Reverse Repurchase Agreements

[Brentastic]

I'm not sure how many of you caught the last FOMC meeting that occurred last week, but in it they finally gave a timeline of mid-2013 for keeping the fed funds rate at or near zero. They also included this little un-noticed paragraph:

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.

 

Well, after some digging, these 'tools' appear to be reverse repurchase agreements which is essentially reverse QE or money contraction. So while keeping rates low - which discourages savings and encourages riskier investments with higher yields (like equities) - the Fed will contract the money supply in a less obvious manner than raising rates. If they were to raise rates, people won't spend because they would prefer the safer bank deposit with a decent return. If they raise rates, people won't borrow and spend more because borrowing would cost more with higher rates. The Fed is only concerned with more borrowing and more spending by the consumer, regardless if that is what is actually best for the consumer. With this new little trick, they can accomplish money contraction by draining reserves from banks temporarily while still encouraging consumer borrowing and consumer spending and essentially forcing the hands of investors into risky investments like equities. Here's an article about it from bloomberg:

 

http://www.bloomberg.com/news/2011-08-15/f...-icap-says.html

[wiegie]

Sounds like a reasonable policy tool to have in the Fed's pocket in case we start to see the financial system returning to normal. If the Fed didn't have ways of reducing reserves (i.e. the monetary base), then we could see a big upswing in the money supply via the money multiplier process which would then lead to inflation. (I'll note that the Fed's interest payments on bank reserves will also likely be used as a mechanism to serve this purpose.)

[Azazello1313]

well, frankly I think it's a very good thing to know that they have both expansionary and contractionary tools at their disposal besides interest rates and that they are prepared to use them.

[The Holy Roller]

Sounds like a reasonable policy tool to have in the Fed's pocket in case we start to see the financial system returning to normal. If the Fed didn't have ways of reducing reserves (i.e. the monetary base), then we could see a big upswing in the money supply via the money multiplier process which would then lead to inflation. (I'll note that the Fed's interest payments on bank reserves will also likely be used as a mechanism to serve this purpose.)

 

I'm OK with the Fed having another reasonable tool to use.

[Big Country]

I'm OK with the Fed having another reasonable tool to use.

 

 

Did you just call wiegie a tool?

[wiegie]

Did you just call wiegie a tool?

no. he called me a "reasonable tool"

 

[westvirginia]

no. he called me a "reasonable tool"

 

 

 

Yeah, I have a set of those stubby ratcheting wrenches in my big box too. Very reasonable for getting into tight spaces...

[SEC=UGA]

What will this do to the actual reserves banks need to maintain a balance between cash on hand and cash out for loans?

 

It is my understanding that currently banks are reticent to loan due to an "unknown" and increasing factor of reserve requirements versus outstanding loan balances that they must maintain to remain viable (read, not shut down by the fed.) So, if you are contracting the reserves the bank has, you are essentially contracting the amount of loans that they can put out, thus decreasing the availability of loans to consumers?

[wiegie]

What will this do to the actual reserves banks need to maintain a balance between cash on hand and cash out for loans?

 

It is my understanding that currently banks are reticent to loan due to an "unknown" and increasing factor of reserve requirements versus outstanding loan balances that they must maintain to remain viable (read, not shut down by the fed.) So, if you are contracting the reserves the bank has, you are essentially contracting the amount of loans that they can put out, thus decreasing the availability of loans to consumers?

Banks are currently sitting on WAY WAY WAY more reserves than they need to hold because of any reserve requirement provisions.

 

 

 

You are correct though, that, if and when the banks ever start lending out reserves again, this new monetary policy tool could indeed limit bank loans--but that is EXACTLY what it is supposed to do (as the Fed attempts to keep the money multiplier (and hence the money supply) in check).

[Brentastic]

What will this do to the actual reserves banks need to maintain a balance between cash on hand and cash out for loans?

 

It is my understanding that currently banks are reticent to loan due to an "unknown" and increasing factor of reserve requirements versus outstanding loan balances that they must maintain to remain viable (read, not shut down by the fed.) So, if you are contracting the reserves the bank has, you are essentially contracting the amount of loans that they can put out, thus decreasing the availability of loans to consumers?

 

This is exactly right. The reserves will be drained from banks meaning even less lending to consumers. But on the flip side, the banks are fine with it because they are loaning to the Fed in this scenario so it's a much safer loan for them and they are very short-term. It's a win-win for the banks like usual.

[Azazello1313]

Banks are currently sitting on WAY WAY WAY more reserves than they need to hold because of any reserve requirement provisions.

 

 

 

You are correct though, that, if and when the banks ever start lending out reserves again, this new monetary policy tool could indeed limit bank loans--but that is EXACTLY what it is supposed to do (as the Fed attempts to keep the money multiplier (and hence the money supply) in check).

 

alternatively, if they were looking for another expansionary tool in their kit, could they begin paying zero or even negative interest (a tax of some sort?) on excess reserves?

[SEC=UGA]

Banks are currently sitting on WAY WAY WAY more reserves than they need to hold because of any reserve requirement provisions.

 

 

 

You are correct though, that, if and when the banks ever start lending out reserves again, this new monetary policy tool could indeed limit bank loans--but that is EXACTLY what it is supposed to do (as the Fed attempts to keep the money multiplier (and hence the money supply) in check).

 

Could be true for the Too Big To Fail banks, how bout the community banks where a lot of people go for smaller loans?

[wiegie]

Could be true for the Too Big To Fail banks, how bout the community banks where a lot of people go for smaller loans?

I doubt that any community banks would actually enter into any reverse repurchase agreements with the Fed

[wiegie]

alternatively, if they were looking for another expansionary tool in their kit, could they begin paying zero or even negative interest (a tax of some sort?) on excess reserves?

