Nationalizing The Federal Funds Market

Last week's volatility in the market for fed funds gave a lot of equity managers an opportunity to brush up on their understanding of the workings of the short-term money markets.  The Fed of New York was forced to offer cash to the Street in the form of forward repurchase agreements all week. These activities are likely to continue.

Nathan Tankus posted a good discussion of the mechanics of adjusting bank reserves on Twitter last week.  He particularly highlights not only the Liquidity Coverage Ratio or LCR, but also the additional liquidity stash meant to fund a resolution of an insolvent money center bank.

Given that we would never actually resolve a bank over $100 billion assets, we wonder why this rule exists: What is the point of the “resolution liquidity” for a G-SIB if we’re likely to just put the bank into an FDIC conservatorship a la Indy Mac and then sell it after a bad asset cleanup?

We appreciate the kudos on our call this past July on CNBC regarding liquidity problems in the markets, but we erred in thinking that merely ending the runoff of the Fed’s portfolio was sufficient. When our colleagues who trade TBA, and agency and whole loan repo, saw cash tightening up in the middle of August, that was a sign that problems lay ahead.  Even with the Fed’s operations, the repo market is still displaying a lack of liquidity.

A lot of people asked: what is going on?  The best primer we can suggest is the 2018 book “Floored” by Dr. George Selgin of Cato Institute, who has been producing excellent research focused on the mechanics of monetary policy for years. Selgin describes “How a Misguided Fed Experiment Deepened and Prolonged the Great Recession.”

Read the entire article