Monday, May 23, 2011

A Sign of Desperation at the Fed

Thanks to Ben Bernanke's new monetary "tools", the Federal Reserve continues to operate in panic mode. Specifically, because the Fed now pays interest on reserves held by banks at the Federal Reserve, excess reserves are piling up at the Fed at a remarkable rate.

There are now $1.5 trillion in excess reserves just sitting there that could explode and hit the economy at anytime and cause huge price inflation. There has never, ever, before Bernanke started paying interest on  reserves so much of an overhang in excess reserves. In the month before the Fed started paying interest on excess reserves, September 2008, excess reserves stood at only $27 billion.

Here's the difference between then and now:

THEN:      27,000,000,000

NOW:   1,500,000,000,000

Here's a graph of the situation:

Click on chart for larger view.

This is where most of the QE1 and QE2 money has been going. It hasn't even hit the economy, yet. The Fed has no idea what is going to happen with this $1.5 trillion once it does hit the system or how quickly it will flow into the system---and cause price inflation. Or how high they might have to raise interest rates to stop the flow.

An alternative the Fed is considering in draining the reserves by getting money market funds to conduct reverse-repos with the Fed. This gets a little technical, so just know that if the Fed does reverse-repos with money market funds, it will drain reserves from the system.

But the money market funds have nowhere near the cash on hand to do the sizable reverse-repos with the Fed that the Fed may need to do. The money markets have most of their funds in short-term paper that they would be required to sell (or certainly not roll-over) if the Fed came to them wanting to do sizable reverse-repos. Huge sales of short-term paper would panic the markets. It is a very dangerous scenario.

The Fed knows this. When they actually figured this out I am not sure. Trust me, they would have never started paying interest on reserves, if they understood the problem back then. So here we are with $1.5 trillion in excess reserves, with Bernanke not knowing when these might hit the system, and so the Fed desperately continues to add money market funds to the list of those they may in the future do reverse repos with. They are expanding the list hoping that with a larger list any reverse-repos conducted won't damage the economy. It's total desperation.

So when you want to see what panic looks like at the Fed. It can look like this: Federal Reserve Bank of New York Expanded Reverse-Repos Counterparties List  


  1. I think I'll start a helicopter company. They'll need quite a few to drop that $1.5 trillion from the air. Think of the money to be made on the money that's already been made! I could be an instant bajillionaire.

  2. I looked at the list via the link you provided. At the end it states: "Inclusion on this list simply means that, should the New York Fed conduct reverse repurchase agreements, those listed would be eligible to participate." Does 'eligible' have the same connotation as an invite to the admiral's reception does in the military: "you are invited [and shall attend]".

    So what should we do if we have a lot of money in one of the 'eligible' money market funds?

  3. What would the money markets be getting in return? The Fed has about $18B in T-Bills on its balance sheet. Not nearly enough to pull a significant amount of reserves out. So wouldn't the money market funds have to accept less liquid securities from the Fed? What would a money market fund want with agency paper or MBSs?

    Even if they reverse repo'd their entire portfolio of Treasury securities there would still be about $2B left in excess reserves and that's assuming a dollar for dollar swap.

    I'm trying to get me head around all this and I just can't help but wonder, "what the hell is Bernanke thinking?" The PDs bid a lot of these bonds knowing they were flipping them to the Fed and now they have to suck them back dollar for dollar?

  4. Joe,

    You are correct the Fed has only $18B in T-Bills, but they do have $1.4 trillion in notes and bonds,but it is still a crazy game. They would have to liquidate huge portions of their portfolios to do the reverse repos with the Fed.

  5. Bob,

    If most of the QE1 and QE2 money is going into excess reserves, then what is causing the rise in prices currently? Previous money printing? Or enough of QE1 and QE2 seeping out to cause price inflation?

  6. Reserves of what? Promissory notes mislabeled as dollars? Backed by what collateral? MBS trash?
    End the Fed.

  7. Have you considered the Fed has simply been conducting a side-car operation? They took in seriously impaired MBS from the banks in exchange for funny money called non-borrowed reserves. The expectation is for the banks to begin using these non-borrowed reserves to "buy" their bad MBS paper back - presumably at a time when folks can start paying their mortgages again...

  8. Educate me here... why are the banks keeping this money in excess reserves and where did they get it?

    I mean if they got it from Fed, then why? I thought all those bailouts were used to stay in business. How can they keep them in reserves then? It doesn't make sense to me!

    Could anyone explain and/or point me towards the answer?


  9. Capitalism works when every party is looking out for their own best interest. Introduce and entity which is working for the 'common good' and you throw the whole system out of balance.

    What did Fannie and Freddie ultimately do to the housing market? What will the ultimate impact be of all the Fed printing and buying be? I don't know the exact end, but I'm guessing it won't be pretty.

  10. hang in there folks, QE 2 is ending soon. QE 3 will start and then we will see the new dollar comming out in New and Improved 2 ply

  11. Maybe Ben Bernanke has a better idea of what's happening in the Fed than you do.

    Maybe excess reserves starting growing not because the Fed started paying 0.25% on them in October 2008, but because the banking system tumbled into near oblivion, and banks were raising cash to improve their chances of survival.

    Maybe they continue to have unprecedented reserve balances because they still have enormous amounts of bad loans to write down, in a real estate market that continues to decline.

    Maybe since it started paying interest on reserves the Fed has grown its balance sheet by $1.5 trillion, giving it the ability to remove cash from the system through asset sales just as quickly as the banks could draw down their reserves.

    Maybe, just maybe, you don't know as much as you think.

  12. If this is such a precarious situation, why doesn't the Fed just change its policy of paying interest on reserves? If its so damaging to give away free money, just don't give it away.