I'm guessing they probably wouldn't try to pay negative interest, but maybe they would. 0% interest on reserves is definitely do-able (and in fact, that is what was paid on reserves up until fall 2008).

[Brentastic]

I doubt that any community banks would actually enter into any reverse repurchase agreements with the Fed

The Fed hand selects the banks from what I understand. Or at the very least they set criteria that banks must qualify for in order to participate.

[wiegie]

The Fed hand selects the banks from what I understand. Or at the very least they set criteria that banks must qualify for in order to participate.

pretty much

[Azazello1313]

I'm guessing they probably wouldn't try to pay negative interest, but maybe they would. 0% interest on reserves is definitely do-able (and in fact, that is what was paid on reserves up until fall 2008).

 

so is it typical that they even pay interest on reserves? because if it's not, then it seems like they should stop paying it right now. the fact that they had depleted reserves was a problem in late 2008...if anything, the opposite seems to be the problem now. not sure why they would be encouraging excess reserves in any way right now?

[wiegie]

so is it typical that they even pay interest on reserves? because if it's not, then it seems like they should stop paying it right now. the fact that they had depleted reserves was a problem in late 2008...if anything, the opposite seems to be the problem now. not sure why they would be encouraging excess reserves in any way right now?

The Fed did not pay interest on reserves until fall of 2008--so it was not typical to do so in the US. (It was not uncommon in other countries though.)

 

Your reasoning concerning the affect on bank lending is the same sort of reasoning that me and my Money & Banking class had back in 2008 when the new policy was announced.

 

The only real answer I can think of is (queue a brentastic orgasm) that paying interest on reserves is/was a sort of hidden way of giving banks a bailout that would cause the banks' balance sheets to get better over time without them having to make any risky loans. (Let's remember, back in 2008, there were SIGNIFICANT fears that several large banks were actually insolvent and could collapse at any time. An explicit bailout of these banks was politically very unpopular and having the government temporarily nationalize the banks (something I thought was not completely unreasonable) was definitely not politically possible due to shouts of socialism. So, it quite possible that the Fed just took matters into its own hands and tried to help the banks grow their way out of insolvency.

 

(I'll note that the standard explanation right now is that they were trying to signal to markets that they had plans in place to limit the expansion of the money supply so that inflation wouldn't be a concern, however it could easily be argued that moderate inflation (say 3%) would be very beneficial right now. And the Fed could just have easily announced the new program of being willing to pay interest on reserves without actually having started to pay interest on reserves.)

Edited August 17, 2011 by wiegie

[Azazello1313]

any ideas on why, if it is atypical, they are still paying interest on reserves NOW, 3 years later, when banks appear to be stockpiling them in excess of requirements and money still seems tight? seems like ditching that policy would get a little more liquidity in the system, encouraging banks to lend, and it wouldn't even be something that was politically susceptible to the howls of the ron paul types.

[SEC=UGA]

The Fed hand selects the banks from what I understand. Or at the very least they set criteria that banks must qualify for in order to participate.

 

Sorta like how they decided which banks would survive and which ones would not?

[wiegie]

any ideas on why, if it is atypical, they are still paying interest on reserves NOW, 3 years later, when banks appear to be stockpiling them in excess of requirements and money still seems tight?

to be honest, no

[Yukon Cornelius]

just got a sweat arse home improvement loan today

[Brentastic]

The Fed did not pay interest on reserves until fall of 2008--so it was not typical to do so in the US. (It was not uncommon in other countries though.)

 

Your reasoning concerning the affect on bank lending is the same sort of reasoning that me and my Money & Banking class had back in 2008 when the new policy was announced.

 

The only real answer I can think of is (queue a brentastic orgasm) that paying interest on reserves is/was a sort of hidden way of giving banks a bailout that would cause the banks' balance sheets to get better over time without them having to make any risky loans. (Let's remember, back in 2008, there were SIGNIFICANT fears that several large banks were actually insolvent and could collapse at any time. An explicit bailout of these banks was politically very unpopular and having the government temporarily nationalize the banks (something I thought was not completely unreasonable) was definitely not politically possible due to shouts of socialism. So, it quite possible that the Fed just took matters into its own hands and tried to help the banks grow their way out of insolvency.

 

(I'll note that the standard explanation right now is that they were trying to signal to markets that they had plans in place to limit the expansion of the money supply so that inflation wouldn't be a concern, however it could easily be argued that moderate inflation (say 3%) would be very beneficial right now. And the Fed could just have easily announced the new program of being willing to pay interest on reserves without actually having started to pay interest on reserves.)

So, you are finally willing to seeing the Fed for what they truly are? I don't blame people for being fooled for so long. The FED are experts at making complex and lop-sided schemes appear to be mundane, logical and necessary. When the truth un-ravels, it's like finally seeing the image in a 3D Stereogram.

[wiegie]

So, you are finally willing to seeing the Fed for what they truly are? I don't blame people for being fooled for so long. The FED are experts at making complex and lop-sided schemes appear to be mundane, logical and necessary. When the truth un-ravels, it's like finally seeing the image in a 3D Stereogram.

This is no new realization to me and it doesn't cause me to change my thoughts about the Fed. Given a choice of letting the financial system completely fail or doing this sort of hidden in plain view bailout, I'll take the latter. (We could have had a cleaner bailout with better stipulations against banks, but that is politically infeasible.) But let's be perfectly clear here, the interest rate that the Fed is paying on these reserves is 0.25%, so any real "bailout" is pretty minor (if my quick calculations are close, the total amount of money that has been earned by banks due to these interest payments has been less than $10 billion--obviously not a tiny amount by any stretch, but a pretty small price to pay if it helped stave off a financial collapse).