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by safog
2286 days ago
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The Fed has been obsessed with liquidity since this crisis has hit. From a high level, I understand why but this coupled with the repo market issues we've been having on and off for the past six months or so, the mortgage markets gumming up (avg 30Y mortgage rate went _up_ after the Fed cut rates), potential strain on dollars in the currency markets (lots of demand from foreign countries, no supply? Unsure about this one) make me think that something else is afoot that we're missing here. Of course it could be as they say, and there are a bunch of overlevered businesses that need cheap capital or they'll go bust and cutting interest rates and injecting liquidity is the only way to save them. |
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The first layer is central bank money (reserves) and payments are ultimately settled in reserves. Reserves can either be cash (notes) or account balances that banks have with the Fed. This first layer money never leaves the banking system and only banks with access to the Fed can have it.
The second layer is money that banks can create themselves out of thin air. When they grant you a loan they create a claim against you on the left side of their balance sheed and they create your deposits on the right side of their balance sheet.
When you wire transfer your deposits to another bank you instruct them to transfer reserves to the other bank, since that is what payments are settled with. Therefore banks can create as many loans as they want and are only limited by their ability to generate reserves.
This is where central banks come in. In order to get reserves, banks participate in Repo auctions and can get reserves against collateral. It used to be that collateral needed to be really good, but the quality has decreased a lot lately so that the Fed even accepts CDOs or regular bank loans that they just created.
Since shadow banks (which is really just a fancy word for Asset Managers, Dealers/Brokers and SPVs or foreign banks) do not have access to the Fed, they rely on other banks that DO have access to the Fed to lend them reserves. This used to be the case in the unsecured LIBOR market overnight, and if there was any doubt that a player was not solvent, simply nobody would lend to them overnight. In order to stabilize this, the Fed was running QE in order to channel reserves into the shadow banking system by buying assets (CDOs, bonds, etc.). Nowdays, the secured Repo market has replaced the unsecured interbank market by a larger extent since the need for trust is lower.
In a crisis just like today even the interbank repo market is drying out a bit since the value of collateral in foreign markets is questioned and US banks are protecting their reserves. Therefore the Fed is jumping in to establish trust in market liquidity again by pumping reserves into the market and show their lender of last resort function (today also dealer of last resort)."
https://miltonfriedman.hoover.org/objects/58159/the-eurodoll...
https://www.reddit.com/r/wallstreetbets/comments/fezfqi/the_...