- Bloomberg.com – Fed in Talks With Money Market Funds to Help Drain $1 Trillion
The Federal Reserve is in talks with money-market mutual funds on agreements to help drain as much as $1 trillion from the financial system as policy makers prepare for the first interest-rate increase since June 2006, according to a person familiar with the discussions. The central bank is looking to the $3.2 trillion money- market mutual-fund industry because the 18 so-called primary dealers that trade directly with the Fed have a capacity limited to about $100 billion, estimates Joseph Abate, a money-market strategist at Barclays Capital in New York…Chairman Ben S. Bernanke yesterday charted ways the Fed might withdraw record monetary stimulus pumped into the economy to fight the recession. Among the central bank’s tools are reverse repurchase agreements, in which the Fed sells securities with the intention of repurchasing them at a later date. The Fed is also considering reverse repurchase agreements with mortgage lenders Fannie Mae and Freddie Mac, said the person familiar with the discussions. Freddie Mac spokeswoman Sharon McHale declined to comment. Fannie Mae spokesman Brian Faith also declined to comment. “To further increase its capacity to drain reserves through reverse repos,” Bernanke said, the Fed is “in the process of expanding the set of counterparties with which it can transact” beyond primary dealers of government securities.
Comment
The idea of reverse repos with money market funds is nothing new. As early as October we wrote about the Federal Reserve’s need to reach out to money market funds in lieu of the primary dealers not being a large enough counterparty. In early November we wrote about the overall failure of this idea:
Let us underscore our comments with stronger language. This entire reverse repo exercise is a diversion. It’s purpose is to make it look like Federal Reserve staffers are busy running around “managing” monetary policy and readying for the exit strategy. This is nothing but kabuki theater. Now the Federal Reserve is trying to continue the rouse by suspending capital requirements with the dealers. In other words, the dealers will accept collateral from the Federal Reserve so long as capital constraints do not get in the way of their current positions.
Then again in December we highlighted the problem with the Federal Reserve attempting reverse repos with money market funds:
Currently the dealer community does not have the capacity to do reverses this large. So, the Federal Reserve has to go directly to the money market industry. As we learned, the Federal Reserve holds considerable sway and influence over the dealers and banks. We believe they can, and have, told the dealers and banks to “forget the rules” about collateral.
The Federal Reserve cannot do this with the money market industry. Everything has to be done by the book. And, if it goes awry, which is the rumor about Monday’s test, the Federal Reserve cannot tell money markets and custodial banks to overlook procedural problems. This is especially the case if the Federal Reserve wants to do hundreds of billions of reverses with money markets.