The year was 2013. The great concern among the Federal Reserve's leaders was that, with the world awash in dollars they had created, they wouldn't be able to raise rates even when they felt they needed to.
Zoom out: Their solution was a tool that has now swelled to massive size — $2.3 trillion as of Wednesday — and is making banks angry, as they see it as a major factor in their loss of deposits.
Why it matters: The "overnight reverse repurchase agreement facility" (ON RRP) enables money market mutual funds to accept vast sums of investors' money and pay their customers higher interest rates than banks typically do.
- That's a boon for savers who want high yields on their cash but is contributing to the destabilization of the banking system, as depositors yank their funds.
State of play: The fear a decade ago was that even when the Fed decided to raise interest rates, it would not be able to actually change the price of money across the economy unless money market funds and other entities could access cash at that rate from the central bank.
- The ON RRP was a solution to that problem. It essentially allowed money funds to park money at the Fed if there are not enough Treasury bills and other super-safe investments floating around to buy at something close to the Fed's target interest rate.
- Usage of the facility was zero two years ago but has soared as the Fed tightens. These repurchase agreements are a major holding of popular money market funds.
- For example, of the Fidelity Government Money Market Fund's $246 billion in assets at the end of February, $136 billion was repurchase agreements with the New York Fed.
The controversy: To banks, this is unwelcome competition. They benefit from their unique access to liquidity (and safety) from the Fed; lightly regulated money market funds are a threat to that, and all the more so in this jittery moment.
- The Bank Policy Institute, the research arm of the bank-lobbyist-industrial complex, this week called the repo facility "a black hole for bank deposits."
- The BPI's Greg Baer and Bill Nelson argue that the facility is essentially sucking money out of the banking system that would be put to more productive use for the economy, if it stayed in banks.
- "The facility is subsidizing money market funds as an attractive alternative for uninsured bank depositors," they write.
Yes, but: This is in large part the banks' own fault, as they have enjoyed the benefits of paying depositors rates that are far below the Fed's policy rate. The sucking sound of money leaving banks would not be so loud if they paid more competitive returns.
- And banks themselves have the ability to park money at the Fed and receive interest on it, in the form of reserves in excess of their regulatory requirements (banks also have access to the ON RRP facility).
The bottom line: "To a first approximation, if the reverse repo facility were to go to zero as it did in 2017, that would be roughly $2 trillion that would flow into the banking system," former Fed vice chair Richard Clarida said Wednesday in a panel at the National Association for Business Economics.
- "I do think at some point the Fed does have to think about what is the role of the reverse repo facility," Clarida said. He added that it worked well for its purpose of keeping a floor under interest rates during his time at the central bank, but "it's not doing that now."
- "It's a question mark and I'll leave it at that," said Clarida.
