Wednesday, January 14, 2009
Nonborrowed reserves surged and nobody seems to care; perhaps its is because the reasoning is just so obvious. But I find the following rather interesting: previous to January 2008, the sharp decline in non-borrowed reserves signaled that a problem was brewing in the banking system; but now, the surge in non-borrowed reserves indicates the Fed is assuming an increasing amount of risk, partly on the behalf the U.S. household.
Non-borrowed reserves before January 2008
In December 2007, the Fed introduced the Term Auction Facility (TAF), and loans totaled $40 billion that month. Non-borrowed reserves plunged by the amount of TAF lending, and there was a roar in the media. Markets took this as a signal that banks were having a tough time making their reserve obligations; possible bank runs? Here was Felix Salmon’s take on it in “Why Non-Borrowed Reserves Don't Matter”.
The Fed calls the TAF loans “borrowed bank reserves” – total reserves = borrowed reserves + non-borrowed reserves – since the program is mostly a substitute for the discount window. Therefore the pluge was simply a technical issue, rather than an immediate problem in the banking system.
The sharp decline in non-borrowed reserves didn't matter: there were plenty of reserves (excess reserves, actually) in the system, and some called it a false alarm.
Non-borrowed reserves since October 2008
Starting in early October 2008, the Fed has beefed up its lending programs to include the following: Term Securities Lending Facility (TSLF), the asset backed commercial paper money market mutual fund liquidity program (ABCP MMMF), the commercial paper funding facility (CPFF), the money market investor funding facility (MMIFF), the term-asset backed securities loan facility (TALF), and international currency swap lines. Reserves stemming from lending under these facilities are called “non-borrowed” reserves.
Since October 22, non-borrowed reserves have surged $587 billion, while contemporaneously, borrowed reserve lending (TAF and discount window) has been slowing, if not falling. But now we should care!
The collateral accepted under the TAF program and at the discount window is sometimes less risky than the collateral being accepted under the new lending programs, especially that of the TALF or the TSLF. Therefore, the surge in non-borrowed reserves indicates that the Fed's portfolio is rising in risk, including various foreign currencies, commercial paper, mortgage-backed assets, and assets backed by student loans, auto loans, and credit cards.
In conclusion, the Fed’s measures are growing in risk. First, it is assuming some collateral that the open market has shunned. And second, the Fed’s exit strategy becomes increasingly hazy with rising non-borrowed reserves; the risk of inflation is on the move.