Money multiplier may be ramping up
- Thread starter scriabinop23
- Start date
Yes on an accounting basis but my premise is that alot of the excess reserves are there as insurance against future additions to reserves for losses or perhaps a run on the bank in the context of rising reserves for losses.
See http://taxesandbudget-blog.ncpa.org/the-feds-balance-sheet-and-excess-bank-reserves/ for a brief overview of the concept by the former president of the Dallas Fed.
See http://taxesandbudget-blog.ncpa.org/the-feds-balance-sheet-and-excess-bank-reserves/ for a brief overview of the concept by the former president of the Dallas Fed.
Take a look at:
http://www.newyorkfed.org/research/staff_reports/sr380.pdf
Explains exactly how the system works, and that excess reserves are only reduced by either required reserves rising, or of course the Fed actually reducing the monetary base and selling assets.
So, I just spent the evening doing some reading and research...I reviewed the historical data (http://www.federalreserve.gov/releases/h3/hist/h3hist1.txt) and it appears that a 5% jump in required reserves in two weeks isn't entirely unprecedented. The required reserves were increasing throughout 2008-09, including a 10+% monthly jump between Dec08 and Jan09.
This reserve trend could be influence by the winding down of the Fed purchase of agency debt. The Fed program was budgeted to buy 1.2T of agency debt by March 31...next week. I don't know where they were with that budget when you looked at the H.3 report. As Fed buys agency debt they credit the primary dealers accounts and it shows up as excess reserves. As the Fed winds down its purchases there should be less of driver on excess reserves.
Another way to look at the movement of excess reserves to required reserves is that it reflects a decline in aggregate asset quality and quantity that drives an increase in short term deposits that drive required liability reserves. As I think Daal mentioned, banks are required to retain liablity reserves in the amount of 10% of demand deposits. Longer term deposits, like CD's and money market accounts lower liability reserve requirements of as low as 4%. If you read a few current retail bank balance sheets you will see that on the asset side thier loan amounts are decreasing year on year and quarter on quarter. Their loan loss reserves are increasing and they continue to take write offs. On the liability side of the ledger the deposits are increasing year on year and among he deposits the demand deposits are increasing while the CD deposits are decreasing. If it were not for the steep yield curve retail bank profits would be declining. So, the short term deposit growth is driving increased required liability reserves.
At the same time due to asset quality deterioration there is an increase in the loan loss reserve which is maintained as Tier 2 capital. In addition as banks are audited for asset quality their risk profile may deteriorate and the examiners will require an increase in the allocation of Tier 1 capital apart from Tier 2 and Tier 3. Tier 1 capital is essentially cash and cash equivilents. So, while banks may meet capital adequacy ratios in whole, they are being pushed to increase the allocation of total required capital dedicated to Tier 1...this increased capital and the increased loan loss reserve both show up as increased required reserves in the H.3.
A way to look at this trend is that it paints a picture of continuing deleveraging of the private sector. Loan assets are paid off or written off driving increased deposits. Assets are sold and the proceeds are not immediately reinvested so they drive up deposits. Earnings are increasingly saved so they drive up deposits. Banks, working to keep pace with declining asset quality continue to build Tier 1 reserves which show up in the required reserve account along with the reserves against deposits.
The original build up of the excess reserves was the emergency TARP and progeny programs to build interbank liquidity. Those funds borrowed from Treasury, moved into the Fed balance sheet, first building it up from 440B to just over 1T. Then as the Fed operated the liquidity programs they bought the illiquid assets from the banks, crediting the bank's Fed reserve accounts. The banks in turn left the money at the Fed becuase there was no loan demand at current underwriting standards, so the Fed balance sheet double again...from IT that they got from Treasury, to 2T that they got from the banks once they exchanged the Treasury funds for the troubled bank assets. Since then the Fed balance sheet has remained reasonably stable as they have focused on acquiring agency debt and now that program is ending.
There should be no further artificial build in excess reserves through Fed action from here on out and continued deleveraging in the aggregate private sector whould incrase the required reserves at the reduction of the excess reserves.
It all makes sense if you just follow the money.
Another way to look at the movement of excess reserves to required reserves is that it reflects a decline in aggregate asset quality and quantity that drives an increase in short term deposits that drive required liability reserves. As I think Daal mentioned, banks are required to retain liablity reserves in the amount of 10% of demand deposits. Longer term deposits, like CD's and money market accounts lower liability reserve requirements of as low as 4%. If you read a few current retail bank balance sheets you will see that on the asset side thier loan amounts are decreasing year on year and quarter on quarter. Their loan loss reserves are increasing and they continue to take write offs. On the liability side of the ledger the deposits are increasing year on year and among he deposits the demand deposits are increasing while the CD deposits are decreasing. If it were not for the steep yield curve retail bank profits would be declining. So, the short term deposit growth is driving increased required liability reserves.
At the same time due to asset quality deterioration there is an increase in the loan loss reserve which is maintained as Tier 2 capital. In addition as banks are audited for asset quality their risk profile may deteriorate and the examiners will require an increase in the allocation of Tier 1 capital apart from Tier 2 and Tier 3. Tier 1 capital is essentially cash and cash equivilents. So, while banks may meet capital adequacy ratios in whole, they are being pushed to increase the allocation of total required capital dedicated to Tier 1...this increased capital and the increased loan loss reserve both show up as increased required reserves in the H.3.
