Counterparties: Reservations about reserves

July 31, 2012

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Banks currently have $1.5 trillion in excess deposits at the Fed, earning 0.25% — a reasonably healthy amount, in a world where T-bills yield even less. So why would banks want to move money out of the Fed and lend it into the economy? It’s possible that even the latest rumblings of new Fed actions to boost the economy may not have much effect, because the real anchor holding down growth is sitting in the Fed’s own vault.

That’s the core of Bruce Bartlett‘s diagnosis. For Bartlett, with interest rates already so low, the remedy lies elsewhere:

The Fed can penalize banks for holding excess reserves by charging them interest rather than paying them interest. This has been done in other countries. From July 2009 to July 2010, the central bank of Sweden charged banks 0.25 percent on their reserves, and on July 5 the central bank of Denmark announced that it would begin charging an interest rate of 0.2 percent on reserves.

In effect, this reduces the real interest rate received by banks and thus, ironically, would ease monetary policy and encourage bank lending.

Bartlett is pushing banks to get excess capital out of the Fed and into the economy. If bankers are “traveling money salesman” and the Fed stops paying interest on their excess deposits, why not give them a new task: hit the road and start hawking loans to customers.

Mike Shedlock disagrees with Bartlett: penalties on excess reserves “sure would get banks to do something, but that something might not necessarily be lending! For example, banks might bet against the US dollar, bet on gold, plow into the stock market, etc.” For Peter Stella the argument boils down to a misguided beliefs that excess deposits and lack of credit are connected. Reducing excess deposits, he argues, would actually cause credit to contract. Michael Pento thinks Bartlett’s idea would lead to more lending, but the wrong kind. Banks would “[shove] loans out through the drive-up window with a lollipop… They will be forced to take a chance on loans to consumers, at the exact time when they should be getting rid of their existing debt”.

Allen Binder thinks the British are on the right track in tackling a lack of lending from a different angle: Instead of penalizing excess reserves, “the more a bank lends, the more it saves on funding costs [from the Bank of England]… no bank is forced to lend, nor told what loans to make”. – Ben Walsh

On to today’s links:

EU Mess
Greece is on the brink of bankruptcy, with “cash reserves [at] almost zero” according to finance minister – Reuters

New Normal
Just 54% of Americans 18-24 were employed last year, the lowest level since data has been kept – FT
Bill Gross: The “cult of equity is dying”. Lenders, labor and the government will get returns – Pimco

Plutocracy Now
There’s just no place like America to be a billionaire – Mother Jones

When Regulators Stop Being Polite
Geithner: Fannie and Freddie’s refusal to use targeted principal reductions is not “the best decision for the country” – Treasury Department
DeMarco: Principal reductions do not improve foreclosure avoidance or reduce taxpayer costs – Federal Housing Finance Agency
DeMarco has “a deep aversion to reducing principal” that is common among bankers and lenders, and he should step aside – Jared Bernstein

Shares of companies with women on their boards outperform similar companies with all-male boards by 26% – Bloomberg

“We have no patience for mystery. We want the deciphering of gods. We want oracles … right now” – Ta-Nehisi Coates

The “linchpin of [Romney’s] economic strategy is to further enrich the richest 1%” – American Progress


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