Thursday, September 24, 2009

Report: Fed's Exit Strategy May Use Money Market Funds

I'm scratching my head on this one.

The Federal Reserve is studying the idea of borrowing from money market mutual funds as part of eventual steps to withdraw stimulus, according to FT.

The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired during the financial crisis.

This would drain liquidity from the financial system. But, the money supply isn't growing, so a drain now would be severely deflationary. Either the Fed is contemplating doing this, if banks start to lend against excess reserves, as a back up to Bernanke's plan to control money growth via the interest rate it pays on excess reserves, or this is an insane plan that will monitor the banks balance sheet without taking into account how reserves are impacting the money supply.

I do not see the Fed draining reserves with money supply stable, but if they do, we are going to have one major deflation.

3 comments:

  1. Wow, they really are just making this shit up as they go along. I love how Bernanke and the Fed-lovers say he's a student and he has a playbook. These announcements make it obvious they've got nothing and will try anything.

    Maybe they should just straight up take money out of people's bank accounts when the inflation gets too hot to handle.

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  2. lol. So the Fed is essentially a much larger--and infinitely solvent--version of Lehman Bros.

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  3. Severe deflation, eh? This reminds me...

    I once read a story written by a retired Russian banker in which he tells about the 1998 events. Long story short, he said his bank was sound, then the foreign shareholders just pulled their capital out. As I understand, it was the same story with numerous banks. The central bank tried to provide some liquidity, but they were simply overwhelmed. The gold reserves were near zero. Essentially it was a shutdown of the financial system, with devastating effects on the economy. I may be missing/mixing up some of the details, but the similarity here is the sudden massive money draining.
    Can the then-Fed head say that he doesn’t know where the money went, or why? That wouldn’t be the first time. Also, that would be an utterly desperate situation for the country, so perhaps he wouldn’t be asked that question at all.

    Look what happened to the Russian currency in 1998. Can something like that now be in the program for the US?

    Here is the 1998 timeline in brief:

    July 6. Short-term government debt yield reaches 93%
    July 7. Central bank cut credit lines to commercial banks. (It’s credit backed by government debt obligations)
    July 10. European Commission states that Ruble devaluation is almost inevitable and even desirable.
    July 14. Treasury offers debt holders to convert short-term debt into a forex debt with longer maturities.
    July 20. IMF provides $14B loan to Russia.
    July 24. Central bank lowers interest rate to 60%.
    August 5. Government decides to raise the foreign borrowing limit from $6B to $14B that year.
    August 11. Stock market collapsed and was shut down.
    August 13. Moody’s и Standard & Poor’s lower Russia’s credit rating. “Financial system is about to collapse, banks queued up for bailouts. US dollar-ruble exchange rate is in high orbit.
    August 14. Central bank: “complete loss of investor confidence.”
    August 17. Europeans ready to cut ties with Russia and expel it from IMF.
    August 17. The Default. Exchange rate goes from 6 to 9.5, non-resident interest payments frozen for 90 days, other limitations of this kind.
    August 19. One week bank holiday declared.
    August 21. Prime minister explains to the public that the country is insolvent.
    August 23. Government resigns.

    All the goodies are there arranged nicely: bond market meltdown and explosion, foreign creditors pull the plug, bank holiday, insolvency, government meltdown. The countries are very different, but the trend seems to be the same. Is any of this likely a port of the program for the US?

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