Readers may recall that a week or two ago, there was a good deal of chatter in the ether about reports issued by the Federal Reserve that showed that the banking system, for the first time ever recorded, showed negative net non borrowed reserves.
Some commentators and analysts were alarmed; others regarded it as no big deal, arguing that those figures had little meaning. Our position was somewhere in the middle. We noted, as others did, that the change resulted from the implementation of the Fed’s Term Auction Facility. We argued that whether this change was a cause for concern depended on why banks were using the TAF so heavily. If it was merely because the funding was cheap (which it is, lower than interbank rates) then this is simply rational profit seeking. But if it is because the banks need the dough and might have difficult raising the funds otherwise, then the TAF use indicated continuing distress.
To give a quick overview of the TAF: it was launched December 17, with two $20 billion actions, one for 28 days (the one conducted on the 17th) and a second for the 20th for 35 days. The reason for the program was that the gap between the Fed funds rate and interbank rates had become very large, suggesting that banks were reluctant to lend to each other. That was even more acute in December, since banks customarily curtail their short term lending then so they can tidy up their books for year end.
We’ve called the TAF a discount window without stigma (and in fact, the Fed implemented the TAF because banks weren’t using the discount window even when they should have). Banks can post a wide range of collateral, borrow on a non-disclosed basis, and can hold on to the cash for a while (by contrast, the discount window is overnight)
Only two auctions were initially announced, but it was assumed that if this device worked, it would be continued for an indefinite time, presumably till the credit markets calmed down.
So what happened? The spread between interbank rates and the Fed funds rate fell, the TAF has been deemed a success, and some have even called it a lasting feature in the Fed’s arsenal.
But are things all that rosy? The Financial Times today raises some concerns, noting that banks are indeed using the TAF to use crappy collateral for borrowing,
And note that, with no announcement I can recall, the facility has been increased to $50 billion even though the year end crunch has passed. That too is not a good sign.
From the Financial Times:
US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch.
The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.
US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.
However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support.
“The TAF . . . allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take . . . [this] suggests a perilous condition for America’s banking system.”
The Fed announced the TAF tool on December 12 as part of a co-ordinated package of measures unveiled by leading western central banks to calm money markets.
The measure marks a distinct break from past US policy. Before its introduction, banks either had to raise money in the open market or use the so-called “discount window” for emergencies. However, last year many banks refused to use the discount window, even though they found it hard to raise funds in the market, because it was associated with the stigma of bank failure.
The Fed has not yet indicated how long the TAF will remain in place.
But the popularity of the scheme is prompting speculation the reform will stay in place as long as the financial stresses last.
“Some Fed officials have expressed an interest in keeping and possibly expanding the TAF,” says Michael Feroli, economist at JPMorgan.
Nevertheless, Mr Feroli said banks now appeared to be using the TAF instead of other funding routes, meaning that the overall level of reserves in the system was remaining constant. “The banking system certainly has its problems, however the notion that . . . banks have trouble maintaining reserves stems from a superficial reading of the Fed’s statistical reports,” he said.