Reserving Observations On The Reverse Repo Of Reserves

For what it ever may have been worth, you have to at least acknowledge the Federal Reserve really did put its (own limited use form of) money where its abundant mouth had been. The entire story of the crisis-era and then post-crisis experience of “abundant reserves” indicated a monetary situation (liquidity, colloquially) where supposedly money was beyond sufficient. Too much, in fact, according to this doctrine.

When the US central bank was forced in 2008 to elevate its ineffective response to the developing disaster, to do so required non-sterilized non-standard policies. In this context, the pertinent term is actually “non-sterilized” whereas popular imagination has been unnecessarily hung-up on “non-standard.”

Basically, the Fed came to do a whole lot of things, and violating longstanding practice in effect up to Lehman Brothers, policymakers weren’t going to focus too much on the systemic level of bank reserves. They would allow these to skyrocket (mostly due to overseas dollar swaps at that point) prioritizing everything else. Further, officials came to believe this “saturation” was responsible for, among other things, depressing the effective federal funds rate (EFF).

In order to address this secondary byproduct of the “rescue”, in order to “soak up” these excessive amounts of excess reserves, the Fed engaged in several seemingly contradictory (in view of the conditions, which were, it somehow has to be pointed out, a gross and global monetary panic in US$s) policies. One of these was IOER, an utterly embarrassing blunder whose long-term purpose will end up being proof that these people have no idea what they are doing.

Another was employing something called the reverse repo program (RRP). These operations are Temporary Open Market Operations, or TOMO’s, therefore typically overnight (O/N). Here, a counterparty who wishes to lend cash on a secured basis activates its electronic bids with FRBNY’s system in order for the Federal Reserve branch to “borrow” funds from the counterparty when FRBNY pledges largely US Treasury assets (agency and even MBS are available, too) as security for this “loan.”

Given the context of the official view of 2008’s “abundant reserves”, you might appreciate why the RRP was inauspiciously inaugurated at that time: the net effect, so far as monetary policies were concerned, was to have removed funds from a marketplace judged to contain “too much.” Instead of further flooding markets, cash holders lured into the RRP (rolled over for as long as needed) with the Fed had essentially taken “money” out of circulation and theoretically leading to the effective federal funds rate moving back upward toward the policy target.

This never happened, of course, simply because the Fed and its top officials haven’t any good idea how the global system really works; EFF remained solidly, distressingly way below its target throughout the worst of the crisis for very different reasons.

But in terms of the RRP itself, these repeated O/N auctions revealed something useful. If you are a cash lender who can’t find a cash borrower with the financial collateral you desire/require, and don’t like the price of T-bills, then the Fed’s UST collateralized operation makes for an emergency substitute in a collateral-constrained environment. And if the RRP rate the Fed offers is sufficient, it might even be an enticing alternative.

In other words, RRP usage could be an indication of collateral constraint regardless of the level of bank reserves.

That said, we have to start by acknowledging in this post-crisis, QE era a relatively close relationship between RRP outstanding and systemic reserves:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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