Finally, the manager reported on potential arrangements that would allow depository institutions to pledge funds held in a segregated account at the Federal Reserve as collateral in borrowing transactions with private creditors and would provide an additional supplementary tool during policy normalization; the manager noted possible next steps that the staff could potentially undertake to investigate the issues related to such arrangements.A slide presentation by the New York Fed's Jamie McAndrews explains it.
The simple version, as I understand it, seems like great news. Basically, a company can deposit money at a bank, and the bank turns around and invests that money in interest-paying reserves at the Fed. Unlike regular deposits, which you lose if the bank goes under, (these deposits are much bigger than the insured limit) the depositor has a collateral claim to the reserves at the Fed.
This is then exactly 100% reserve, bankruptcy-remote, "narrow banking" deposits. I argued for these in "toward a run-free financial system" as a substitute for all the run-prone shadow-banking that fell apart in the financial crisis. (No, this isn't going to siphon money away from bank lending, as the Fed buys Treasuries to issue reserves. The volume of bank lending stays the same.)
A second function of such deposits is that, like the new repo facility, it's going to help the Fed to raise rates. When the Fed wants to raise rates it will pay more interest on reserves. The question is, will banks pass that interest on to depositors? If they were competitive they would, but that's not so obvious. If large depostitors can access interest-bearing reserves through the repo program, or now through this narrow-banking program, it's likely to more quickly transmit the interest on reserves to the wider economy.
I remember a presentation by Darrell Duffie on centralized clearing parties and their need for collateral, where he noted that people are starting to ask about the availability of risk-free government debt. Is there enough to meet the need for it in such applications?
ReplyDeleteHow would an economist answer a question about shortages? Perhaps by looking at prices. The deposits described in this post do allow the Fed to raise rates, but the equilibrium rate in the US and the EU is negative, and people are looking for ways to lower rates below the zero bound. The proposed segregated accounts would also allow for parking fees, but we really need to look for ways to raise the equilibrium risk-free rate.
Shadow banks can offer yields higher than zero by exposing their investors to some risk. The financial innovation that we need is a way to deliver such risk exposure and higher yield without the systemic fragility that we saw in the crisis. That is the way to get "interest-paying money". The other way is to do so much QE that the US would need to pay interest to borrow short term.
Seems more like a step toward socialized banking and away from free markets. Right now, a private bank can accept deposits and buy US bonds, thus holding 100% reserves of US bonds against its deposits. Under the new system, the same private bank accepts a deposit and deposits it with the Fed, which in turn buys US bonds, thus holding 100% reserves of US bonds against its deposits. At least it's not mandatory yet, but just wait.
ReplyDeleteAlso, central banks have been known to become insolvent, and are not run-proof.
Mike I think you are pointing out that the friction being removed with these segregated accounts is a very small one, because we already have MMFs that are limited to investments in government debt. What we don't have is a good substitute for *prime* MMFs, which were rescued with guarantees during the financial crisis. Prime MMFs are at a different point on the efficient frontier, and many people want to be there with their short-term holdings - especially large companies with massive cash pools.
DeleteI see this as an integral step toward the run-free financial system you've described. The next step I think should be to eliminate the deductibility of interest on all instruments with maturity of less than 90 days (or whatever is politically feasible).
ReplyDelete