Image Credit: Allmusic
By Stan Szymanski
…’Maybe I should have saved those leftover dreams
Funny but here's that rainy day
Here's that rainy day they told me about
And I laughed at the thought
That it might turn out this way’…
(Verse 1 from ‘Here’s That Rainy Day’ (Van Heiden/Burke)
Just a few days ago (Feb 7, 2025), the Federal Reaerve released an update of ‘Overnight Reverse Repurchase Agreements: Treasury Securities Sold by the Federal Reserve in the Temporary Open Market Operations’. This report showed that the Federal Reserve was currently engaged in providing $95.258 Billion Dollars of liquidity to the banking system; the lowest level reported since February 2021.
This is down dramatically from the height of the use of the Reserve Repo Facility (RRP) in December 2022 when the Federal reported that the level of use of said facility was an astounding $2.553 Trillion Dollars.
If we want to know why the Federal Reserve Bank (FRB) had to employ the RRP in the first place, we have to go back and visit the press release from the FRB in March of 2020:
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…’For many years, reserve requirements played a central role in the implementation of monetary policy by creating a stable demand for reserves. In January 2019, the FOMC announced its intention to implement monetary policy in an ample reserves regime. Reserve requirements do not play a significant role in this operating framework.
In light of the shift to an ample reserves regime, the Board has reduced reserve requirement ratios to zero percent (emphasis added) effective on March 26, the beginning of the next reserve maintenance period. This action eliminates reserve requirements for thousands of depository institutions and will help to support lending to households and businesses.’… (Board of Governors of the Federal Reserve System, 3/15/2020)
So the Federal Reserve reduces the long standing ‘reserve requirement’ for member institutions of the FRB from 10% to ZERO. Previous to 3/26/20, banks in the Federal Reserve System had to maintain 10% of their deposits in reserve. If they didn’t have quite enough to make the 10% maintenance reserve requirement they could borrow the funds they needed from other banks in the ‘Overnight’ or ‘Federal Funds Market’
This reduction of the long standing was a way reducing monetary pressure on the banks. Why did the Fed have to do this? Because of ‘What Happened in Money Markets in September 2019?’
The following synopsis of what happened in September 2019 paints a bleak picture of liquidity in the banking system:
…’Strains in money markets in September seem to have originated from routine market events, including a corporate tax payment date and Treasury coupon settlement. The outsized and unexpected moves in money market rates were likely amplified by a number of factors. First, these events occurred against a backdrop of increased Treasury outstanding and reduced reserve balances. Reserves were at a multi-year low, which reduced liquidity, while Treasuries outstanding were at an all-time high, which led to increased borrowing demand. Second, borrowing demand in the repo market proved to be highly inelastic, which along with the persistence of trading relationships in the triparty segment, led cash borrowers to pay up significantly to secure the funding they needed. Lastly, on the lending side, uncertainty about cash flows and market conditions was a factor contributing to the reluctance of lenders to increase their lending in response to higher rates. For banks, this reluctance may have been exacerbated by frictions due to supervisory and regulatory factors, including their internal risk management practices, which may have prevented them from lending their excess funds to take advantage of higher rates. These factors appeared to have contributed to acute pressures on money market rates in September. Ongoing analysis may help us better understand how pressures emerged and spread across different money markets.’… (What Happened in Money Markets in September 2019?)
When the above quote from the FRB in 2019 states: …’ Reserves were at a multi-year low, which reduced liquidity, while Treasuries outstanding were at an all-time high, which led to increased borrowing demand.’…Are things really all that different today?
The difference today is that the the reserve requirements for the member banks of the Fed are already AT ZERO. Starting in 2021 (and apparently ending in 2025) the FRB provided liquidity to its member banks through the Reserve Repo Facility; pumping, at one point, over $2.5 TRILLION DOLLARS into the banking system (2022). The same facility is now trickling less that $100 Billion into the same system. Yes, the member banks of the Fed do have ‘excess reserves’ on deposit at the Fed, but the amount is roughly 30% less than what it was at the beginning of 2022 when the banks had lots of -Trillions- of assets in the Reserve Repo facility.
With an exploding national debt and a lot of Treasury issue to roll over in 2025 (a problem noted above in 2019) could we see a similar problem in the money markets again? Money Market instruments are typically 30 to 60 day (technically up to a year in maturity) in length and are largely made up if US Treasury Bills (13 and 26 week) and Commercial Paper (debt issue by corporations with maturity as short as 1 day).
The first thing to crack at the beginning of the GFC (Great Financial Crisis) was Commercial Paper.
…’Until 2005, the total amount of CP (commercial paper) outstanding was relatively stable. Between early 2005 and the summer of 2007, the amount outstanding doubled, reaching a peak of $1.2 trillion in July 2007. As the ABCP (Asset Backed Commercial Paper) market collapsed, some conduits were unable to roll over their paper, resulting in defaults (Keogh, 2007). Investors became increasingly worried that banks, which provided liquidity facilities to the conduits, would be unable to support them (Mollenkamp, 2007). (The Commercial Paper Market, the Fed, and the 2007-2009 Financial Crisis)
Said a little more succinctly:
…’When short term liquidity funding like ABCP (asset backed commercial paper) and repos suddenly dried up, financial institutions effectively faces a “run” and found themselves exposed with very little capital.’…(The Origins of the Financial Crisis, page 28)
I took a look at Commercial Paper issuance during the short time of the new administration. Even though it is not long enough to establish a trend, in light of the above info on how CP problems contributed to the GFC-it is troubling.
The last five weeks reported of CP outstanding is in an uptrend. During the week of January 31 the amount of CP issued was -double- that of the averages of 2023 and 2024. (Commercial Paper Rates and Outstanding Summary).
Whether the trend in CP issuance continues remains to be seen. But I think that there is ample information to look at and see the the banking system really is abject of having sufficient ‘funds for a rainy day’ that your parents probably told you to make sure that you have for yourself.
Put together the dwindling levels in the Reserve Repo facility, zero reserve requirements still in place for FRB member banks and the role that Commercial Paper played at the beginning of the GFC to me, it looks like the kindling to a fire that could start a banking/financial crisis.
The last line of Here’s That Rainy Day’ is ‘Funny that rainy day is here’. For the banking system, IMHO, it is raining, it is, however, not funny and there doesn’t appear to be enough in the piggy bank.
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Stan Szymanski (or Encouraging Angels) is not a medical doctor. This is not medical advice. In all matters pertaining to the health and care of a human being consult a medical doctor. This is not legal, financial or personal advice. Consult appropriate professionals in those fields for that type of advice. For informational purposes only.
