"The Banks are broke"
February 24, 2008
– Comments (7)
There is a chart swirling around on bear blogs that is supposed to show, how so called non-borrowed reserves of banks have gone negative, indicating they are broke and rely on the Fed for reserves. And that you should even pull out your deposits!
First here's the chart:
http://thoughtsfromthetrenches.blogspot.com/2008/02/weekly-report-25th-february-2008.html
But let's dig deeper. Helped from an article by Caroline Baum :
-Banks require a certain amount of reserves, as cash or on deposit at the Fed, to meet withdrawal demands. These are so called required reserves. If the banks hold more than what's required, these reserves are called excess reserves.
-If the banks obtain their reserves via open market operations from the Fed, they are called non-borrowed reserves. Open market operations are when the Fed buys or sells securities (usually Treasuries) from the primary dealers (very big banks who are allowed to deal directly with the Fed). This is done to affect the Fed Funds rate, the rate at which banks can borrow reserves from each other overnight against collateral. These operations usually last one or two days. They are also called repurchase agreements or repos.
Banks can also lend money (=reserves) to each other for longer than overnight (1, 2, 3 months etc.) at the so called London Interbank Offered Rate or LIBOR.
If however the banks borrow the reserves directly from the Fed from the discount window at the discount rate (also against collateral), they are called borrowed reserves.
The Fed doesn't care if the banks get their reserves directly from the Fed or via the interbanking market at the Fed Funds rate or LIBOR.
Last year banks were reluctant to lend money to each other longer than overnight, to keep reserves and balance sheets stable for year end. This showed up in the huge spread between the Fed Funds rate (money overnight between banks) and the LIBOR rate (money for longer). That doesn't mean however that they didn't lend each other anymore. They just had to pay more, or a higher rate.
So what's up, why the sudden drop in non-borrowed reserves?
The Fed has recently introduced the Term Auction Credit Facility (TAF), where banks can borrow for 28 days (instead of a few days)
From Wikipedia: the Term Auction Facility, enables the Fed to auction a set amount of funds to depository institutions, against a wide range of collateral. Auctions held on December 17th and December 20th released $20 billion each in the form of 28- and 35-day loans, respectively.[4] On the December 17th Auction, bids began at 4.17% and ended with a rate of 4.65%, substantially below the discount rate. The Fed received over $63 billion in bids and released the full $20 billion to 93 different institutions.[5]
For the TAF the Fed accepts a wide range of collateral, like mortgage backed securities, CDOs etc. not just Treasuries. In fact almost every junk. Also, any bank can come not just the primary dealers. The idea was to get banks borrowing without having to tap the discount window. The discount window is regarded as a facility that is being tapped by banks in distress, since they can't get funds from the cheaper fed funds rate. So banks are reluctant to use it because it will be made public. So as to not be regarded as potentially in trouble, they will pay high rates in the interbanking market.
http://en.wikipedia.org/wiki/Term_Auction_Facility
Since reserves from the TAF are also called borrowed reserves, and every bank has chosen this facility (long term cheap money instead of very short term money), the so called borrowed reserves have vanished. Since they now have borrowed more than they need the number is now even negative. Apparently it's just accounting stuff. So currently there are total reserves ($42.1b) minus TAF credit ($60b) minus discount window borrowing ($109m) equals non borrowed reserves of minus $18b. So today the chart would look even weirder...
http://www.federalreserve.gov/releases/h3/Current/
If the Fed would reduce the discount rate below the Fed Funds rate, banks would probably go to the discount window.
Conclusion: banks have enough reserves, in fact excess reserves of around $20b, if I interpreted the data correctly (correct me if I'm wrong!). There is no doubt that there is a financial crisis and probably the Fed wanted to make sure that as many banks as possible have adequate reserves and more.
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