A way to look at this trend is that it paints a picture of continuing deleveraging of the private sector. Loan assets are paid off or written off driving increased deposits. Assets are sold and the proceeds are not immediately reinvested so they drive up deposits. Earnings are increasingly saved so they drive up deposits. Banks, working to keep pace with declining asset quality continue to build Tier 1 reserves which show up in the required reserve account along with the reserves against deposits.
The original build up of the excess reserves was the emergency TARP and progeny programs to build interbank liquidity. Those funds borrowed from Treasury, moved into the Fed balance sheet, first building it up from 440B to just over 1T. Then as the Fed operated the liquidity programs they bought the illiquid assets from the banks, crediting the bank's Fed reserve accounts. The banks in turn left the money at the Fed becuase there was no loan demand at current underwriting standards, so the Fed balance sheet double again...from IT that they got from Treasury, to 2T that they got from the banks once they exchanged the Treasury funds for the troubled bank assets. Since then the Fed balance sheet has remained reasonably stable as they have focused on acquiring agency debt and now that program is ending.
There should be no further artificial build in excess reserves through Fed action from here on out and continued deleveraging in the aggregate private sector whould incrase the required reserves at the reduction of the excess reserves.
It all makes sense if you just follow the money.
This is incorrect. As loan assets are paid off, aggregate deposits decrease and reserve requirements fall. Attached is a simple spreadsheet showing the movement of funds in various scenarios.
Simplified, if I hold a deposit of 10K at Bank A and pay off a loan with that 10K that is held as an asset at bank B, bank A's total deposits fall 10K and reserve requirements fall by 1K. Bank B's loan is paid off and its cash position increases while its loan position decreases an equal amount. But Bank B's deposits are unchanged - the nature of its assets just change.
As far as deposits, bank A's deposit falls while bank B's deposit remains unchanged (and asset equality changes). Aggregate fall in deposits from delevering, with loan assets falling an equal amount. Aggregate cash levels remain unchanged, but required reserves fall due to deposits falling.
Deposits only increase substantially as new loans are made within the system (and/or an equal amount to direct money printing). Loan payoff is deflationary. New loans are inflationary... all other things held constant. Anything like systemic bank runs or new loan volumes not at least equal or slightly exceeding existing loan payoff rates is profoundly deflationary. Its hard to read all of this precisely, because reserve ratios vary from 0% to 10% depending on the type of deposits/loans being made in the system. Required reserves as a measure leaves a lot to be desired.
Whats so fascinating is that the Fed was able to print around 1.5T and see M2 barely move. That tells me they synchronized money printing pretty well to the rate of money destruction through deleveraging. I do think the Fed has the tools now to keep a large balance sheet and raise interest rates (and halt loan growth), but that's another story. Interest on reserves policy allows this.
Scriabinop23, you are right, my formuulation was wrong. I didn't think it through clearly and I understand your reasoning and I agree with you. Thank you for the correction.
Stated in my own words, do you agree with this reformulation: the pay off of a loan asset, to the extent that existing deposits are used, will reduce existing liability reserve requirements, without creating any new deposit reserve liability. In fact a net reduction will occur in the aggregate required reserve account by virtue of the net deposit reduction.
At the end of your post you assert that the Fed printed 1.5T of new money. It is my understanding of TARP and the other derivative liquidity acronyms that the predicate increase in the Fed balance sheet came from loans of Treasury Debt Securities and direct loans from the Treasury with funds raised by the sale of Treasury securities. I don't understand that as printing money. There is a liability on the other side of the new Fed assets. I think of money as 'printed' when it is created without an offsetting liability. What do you think?
With regard to the balance of the substance of my post that you did not comment on, can I assume that you generally agree?
Stated in my own words, do you agree with this reformulation: the pay off of a loan asset, to the extent that existing deposits are used, will reduce existing liability reserve requirements, without creating any new deposit reserve liability. In fact a net reduction will occur in the aggregate required reserve account by virtue of the net deposit reduction.
At the end of your post you assert that the Fed printed 1.5T of new money. It is my understanding of TARP and the other derivative liquidity acronyms that the predicate increase in the Fed balance sheet came from loans of Treasury Debt Securities and direct loans from the Treasury with funds raised by the sale of Treasury securities. I don't understand that as printing money. There is a liability on the other side of the new Fed assets. I think of money as 'printed' when it is created without an offsetting liability. What do you think?
With regard to the balance of the substance of my post that you did not comment on, can I assume that you generally agree?
On balance I understood and agree with most of your other statements. Very good post.. your restatement makes sense.
my understanding of 1.5T of "money printing" had entirely to do with the increase in the Fed balance sheet, independent of how much of that went to treasury or TARP, etc. Initially, the 'printing' was in self-expiring credit facilities (many of which aren't being used anymore). Now most of that composition is devoted to the agency MBS program (about completed) as well as the 300B used to finance treasury purchases.
The bulk of new increased liability side of the Fed balance sheet to offset those purchases is entitled "Reserve balances with Federal Reserve Banks" which is at 1.1T right now. Other accounts ie currency in circulation have increased a bit as well.
http://www.federalreserve.gov/Releases/H41/Current/
http://www.federalreserve.gov/Releases/H41/hist/h41hist15.txt
Look at the last one to see the liability composition. The field of excess reserves is left off, so you'll have to derive that from totalling all of those fields and subtracting it from the right most field in this one:
http://www.federalreserve.gov/Releases/H41/hist/h41hist10.txt
Which is the total size of the fed balance sheet. From 930B balance sheet to 2.35T. 1.42T increase. That increase was literally money printing.