constraints etc.) there were ~1.5T in aggregate reserves (and 0 in RRP). Sure, 30% money growth since then but also some auto-reserve printing capabilities like SRF as well. Anyways we shouldnt need x2 the bank reserves (again not even considering the 2.2T reserve tank we also have in the RRP). Bottom line, its not an aggregate reserve problem imo, its a deposit/funding problem for banks with problematic asset profiles and a collapse in trust from their depositors (particularly their uninsured ones) intermixed with a desire of those depositors to not get basically 0 on the bank deposits in excess of their operational liquidity need.
Regardless, still love this article and how it explains the setup, just disagree with what i think is a fundamental premise behind your conclusion and thought you might find my perspective thought provoking.
Anyways keep up the great work! It is much appreciated.
John - your thoughts are always welcomed, as you come to the table with some of the most data driven and informed perspectives out there. The mechanism around FHLB diverting cash from the RRP is interesting and frankly I need to explore it more.
The question of "adequate reserves" is tough to answer. Yes banks got down to $1.57tr in Sept 2019, but recall that the Fed thought that the adequate threshold reserves level should have been lower at that point. Even the bank manager survey suggested it should be well lower. And yet, we know what happened.
Extrapolating from the bank asset growth since 2019, you're right that we would expect the threshold to be in the low $2 trillions now. The number I had in my mind was ~$2.5tr. So I personally was a bit surprised at the level of liquidity stress we have already seen.
But I think you can look at it from a top-down or bottoms-up perspective. Bottoms-up, we can say that there "should" be adequate reserves, but top-down if banks are borrowing $392b from the Fed, its fair to say that there is a problem. I guess the point is that you find the level of reserves by hitting the wall.
Clearly the distribution of reserves (median vs. mean) is a huge factor here, and as reserves start to become more scarce you will see more hoarding of reserves. It's also not clear that cash squeezed from the RRP would go to the right places anyway. I meant to address this point in the article, but left it for another day (or the comments section :) ).
I still disagree about the characterization of the SRF and RPP. These are the "theoretical" sources of cash for the banking sector, but if they aren't providing liquidity in practice its not of much use. By this logic, the Fed can create unlimited reserves, and so there should never be a liquidity shortage ever. In the long run this is true, but it doesn't prevent crises from popping up to prompt intervention.
All of these points are totally valid, and admittedly the issue is more complex than one article can express. My big picture point I think is still valid. Why is the Fed borrowing from MMFs and lending to banks?
Could the answer to why is the Fed borrowing from MMFs and lending to banks be:
1. So that they can ensure transmission of their policy rates to the financial system (and hopefully influence credit creation to meet their inflation objectives and
2. Prevent liquidity issues at certain banks and the contagion issues that might bring
If they restricted access to the RRP, they could solve issue #2 but at the cost of #1.
Absolutely - for #1, the RRP has worked well at its primary objective, which is to ensure an overnight rate floor (at least until reason). And since their policy has been intentionally very restrictive, the RRP has removed a ton of liquidity, which brings about its own issues.
"Squeeze" would be the opposite. trading off #1 because #2 seems more pressing.
Agree Fed was caught off guard in sept 2019 but not everybody was. It is absolutely striking to me how well Zoltans Global Money Note 22 described what would happen (in all his gory/glorious detail) published May 31 2019, 3.5 months in advance of it happening.
It is certainly true that some banks are borrowing significant reserves from the FED. On the flip side though, some other banks (gsibs) are flooded with them. This is notably different than 9/2019 when all banks save jpm were merely adequate (to meet intraday liquidity requirements) at best and when jpm went from awash in reserves to just adequate (some say Dimon became stingy to prompt a response and they could be right but it would have happened eventually either way) and there was none in the RRP to tap, the cost to borrow them (effr, repo) skyrocketed. So in the aggregate, I believe reserves, both in the banking system and readily convertible into the banking system (RRP) are well in excess of whats needed for banks to settle the system each day.
