Wednesday, March 23, 2011

Goofy Fed Continues Goofy Emergency Tests

The Federal Reserve Bank of New York has announced that it will launch a new round of small reverse repo operations on Thursday that will move toward including its newly expanded list of primary dealers and money funds, WSJ reports.

The New York Fed said the reverse repo operations aren’t intended to signal any shift in the Fed’s monetary policy stance, but merely a test. The reverse repos are designed to drain reserves from the system by temporarily selling to Fed counterparties securities like Treasury, mortgage and agency debt.

The problem with this goofy program is that the money market funds and primary dealers involved have nowhere near enough cash to absorb a heavy drain operation by the Fed. A test is one thing, but with over a trillion dollars in excess reserves that could hit the system at any time, there is no way PD's and

 mutual funds could absorb any significant selling from the Fed. They would have to start dumping securities in boatloads to raise the cash. It would make any previous stock market crash look like a blip.

This program will never work, and it should be added that this Bernanke "tool" is created only because Bernake's other new "tool" of paying interest on excess reserves has created the huge trillion dollar pile up in excess reserves.

I'm not for Fed manipulation of the money supply at all, but at least prior to Bernanke, Fed manipulators used the three basics, control of the reserve requirement, the discount rate and open market operations to control money supply. These instruments worked for Alan Greenspan, Paul Volcker, Arthur Burns and right on down the line. Bernanke is positively insane for introducing all these new "tools", when the old ones worked fine. Now, he is introducing tools on top of tools. No one knows how all these tools will work in a major crisis, the system is too complex to know all the ramifications in advance. It is madness squared.


  1. This is confusing. Isn't this a way to drain excess reserves? The primary dealers take their excess reserves and use that money to buy back Fed-owned securities? This increases cash at the Fed and lowers excess reserves and lowers Fed balance sheet of Treasuries. Right? The fed could just delete the "cash" rec'd from the primary dealers and effectively shrink the monetary base??

    If this is right, it doesn't make sense that primary dealers " have nowhere near enough cash to absorb a heavy drain operation." They have over a trilliion dollars.

  2. Mr. Wenzel,

    Would could the PDs not take money out of excess reserves to supplement their cash on hand?

  3. Ignore my previous question. Obviously if the goal of this "tool" is to drain money from the system, using money in excess reserves to complete these purchases would have zero effect on M2

  4. @Matt M.

    The banking system overall has a trillion dollars, not the primary dealers---at least half is with small banks that will never become PDs.

    Further, depending on the Fed's collateral, the capital requirements for PDs would be impacted. Reserves with the Fed don't have a capital requirement, most of what the Fed would be selling or borrowing against would require the bank to have various capital levels, thus limiting their ability to just convert from excess reserves to whatever the Fed is laying off.

    When the Fed ran a test drain of the Primary Dealers some time back, they were amazed at how little the PDs could bid for , that's why they brought in the mutual funds.

    But the MFs have even less liquidity.

  5. Ahhh, that makes sense. I assumed that most of the money in excess reserves was PD's. I thought most of the money initially was from "toxic assets" that the Fed bought, but now that is clouded with this QE2.

    That makes sense. Thanks. It seems this is not really an option for them. Cutting or raising excess reserve rate seems like a smarter choice.

  6. @Matt M.

    Actually in private conversations I have had with Fed economists, they tell me it is the big banks that are starting to loan out excess reserves and small banks that continue to hold large levels of them.

    So that would even make the situation more difficult for Bernanke to use this "tool".

  7. Glad to hear that you have moles at The Fed, Robert! Feed 'em well, so that we have a channel telling us what is REALLY going on.

  8. I would think that PDs don't have a lot of liquidity because they are constantly purchasing and selling various assets on the international market (like Japanese, Mexican, Chinese, Brazilian, etc. bonds).

    In a sense, the PDs have a lot of capital but like the FED use these funds to purchase securities from everywhere instead of leaving it in cash.