“Gradually and then suddenly.”
“Your ATMs are safe, your cash is safe. There’s enough cash in the financial system and there is an infinite amount of cash in the Federal Reserve.”
–Neel Kashkari, President of the Central Bank of Minneapolis
The Federal Reserve’s market activity is reaching a fever pitch.
In response to a market bloodletting that seems to precipitate new record losses every day, the Federal Reserve has responded to a somewhat unprecedented crisis with its most thorough market interventions since 2008.
Liquidity is drying up in the financial system, the economy is shutting down as COVID-19 arrests the global populace and the Fed’s only response at this point has been to pump cash into the system by buying up assets directly from banks and the Treasury, and lowering interest rates and reserve requirements to zero percent. If this fails to ballast the economy, negative interest rates may entrench themselves into our financial system (they’ve already arrived for Treasury Bonds).
The Federal Reserve’s market operations are ramping up by the day, and it’s using more tools simultaneously to “fix” markets than ever before. So what are these tools and how is the Fed using them? Where is this money coming from and where is it going?
Let’s get up to speed.
Started From the Repo; Now We’re Here
Despite some headlines and talking points that this crisis precipitated from the COVID-19 pandemic, the fact is, U.S. financial markets were suffering ailments of their own before this virus gripped the international stage.
They came in the form of repurchasing agreements, or repos for short. As I reported in September 2019, the Federal Reserve began open repo operations in response to rising interest rates in the overnight lending market; interest rates soared from the Fed’s target rate of 2 percent to as high as 10 percent.
Why did the rate rise above the Fed’s suggested, and usually closely followed, rate? Simple answer: There was a cash crunch and banks were reluctant to lend cash. The repo market finances short-term loans, with the maturity usually lasting a day, a week or two, or no longer than a month. Banks make these intraday loans to each other to cover their reserve requirements set by the Federal Reserve at the end of each business day. The Fed stepped in because banks weren’t lending to each other, so the banks with too little cash in the vaults didn’t have enough to cover their debts and obligations.
Cue the market operations that began in September and which continued until 2020, only to be revived by a new round of repo recently. From September 2019 to the end of 2020, the Fed financed $500 billion in repo operations. By March 12, 2020, the Fed announced it would conduct $1.5 trillion in repo. On March 20, 2020, it announced it would be offering $1 trillion in daily repo loans until the end of the month. That’s a trillion with 12 zeros, every day.
Now, this doesn’t mean that banks will be borrowing $1 trillion every day. But this limit is so large as to basically guarantee unfettered liquidity.
In my September coverage, I rhetorically asked if a limit exists. The Fed is showing us very clearly that one does not exist.
QE4: Zero Rates, Zero Reserves, Zero F***s
Repos are loans. The money that the Fed lends out in open repo operations, theoretically, is paid back under the agreed timeframe and banks must issue collateral to receive these loans. If the banks don’t pay back the loan, then the Fed keeps the collateral.
Since repos are basically loans and trillions of dollars in repos take place regularly in the bank-to-bank lending market, some would say the Fed’s operations represent business as usual, don’t have an outsized impact and aren’t the same as printing money.
Then there’s the counterargument that these repos are basically subsidies reserved for a financial elite. And, of course, even if the money is loaned and paid back, the cash has to come from somewhere. This is why you might hear folks call repo operations “QE-lite.”
But QE-lite was not enough, apparently, so the Fed is going whole hog with QE4: its fourth quantitative easing action since 2008.
Quantitative easing, or QE, is the process by which a central bank prints new currency by expanding its balance sheet. In the U.S., the Fed prints cash and buys bonds from financial institutions to drive interest rates down. When you hear someone rave about the Fed printing money, this is what they mean.
The intended effect is to ease lending and boost spending. When the Federal Reserve prints fresh cash, it then buys up bonds and securities from banks and financial institutions for low rates to flood the system with liquidity. In 2008, this was done with 0.25 percent interest rates, which only rose to 2.5 percent again by 2018, in just enough time for it to come tumbling down again.
QE is the means by which the Fed controls this interest rate. Banks don’t…