But, thats cold comfort for an individual bank facing a shortage of reserves it owns because its spending them like mad to settle deposit flight and now it needs to generate more by either borrowing them or selling its assets (made worse by the fact those assets are MTM big down due to the rise in rates). So I think the real culprit are some individual bank balance sheet troubles which became liquidity problems (for those banks) due to depositors running. There is more to this (depositors profile, HTM accnt rules etc.) but I think this in essence explains why the Fed is lending reserves to banks. Its only some banks, and only because those banks needed it to meet deposit outflow/meet liquidity requirements and because those banks effectively could not borrow the reserves from other holders of reserves for various reasons, but those reasons related to the creditworthiness of the borrowing bank, not because the other reserve holders didnt have reserves to spare (like 9/2019)
Why is Fed borrowing from MMFs? Agree with you answer to Kevin. To police the floor of the range. For better or for worse its their framework.
I appreciate the dialog. Hopefully my end of it provides some value.
Its is absolutely helpful - and for the record, I think this take is probably more nuanced and accurate than the blanket way that I've described it in the article. Recall, prior to the SVB debacle, my intuition said that banks wouldn't be the problem this time because of the GSIB reserves that you're referencing.
I do think that QT mechanically shreds dollars, and those dollars have to come from somewhere. This will lead to higher leverage and lower liquidity in the banking sector.
Maybe ironically, if banks were allowed to fail, it would help address the gap between your explanation and my explanation. In other words, if the Fed was to take a hardline stance that there are adequate reserves, and if you don't have them that's too bad.
But our current leadership will not allow such a thing to happen. The expedient solution is to print liquidity for those who fucked up. therefore, if we are insuring the weakest link at a national level, then our assessment of adequate reserves must only focus on the weakest link.
In any case, I want to again stress how much I appreciate your feedback. I think we are of similar minds - neither of us with a ton of background in the topic but both eager to look at the data and *figure it out*.
"The best solution is the simplest: forcibly reunite money market funds and banks"
That mechanic is already occurring naturally through the FHLBs. Why did RRP significantly drop 3/9 -> 3/14? Because FHLB issued a couple hundred bil of debt (to fund advances to probably mostly smaller banks looking to replace fleeing deposits). MMFs bought that debt (at the expense of RRP). Of course RRP has risen again since due to the inflows of new deposits/reserves into MMFs (117b last week) overwhelming any reallocation from RRP to FHLB debt
Mechanics aside.... I heartily disagree that there are too few aggregate reserves in the system, even when you just look at bank reserves (excluding RRP). Before SVB and the deposit runs on smaller banks there were 3T in bank reserves (~3.4T today). In Sept of 2019, when system legit snapped imo due to lack of aggregate reserves (given regulatory intraday liquidity constraints etc.) there were ~1.5T in aggregate reserves (and 0 in RRP). Sure, 30% money growth since then but also some auto-reserve printing capabilities like SRF as well. Anyways we shouldnt need x2 the bank reserves (again not even considering the 2.2T reserve tank we also have in the RRP). Bottom line, its not an aggregate reserve problem imo, its a deposit/funding problem for banks with problematic asset profiles and a collapse in trust from their depositors (particularly their uninsured ones) intermixed with a desire of those depositors to not get basically 0 on the bank deposits in excess of their operational liquidity need.
Regardless, still love this article and how it explains the setup, just disagree with what i think is a fundamental premise behind your conclusion and thought you might find my perspective thought provoking.
Anyways keep up the great work! It is much appreciated.
John - your thoughts are always welcomed, as you come to the table with some of the most data driven and informed perspectives out there. The mechanism around FHLB diverting cash from the RRP is interesting and frankly I need to explore it more.
The question of "adequate reserves" is tough to answer. Yes banks got down to $1.57tr in Sept 2019, but recall that the Fed thought that the adequate threshold reserves level should have been lower at that point. Even the bank manager survey suggested it should be well lower. And yet, we know what happened.
Extrapolating from the bank asset growth since 2019, you're right that we would expect the threshold to be in the low $2 trillions now. The number I had in my mind was ~$2.5tr. So I personally was a bit surprised at the level of liquidity stress we have already seen.
But I think you can look at it from a top-down or bottoms-up perspective. Bottoms-up, we can say that there "should" be adequate reserves, but top-down if banks are borrowing $392b from the Fed, its fair to say that there is a problem. I guess the point is that you find the level of reserves by hitting the wall.
Clearly the distribution of reserves (median vs. mean) is a huge factor here, and as reserves start to become more scarce you will see more hoarding of reserves. It's also not clear that cash squeezed from the RRP would go to the right places anyway. I meant to address this point in the article, but left it for another day (or the comments section :) ).
