Thursday, February 11, 2010

Fed in Talks With Money Market Funds to Help Drain $1 Trillion

Here he goes again! Time Mag's "Man of the Year" who seems more confused on a daily basis. His new "big idea" is to consider allowing money market mutual funds to enter into some kind of direct relationship with the Fed, like primary dealers, in order to help "drain all the liquidity pumped in during the financial crisis." The idea being, that primary dealers' capacity to buy securities is limited and more buying power is needed?

Wait...I'm confused.

So far this fiscal year (that's four months) the Treasury has sold $2.7T worth of securities (see data here). That's nearly THREE TIMES AS MANY RESERVES AS ARE CURRENTLY IN THE SYSTEM!

In other words, the Treasury debt sales would have drained Bernanke's worrisome reserves three times over in a mere four-month period had the Fed not been there to BUY an equal or greater amount of those securities to keep interest rates at zero.

What I'm saying is, by simply doing nothing all the reserves go away automatically. You don't have to call in the money market mutual fund cavalry!!

How can we ever hope to get out of this mess when the highest policy makers in the land don't understand basic concepts and principles? We are surely doomed!


Steve B Wise said...

I have to admit, I don't understand the thrust of the policy statement either...

...the Fed bought most/all of the tresury debt and issued $1 bills in exchange, right? This has the impact of swelling the reserves.

When the bills come due and the debts are paid back to the Fed... it just has to pull all those $1 bills back out of the system (a.k.a run them through shredder), right?

What am I missing?

Mike Norman said...

You're not missing anything, Steve.

Matt Franko said...

This is right from Bernanke's statement on Tuesday:

"However, to help reduce the size of our balance sheet and the quantity of reserves, we are allowing agency debt and MBS to run off as they mature or are prepaid. The Federal Reserve is currently rolling over all maturing Treasury securities, but in the future it may choose not to do so in all cases."

Maybe the reporters at Bloomberg dont understand what Bernanke is talking about here? I believe it has happened there before!

Matt Franko said...


He also said:
"Most importantly, in October 2008 the Congress gave the Federal Reserve statutory authority to pay interest on banks' holdings of reserve balances. By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates, as banks will not supply short-term funds to the money markets at rates significantly below what they can earn by holding reserves at the Federal Reserve Banks. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally."

Is he saying that the Fed now believes long term interest rates are set due to what the market believes what the Fed will do? Instead of "inflation expectations"? If so wouldn't this be news that was missed? Or is the Fed already on record on this?