A bit off-topic, but I asked GPT-4 for a one paragraph summary of your last three posts:
In a series of posts, the author discusses the issues surrounding the U.S. financial system, highlighting the impacts of Silicon Valley Bank's failure and the subsequent actions by the Federal Reserve. The author argues that the Fed's focus on interest rates rather than balance sheet policy has left the financial system vulnerable to liquidity stress. Since the pandemic, Quantitative Easing (QE) has driven money growth, while Quantitative Tightening (QT) is now causing liquidity problems in the banking sector. To address these issues, the author proposes "Operation Squeeze," which involves forcibly reconnecting money market funds and banks by reducing the Reverse Repo facility counterparty limit, allowing the Fed to continue QT while maintaining or improving bank liquidity.
I, for one, feel like I have no choice but to welcome our new AI overlords
"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.
Thanks for the perspective, appreciate the thought-provking experiment.
I think as you say, it's all about (finally) losing trust in Fiat. They see the harvest of what they have sown since 2008 - all the "experts" saying this time inflation and devaluation is different from 1929; 1970 might be right only in that it's way more central-bank-induced than anyone (in said central banks) admits. And the macro and economical backdrop is a very bad mixture of both of these very different periods.
After all I have read and researched, 2023 looks to be a mix of "roaring 20s ending and swinging into war economy with massive expansion" - then 1929-33 recession / depression with rapid expansion of prices runaway inflation (already happening) and potentially more than that.
To this, add the 1970s Energy Crisis/Oil Shock energy price inflation due to supply congestions in Europe with to bad political actors all around, who proved they cannot handle an energy crisis because they are pressuring to "go green" despite this scenario, shooting your own or rather the public's foot - and knee, and ass - in the process.
These factors cannot be solved by Fed QT - it would actually need massive expansion and QE to plaster over it, again.
Which would make the whole scenario worse, again.
This is not a rock and a hard place, it's a vast chasm in front and a lava stream advancing behind you.
Great article. Why do you think QE is the key driver of the inflationary impulse? I think the lesson since the GFC is that credit growth (in both the public and private sector) is the main driver of inflation (see the last 12 months when inflation has been high despite QT and aggregate money supply declining). If restricting RRP means the Fed's target rates are not transmitted to the real economy, that would seem to encourage credit growth and go against their inflation goals. They don't want a banking crisis either, but it seems like the Fed is in a very tricky spot.
How quickly things have changed! The whole purpose of the ON-RRP was to create a reserve-like account for MMFs, since banks didn't want and couldn't take all the excess reserves. The main reason was SLR, it would be forcing banks to raise CET1 only to meet their SLR.
Now that banks are bleeding deposits, I think you're right that reversing that flow by restricting RRP would alleviate some of the stress.
Bear, solid gold. This one really draws some things together. Thank you!! And the foot notes, I had a question about a data source -- right there in the foot notes. Top notch work, sir!
Remember, the repo market is divided equally between tri-party repo (centrally cleared) and bilateral repo (no clearing house). Banks tend to use centrally cleared repo. Regulators have visibility into the centrally cleared part of the repo market. So your proposed solution might work well for centrally cleared repo.
But what about the bilateral repo side of the repo market--used by non-banks (hedge and PE funds)? Regulators have no visibility into these repo transactions. So would your solution work for non-bank transactions in the bilateral side of the market?
Very good point. The RRP facility should be dismantled in time because it wasn't meant to be a long-term thing (much like the BTFP, right). The cash sitting there shouldn't exist at all since it embodies money-like instruments that create more money out of thin air.
QT isn't the main problem why banks are losing deposits; the problem is that banks have not raised deposit rates in order to safeguard thier NIMs (profitability), knowing that the Fed will sooner or later blink, and the Fed did blink with the BTFP facility. Financial institutions know that there is no political will in punishing grift, so they will keep pushing until the Fed has to step in more and either lower rates or make up another facility.
Nonetheless, I agree. The Fed broke one of the key mechanisms of monetary transmission with their freevolous use of QE/ZIRP. They must now fix that mechanism or we just keep digging ourselves deeper into the mess...
I like this plan. I also think the Fed could just admit its error and fix it. Obviously switching gears from negative interest rates to aggressive QT was going to make a heap of older T-bonds from the QE era next-to-worthless. Who wants an asset earning 1.3% with a 10-year maturity when a savings account is paying 3.5%? The Fed couple simply... buy the old bonds back at face value. Voila.
Thanks for exploring this - really interesting. A few thoughts I'd be curious to hear your reaction to:
-- You suggest that limiting access to RRP could limit the Fed's ability to keep policy rates as high as it would like/need. Isn't this a great indicator to use to shift QT from autopilot to active management?
-- If there are too many reserves in the system, limiting access to RRP should pressure short rates below the RRP rate, indicating you can sell more securities from the Fed balance sheet
-- If/when there are too few reserves in the system, you would see short rates creep above the RRP rate, indicating it's time to slow down selling securities
-- All this while having pretty limited incremental impact on real economic activity beyond that implied by policy rates around current levels (inverse of your point that organic credit expansion played a limited role in money supply growth)
The article presents a new Federal Reserve scheme but does not identify its impact on a most important flow loop - international currency exchange rates.
