The Fed’s Real Plan

Hey There Income Hunters,

I disagree with blog chatter that the Fed is risking another repo disaster by soaking up excess cash via their reverse repo facility.

Instead, I think it’s part of a bigger plan to allow our central bank to continue printing money.

First, let’s look at an update on the balances in the Fed’s reverse repo facility …

The balances in the account are up to $1 trillion …

And the main reason it is growing is because the Fed is paying .05% interest on the funds, which is the highest rate paid on highly-rated, short-term instruments…

Let’s look at where the money is coming from:

      • Banks swap their reserves credited into their Fed account from quantitative easing (QE) into the RRP
      • Government Sponsored Enterprises (GSE) park their unpaid cash in RRP
      • Money Funds swap the T-Bills they buy on behalf of their customers into RRP

So, banks are concerned the Fed is making a mistake that could lead to a tightening of available credit, which could then cause significant selling of stocks and bonds.

I don’t see it that way.

I think the Fed is protecting the entities that got hurt in 2008 — while plotting to go around the banks and inject money directly into the economy.

Who the Fed is Protecting?

The Fed is protecting the two segments of the market that caused the most problems for consumers in 2008:

      1. Mortgage Guarantors: Fannie Mae and Freddie Mac almost collapsed in 2008, which would have brought the housing market down, as well. They had to be bailed out to the tune of $187 billion dollars. The Fed is providing positive interest on their liabilities with the RRP facility.
      2. Money Funds: Money Funds guarantee investors’ principal is returned, so they have a big problem if their returns are negative. It’s called “breaking the buck,” which means investors’ principal is declining. This could lead to insolvency for the money fund, so the Fed is providing a cushion to the funds via the RRP facility.

Janet Yellen’s Tough Love Approach to the Banks

After the massive financial crisis bailout of the banks in 2009 ($440 billion!), Yellen, the Treasury and the whole of the US government is not interested in showing the banks any love.

Congress passed legislation to put capital requirements on the banks to strengthen their capital base in case of another crisis …

Now the Fed is throwing them a bone by providing the RRP facility so the deposits the banks push away to avoid the capital charge can ultimately be invested in the facility and earn .05%.

You see, the Fed relies on the banks to purchase and distribute Treasury Bonds that pay for their stimulus programs.

The Fed’s Real Plan

I have been pounding the table for months on the Fed’s plan to go around the banks so they can control US monetary policy and directly lend the spenders in the economy …

Janet Yellen has brought a lot more political power to this mission, and every move by the Fed is intended to help reach this goal.

With inflation running hot, the RRP gives them a tool that could be used to pull back liquidity while avoiding raising interest rates. The Fed must avoid raising interest rates because higher rates could trigger a debt crisis that they may not be able to control…

The Fed’s real plan is to talk tough while finding excuses for the Treasury to continue spending so it appears the government is doing right by voters.

What’s Next

I think the Fed would benefit from a stock market correction.

It could soften the fear of inflation while also giving the government a reason to print more money.

You can see the first step was to utilize the Treasury Government Account (TGA) to continue injecting money into the economy. Those funds have found their way into the RRP facility… 

They have also stabilized bank deposits and provided $.05% interest for the GSE’s and money funds.

The banks are the problem with no real solution …

The Fed will not be able to bail out the banking system in the next crisis.

The main systemic risk in the economy is still the banks’ risk in the derivative markets. The Global OTC derivative market is not much smaller than it was in 2008 … 

Bring It Home

The banks are not getting much love from the Fed or the government.

They can complain all they want, but the path for the Fed is clear, and it doesn’t include the banks….

There may be a role the banks can play in the digital currency, as the Fed may not want to have to manage all Americans’ personal accounts.

But that’s a longer-term issue.

In the medium-term, the banks own a ton of risky assets with small profit margins, and they will lean on the Fed as much as they can.

But in the next crisis, banks will be at the mercy of markets.

Until next time …

Live and Trade With passion My Friends,

Griff

 

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