‘Markets Were Not Effectively Distributing Liquidity’: John Williams ‘Explains’ Repo Chaos, Paves Way For QE-Lite

2 thoughts on “‘Markets Were Not Effectively Distributing Liquidity’: John Williams ‘Explains’ Repo Chaos, Paves Way For QE-Lite”

1. Are banks too big to hoard?

   As we’ve discussed, the Fed can help address banks’ unwillingness to substitute reverse repo for excess reserves by installing a standing repo facility, although they don’t appear quite ready to do so, perhaps for good reason (see “Design Challenges for a Standing Repo Facility”). And they can address year-end by selling Y2K repo options to hedge funds.[3] It is notable, though, that these and other solutions being discussed by policymakers have in common the Fed playing an ever-larger role in financial markets.

   This result is deeply ironic because the purpose of post-crisis liquidity requirements on banks was largely to prevent them from having to access the Federal Reserve’s discount window, which was seen as a “bailout.” So, rather than having the Fed lend to banks in stress once every generation or so at some (very minimal) risk to taxpayers, current solutions tend towards the Fed acting as a regular market participant at direct risk to taxpayers.

   https://bpi.com/what-just-happened-in-money-markets-and-why-it-matters/

   FYI Dodd-Frank Wall Street Reform and Consumer Protection Act : The 165(d) Rule requires the Firm to demonstrate how MS Parent could be resolved under the U.S Bankruptcy Code, without extraordinary government support and in a manner that substantially mitigates the risk that the failure of the Firm would have serious adverse effects on U.S. financial stability. The Resolution Plan is not binding on a court or resolution authority.
   2 Material Entity is defined in the 165(d) Rule as a subsidiary or foreign office of the Firm that is significant to the
   Firm’s core businesses and critical activities.

2. Pottermania and hoarding?:

   Banks may now have different motives for engaging counterpar-
   ties on the federal funds market beyond simply meeting reserve require-
   ments. Moreover, as Potter (2018) discusses, the “flat” portion of the
   demand for reserves may not be perfectly flat. Therefore, whether the
   current quantity of reserves is large enough to effectively eliminate the
   liquidity effect remains an empirical question.

   The strong pass-through observed in this impulse response is consistent with Potter’s (2018) observation that changes in the funds rate have transmitted fully to other overnight interest rates. Compared with reserve and Treasury bill supply shocks, the movement in the federal funds-IOR spread following a federal funds-market-specific shock are much less persistent, suggesting these idiosyncratic shocks are not a primary driver of the dynamics in the federal funds-IOR spread over longer horizon.

   We should also recognize that the fed funds rate might occasionally firm somewhat due to increases in interest rates in other money markets, which can affect the fed funds rate via arbitrage. Such developments are not necessarily a sign that reserves are becoming scarce. It is therefore important to understand dynamics not only in the fed funds market, but also across a broader range of money market instruments and transmission across them. Simon Potter features some such analysis in Money Markets at a Crossroads: Policy Implementation at a Time of Structural Change, remarks at the Master of Applied Economics’ Distinguished Speaker Series, University of California, Los Angeles, April 5, 2017.