A bit off-topic, but I asked GPT-4 for a one paragraph summary of your last three posts:
In a series of posts, the author discusses the issues surrounding the U.S. financial system, highlighting the impacts of Silicon Valley Bank's failure and the subsequent actions by the Federal Reserve. The author argues that the Fed's focus on interest rates rather than balance sheet policy has left the financial system vulnerable to liquidity stress. Since the pandemic, Quantitative Easing (QE) has driven money growth, while Quantitative Tightening (QT) is now causing liquidity problems in the banking sector. To address these issues, the author proposes "Operation Squeeze," which involves forcibly reconnecting money market funds and banks by reducing the Reverse Repo facility counterparty limit, allowing the Fed to continue QT while maintaining or improving bank liquidity.
I, for one, feel like I have no choice but to welcome our new AI overlords
"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.
Thanks for the perspective, appreciate the thought-provking experiment.
I think as you say, it's all about (finally) losing trust in Fiat. They see the harvest of what they have sown since 2008 - all the "experts" saying this time inflation and devaluation is different from 1929; 1970 might be right only in that it's way more central-bank-induced than anyone (in said central banks) admits. And the macro and economical backdrop is a very bad mixture of both of these very different periods.
After all I have read and researched, 2023 looks to be a mix of "roaring 20s ending and swinging into war economy with massive expansion" - then 1929-33 recession / depression with rapid expansion of prices runaway inflation (already happening) and potentially more than that.
To this, add the 1970s Energy Crisis/Oil Shock energy price inflation due to supply congestions in Europe with to bad political actors all around, who proved they cannot handle an energy crisis because they are pressuring to "go green" despite this scenario, shooting your own or rather the public's foot - and knee, and ass - in the process.
These factors cannot be solved by Fed QT - it would actually need massive expansion and QE to plaster over it, again.
Which would make the whole scenario worse, again.
This is not a rock and a hard place, it's a vast chasm in front and a lava stream advancing behind you.
Great article. Why do you think QE is the key driver of the inflationary impulse? I think the lesson since the GFC is that credit growth (in both the public and private sector) is the main driver of inflation (see the last 12 months when inflation has been high despite QT and aggregate money supply declining). If restricting RRP means the Fed's target rates are not transmitted to the real economy, that would seem to encourage credit growth and go against their inflation goals. They don't want a banking crisis either, but it seems like the Fed is in a very tricky spot.
Great article as always.
How quickly things have changed! The whole purpose of the ON-RRP was to create a reserve-like account for MMFs, since banks didn't want and couldn't take all the excess reserves. The main reason was SLR, it would be forcing banks to raise CET1 only to meet their SLR.
Now that banks are bleeding deposits, I think you're right that reversing that flow by restricting RRP would alleviate some of the stress.
Bear, solid gold. This one really draws some things together. Thank you!! And the foot notes, I had a question about a data source -- right there in the foot notes. Top notch work, sir!
Remember, the repo market is divided equally between tri-party repo (centrally cleared) and bilateral repo (no clearing house). Banks tend to use centrally cleared repo. Regulators have visibility into the centrally cleared part of the repo market. So your proposed solution might work well for centrally cleared repo.
But what about the bilateral repo side of the repo market--used by non-banks (hedge and PE funds)? Regulators have no visibility into these repo transactions. So would your solution work for non-bank transactions in the bilateral side of the market?
Thanks.
Very good point. The RRP facility should be dismantled in time because it wasn't meant to be a long-term thing (much like the BTFP, right). The cash sitting there shouldn't exist at all since it embodies money-like instruments that create more money out of thin air.
QT isn't the main problem why banks are losing deposits; the problem is that banks have not raised deposit rates in order to safeguard thier NIMs (profitability), knowing that the Fed will sooner or later blink, and the Fed did blink with the BTFP facility. Financial institutions know that there is no political will in punishing grift, so they will keep pushing until the Fed has to step in more and either lower rates or make up another facility.
Nonetheless, I agree. The Fed broke one of the key mechanisms of monetary transmission with their freevolous use of QE/ZIRP. They must now fix that mechanism or we just keep digging ourselves deeper into the mess...
I like this plan. I also think the Fed could just admit its error and fix it. Obviously switching gears from negative interest rates to aggressive QT was going to make a heap of older T-bonds from the QE era next-to-worthless. Who wants an asset earning 1.3% with a 10-year maturity when a savings account is paying 3.5%? The Fed couple simply... buy the old bonds back at face value. Voila.
Thanks for exploring this - really interesting. A few thoughts I'd be curious to hear your reaction to:
-- You suggest that limiting access to RRP could limit the Fed's ability to keep policy rates as high as it would like/need. Isn't this a great indicator to use to shift QT from autopilot to active management?
-- If there are too many reserves in the system, limiting access to RRP should pressure short rates below the RRP rate, indicating you can sell more securities from the Fed balance sheet
-- If/when there are too few reserves in the system, you would see short rates creep above the RRP rate, indicating it's time to slow down selling securities
-- All this while having pretty limited incremental impact on real economic activity beyond that implied by policy rates around current levels (inverse of your point that organic credit expansion played a limited role in money supply growth)
WoW!! Thank you for this! We need TLBS as the new chairman of the Federal Reserve.
Hi TLBS,
Great article that I was re-reading now. Can I ask about the variables and sources you use for the series on the chart on Bank Deposit Creation?
Thank you in advance. Keep up these posts!!
Best,
Christany
The article presents a new Federal Reserve scheme but does not identify its impact on a most important flow loop - international currency exchange rates.
One of the most brilliant insights so far.
Have you applied for Governor of NY Fed or Chairman?
Fed.com/careers