Interest Rate Hikes and Quantitative Easing

[kmiklas]

Given that the QE program created about $3.5T, about 80% of which is sitting in accounts at the Fed, paying 0.25% interest, why does the Federal interest rate matter?

As I understand it, the interest rate affects the cost that banks have to pay to borrow money from each other. If they've already got billions in their QE accounts, then they don't have to borrow at all--they can simply withdraw the required loan amount.

For example, a customer needs $300K to mortgage a home, and they apply at a bank that DID NOT receive QE dollars. With a Federal interest rate at, say, 5%, the bank would borrow this money from another bank, paying the $300K * 0.05 = $15K in interest, and then turn around and charge the customer 8% interest on the mortgage--that's their business. However, at a bank that DID receive QE dollars, the loaning bank can simply withdraw the 300K from their QE account at the fed, and loan it out, paying no Federal interest rate. Was this not the point of creating these dollars? To make money more easily accessible to borrowers for assets like this?

So, how then do interest rates matter? With so much extra money created, banks, don't have to borrow; and thus, the Federal interest rate is somewhat irrelevant--until they burn through that 3T in surplus.

 

[Martinghoul]

It's not that simple... The excess reserves that the commercial banks have sitting at the Fed are there for a reason. That reason is regulatory in nature. Basically, for a bank, reserves are the ultimate, most cost-effective HQLA (High Quality Liquid Asset) which satisfies their LCR (Liquidity Coverage Ratio) requirement. This means that a commercial bank cannot just "withdraw" the money from its reserve account at the Fed and lend it to a customer. I could go on, but you get the idea...

 

[ETcallhome]

perhaps a higher rate would incentivize the banks to loan more money more profitably? IDK. The problem seems to be nobody but renters want to borrow right now and they can't qualify.

 

[Cswim63]

They keep talking about 2 percent inflation. I'm starting to think it's like The Great Pumpkin. Except Halloween is a ways away.

 

[easymon1]

QE program

 

[morganist]

Given that the QE program created about $3.5T, about 80% of which is sitting in accounts at the Fed, paying 0.25% interest, why does the Federal interest rate matter?

As I understand it, the interest rate affects the cost that banks have to pay to borrow money from each other. If they've already got billions in their QE accounts, then they don't have to borrow at all--they can simply withdraw the required loan amount.

For example, a customer needs $300K to mortgage a home, and they apply at a bank that DID NOT receive QE dollars. With a Federal interest rate at, say, 5%, the bank would borrow this money from another bank, paying the $300K * 0.05 = $15K in interest, and then turn around and charge the customer 8% interest on the mortgage--that's their business. However, at a bank that DID receive QE dollars, the loaning bank can simply withdraw the 300K from their QE account at the fed, and loan it out, paying no Federal interest rate. Was this not the point of creating these dollars? To make money more easily accessible to borrowers for assets like this?

So, how then do interest rates matter? With so much extra money created, banks, don't have to borrow; and thus, the Federal interest rate is somewhat irrelevant--until they burn through that 3T in surplus.

They cannot use the QE money because it is there to prevent a bank run. The bank has to have sufficient funds to pay out to people when they want to withdraw the money they have saved in the bank. In terms of the interest rate alteration, you are only looking at it from an initial issuance perspective. An alteration in the interest rate impacts all outstanding loans linked to the central bank's base rate. This is why the interest rate mechanism is so powerful when it is changed. There are many other mechanism they can use to stimulate growth for example changing the way people pay into their pensions, this does not have the detrimental consequences an interest rate alteration can bring with it and offers other advantages too.

 

[morganist]

Pension Pump, see below.

http://morganisteconomics.blogspot.com/2019/03/pension-pumping.html?q=pension+pumping

 

[piezoe]

They cannot use the QE money because it is there to prevent a bank run. The bank has to have sufficient funds to pay out to people when they want to withdraw the money they have saved in the bank.

This seems somewhat wrong to me. Excess reserves are held at the fed in electronic form and would be of no use were there to be a "run on the bank" and depositors all tried to withdrew their money and demand cash. I think the regulation (LCR) is more there to protect the Government than it is to protect depositors.

