Banking Crisis: The Fed Has Spent $500B Bailing Out The Overnight Lending Market
Since September, the Federal Reserve has pumped $500 billion into the overnight money market, directly financing repurchasing agreements meant to help banks meet reserve requirements at the end of each business day.
According to Bitcoin Magazine, this could be cause for alarm.
The overnight money market is “a short-term lending market where banks borrow cash from each other,” which becomes necessary due to regulations with strict cash reserve requirements and banks’ tendency to push the limits on leveraging their assets.
In September, the interest rate for such short-term loans soared to 10 percent, as banks became less willing to lend out their own capital to hit the Fed’s target interest rate of two percent.
So the Fed stepped in — and has yet to step back out.
For what was supposed to be about one month, the Fed began “financing these so-called repurchasing agreements (repos, for short) directly,” offering “the 2 percent interest on these short-term loans (they’re usually paid back in days or weeks) to bring the interest rate down and pump cash into a strapped lending market.”
But rather than stop the cash flow in October as initially projected, the Fed continues offering the overnight loans on a daily basis today.
This marks the first time the Fed has intervened in repo markets since the Great Recession, Bitcoin Magazine noted, and the central bank currently has $229 billion in outstanding repos on its balance sheet.
“The key question is ... should the average American be worried?" Gang Hu, managing partner at WinShore Capital hedge fund, told the magazine. "If [the Fed] keep[s] going, then they should be worried, but if they didn’t do anything, they should worry more. It’s just, where do they stop? I don’t think anyone knows what the perfect balance sheet size of the Fed is. The Fed is guessing as much as we are.”
What started this mess in the first place? “Ironically, the cash crunch that necessitated the Fed’s repo intervention arose from regulations that are meant to keep cash in reserves to prevent a run on banks or other liquidity crises,” Bitcoin Magazine reported, offering J.P. Morgan — the country’s largest bank — as an example.
According to a Reuters report, “bankers and analysts believe that J.P. Morgan, the largest bank in the U.S., may have had liquidity to finance these repos itself if it hadn’t withdrawn 57 percent of its cash ($158 billion from the Federal Reserve throughout 2019) and if new regulations didn’t mandate stricter reserve requirements.”
J.P. Morgan became hesitant to lend to other banks, because it lacked enough cash to finance the repos and meet reserve requirements. It could not legally lend out the money it had left, Hu noted.
The country’s second largest bank ran into the same problem, though to a somewhat lesser degree: Bank of America “drew in cash from their Fed account in 2019 but at a less drastic 30 percent.”
What now? Hu said no one really knows.
“If you listen to the Fed, the Fed is aware of this,” Hu said, referring to the potential danger of injecting several hundred billion dollars into these markets. “If this $500 billion becomes $1 trillion or $2 trillion, then the average American should worry. But now, the Fed’s argument is that we’ve gone too far with shrinking the balance, that since September  we’ve had too little in reserves and that this has hurt the system.”
September showed us “the limit of the system,” he added.
But with the arrangement still continuing well past the original deadline, we might now be asking, “Does the limit even exist?” Bitcoin Magazine noted.