I still disagree about the characterization of the SRF and RPP. These are the "theoretical" sources of cash for the banking sector, but if they aren't providing liquidity in practice its not of much use. By this logic, the Fed can create unlimited reserves, and so there should never be a liquidity shortage ever. In the long run this is true, but it doesn't prevent crises from popping up to prompt intervention.
All of these points are totally valid, and admittedly the issue is more complex than one article can express. My big picture point I think is still valid. Why is the Fed borrowing from MMFs and lending to banks?
Again, thanks as always for your feedback.
Could the answer to why is the Fed borrowing from MMFs and lending to banks be:
1. So that they can ensure transmission of their policy rates to the financial system (and hopefully influence credit creation to meet their inflation objectives and
2. Prevent liquidity issues at certain banks and the contagion issues that might bring
If they restricted access to the RRP, they could solve issue #2 but at the cost of #1.
Absolutely - for #1, the RRP has worked well at its primary objective, which is to ensure an overnight rate floor (at least until reason). And since their policy has been intentionally very restrictive, the RRP has removed a ton of liquidity, which brings about its own issues.
"Squeeze" would be the opposite. trading off #1 because #2 seems more pressing.
Always a trade-off and this one isn't perfect.
Thanks TLBS. I appreciate the kind words.
The FHLB/RRP dynamic can be seen pretty well
in the Dreyfuss govt MMF holdings if you compare the 3/8 holdings to the 3/15 holdings (Its the only MMF I know about that publishes holdings on a daily basis, one of those hidden data gems) https://www.dreyfus.com/products/mm/fund/dreyfus-government-cash-management.shareclass.Wealth-Shares.html#?section=expenses
Agree Fed was caught off guard in sept 2019 but not everybody was. It is absolutely striking to me how well Zoltans Global Money Note 22 described what would happen (in all his gory/glorious detail) published May 31 2019, 3.5 months in advance of it happening.
It is certainly true that some banks are borrowing significant reserves from the FED. On the flip side though, some other banks (gsibs) are flooded with them. This is notably different than 9/2019 when all banks save jpm were merely adequate (to meet intraday liquidity requirements) at best and when jpm went from awash in reserves to just adequate (some say Dimon became stingy to prompt a response and they could be right but it would have happened eventually either way) and there was none in the RRP to tap, the cost to borrow them (effr, repo) skyrocketed. So in the aggregate, I believe reserves, both in the banking system and readily convertible into the banking system (RRP) are well in excess of whats needed for banks to settle the system each day.
But, thats cold comfort for an individual bank facing a shortage of reserves it owns because its spending them like mad to settle deposit flight and now it needs to generate more by either borrowing them or selling its assets (made worse by the fact those assets are MTM big down due to the rise in rates). So I think the real culprit are some individual bank balance sheet troubles which became liquidity problems (for those banks) due to depositors running. There is more to this (depositors profile, HTM accnt rules etc.) but I think this in essence explains why the Fed is lending reserves to banks. Its only some banks, and only because those banks needed it to meet deposit outflow/meet liquidity requirements and because those banks effectively could not borrow the reserves from other holders of reserves for various reasons, but those reasons related to the creditworthiness of the borrowing bank, not because the other reserve holders didnt have reserves to spare (like 9/2019)
Why is Fed borrowing from MMFs? Agree with you answer to Kevin. To police the floor of the range. For better or for worse its their framework.
I appreciate the dialog. Hopefully my end of it provides some value.
Its is absolutely helpful - and for the record, I think this take is probably more nuanced and accurate than the blanket way that I've described it in the article. Recall, prior to the SVB debacle, my intuition said that banks wouldn't be the problem this time because of the GSIB reserves that you're referencing.
I do think that QT mechanically shreds dollars, and those dollars have to come from somewhere. This will lead to higher leverage and lower liquidity in the banking sector.
Maybe ironically, if banks were allowed to fail, it would help address the gap between your explanation and my explanation. In other words, if the Fed was to take a hardline stance that there are adequate reserves, and if you don't have them that's too bad.
But our current leadership will not allow such a thing to happen. The expedient solution is to print liquidity for those who fucked up. therefore, if we are insuring the weakest link at a national level, then our assessment of adequate reserves must only focus on the weakest link.
In any case, I want to again stress how much I appreciate your feedback. I think we are of similar minds - neither of us with a ton of background in the topic but both eager to look at the data and *figure it out*.
Cheers.