Whether a bank is technically solvent or not makes no difference to the depositor, other than perhaps causing a minor brief inconvenience. The Fed will fully protect any depositor up to the F.D.I.C. limit, which in a crisis can technically be raised without limit, regardless of whether a particular bank is solvent or not. Banks can not go bankrupt under the U.S. Federal Reserve-Treasury system. They can become insolvent however, in which case they will undergo "resolution." Regardless depositors are protected. You can write a check drawn on an insolvent bank, and so long as you have deposited funds to cover the check, the check will clear through the Fed system, no problem.

However, if in a bank run where the public went to the bank and demanded to withdraw their deposits in the form of cash, the bank could temporarily, and briefly, run out of cash. But I don't think the LCR regulations that Martinghoul was referring to, nor swollen bank reserves due to QE, have anything to do with that.

 

[morganist]

This seems somewhat wrong to me. Excess reserves are held at the fed in electronic form and would be of no use were there to be a "run on the bank" and depositors all tried to withdrew their money and demand cash. I think the regulation (LCR) is more there to protect the Government than it is to protect depositors.

Whether a bank is technically solvent or not makes no difference to the depositor, other than perhaps causing a minor brief inconvenience. The Fed will fully protect any depositor up to the F.D.I.C. limit, which in a crisis can technically be raised without limit, regardless of whether a particular bank is solvent or not. Banks can not go bankrupt under the U.S. Federal Reserve-Treasury system. They can become insolvent however, in which case they will undergo "resolution." Regardless depositors are protected. You can write a check drawn on an insolvent bank, and so long as you have deposited funds to cover the check, the check will clear through the Fed system, no problem.

However, if in a bank run where the public went to the bank and demanded to withdraw their deposits in the form of cash, the bank could temporarily, and briefly, run out of cash. But I don't think the LCR regulations that Martinghoul was referring to, nor swollen bank reserves due to QE, have anything to do with that.

I think the electronic QE funds you are referring to are there to protect another issue that leads to a bank run. When banks lend money they sell the debt off to someone else in a debt package. If the debt defaults or the full payment is not made the expected return cannot be paid. This causes a problem for the bank because it is now not in receipt of the funds it is expected to get from the debt it sold or bought depending on which position the bank is holding.

In any event to make sure the bank has enough money to cover the lost inflow of cash its held assets are supposed to provide the electronic funds act as a cushion making sure funds are there to cover depositors withdrawals. Although I am not certain I think the funds and the position Martinghoul is explaining is a protection of expected returns of reinvested assets held by the bank, which would potentially cause a bank run if they were not made. The bank's inflow of cash has to be maintained to payout to customers when they withdraw money.

 

[morganist]

This seems somewhat wrong to me. Excess reserves are held at the fed in electronic form and would be of no use were there to be a "run on the bank" and depositors all tried to withdrew their money and demand cash. I think the regulation (LCR) is more there to protect the Government than it is to protect depositors.

Whether a bank is technically solvent or not makes no difference to the depositor, other than perhaps causing a minor brief inconvenience. The Fed will fully protect any depositor up to the F.D.I.C. limit, which in a crisis can technically be raised without limit, regardless of whether a particular bank is solvent or not. Banks can not go bankrupt under the U.S. Federal Reserve-Treasury system. They can become insolvent however, in which case they will undergo "resolution." Regardless depositors are protected. You can write a check drawn on an insolvent bank, and so long as you have deposited funds to cover the check, the check will clear through the Fed system, no problem.

However, if in a bank run where the public went to the bank and demanded to withdraw their deposits in the form of cash, the bank could temporarily, and briefly, run out of cash. But I don't think the LCR regulations that Martinghoul was referring to, nor swollen bank reserves due to QE, have anything to do with that.

I think it is the electronic funds that are the protection to this scenario. They cushion the potential risk of a default of assets held by the bank that would prevent the bank from being able to pay the depositors' withdrawals. This is the reason that I think Martinghoul is referring to, the QE funds held are the mechanism that is preventing the banks from failing. Taking that away to lend out further funds to people would potentially cause an inability to guarantee the existing depositors can get their money out when they want to.