An article entitled, "Why the Fed Should Create a Standing Repo Facility," written by economists at the Federal Reserve Bank of St. Louis, explains, "The Federal Open Market Committee (FOMC) is locking down its long-run monetary policy implementation framework. We know it will consist of a floor regime characterized by an ample supply of reserve balances. We argue below that the FOMC should include a standing repo facility as a part of this framework."
It continues, "These banks would presumably not want or need $784 billion in reserves if higher-yielding Treasuries could be liquidated at a modest discount on a reliable basis in times of stress. The Fed could easily incentivize banks to reduce their demand for reserves 3 by operating a standing overnight repurchase (repo) facility that would permit banks to convert Treasuries to reserves on demand at an administered rate. This administered rate could be set a bit above market rates -- perhaps several basis points above the top of the federal funds target range -- so that the facility is not used every day, but only periodically when a bank needs liquidity or when market repo rates are elevated."
The economists explain, "With this facility in place, banks should feel comfortable holding Treasuries to help accommodate stress scenarios instead of reserves. The demand for reserves would decline substantially as a result. Ample reserves -- and therefore the size of the Fed's balance sheet -- could in fact be much closer to their historical levels."
They add, "Even though balance sheet normalization is well underway, we think it is never too late to introduce a repo facility. The FOMC would learn over time whether the facility is working to reduce the demand for reserves. The FOMC could do so, for example, by permitting reserves to run off organically with the growth of currency in circulation while remaining confident that interest rate control would be maintained through the repo facility."
In other news, Pensions & Investments recently posted Commentary that asked if it's "Time to allocate out of stable value funds?" Contributor Henry Heitman writes, "Stable value funds continue to be by far the largest investment type for 401(k) participants who seek low risk and a reasonable return. Stable value balances are estimated to be more than $300 billion and growing. However, rising interest rates are creating problems for some of the largest stable value funds, which reflect in rates paid to participants that are less than money market funds and bank deposits. Participants in 401(k) plans may need to reallocate to money funds or FDIC insured deposit alternatives."
He continues, "For example, Wells Fargo Stable Value Fund, one of the largest with about $26 billion in assets, currently has about the same yield as a comparable Fidelity Money Market Fund, based on most recently reported Wells Fargo data as of Nov. 30 and Fidelity data as of Jan. 15. The comparison on the surface isn't equitable because the Fidelity fund has had the full benefit of the December 2018 25-basis-point rate hike, while the December Wells Fargo numbers have had two weeks less to absorb those increases. However, after years of having a substantial performance advantage over money market funds, stable value returns have converged. Other major stable value funds such as Morley Capital Management have had similar, and in some cases, worse results."
Heitman adds, "Two other factors should give an adviser or fiduciary pause to continue to recommend stable value: capacity and stability. It isn't well-known, but several stable value funds have either been bankrupt or sued over low participant payouts. The weakness was largely due to broader issues during the financial crisis when these funds had to actually write down a 100% loss on securities the fund was holding. More severe than today's situation, but starkly in contrast to the safety of FDIC insured product options."
He writes, "It also isn't well-known that stable value capacity is limited. Relatively few insurance companies provide the credit and liquidity wrappers stable value funds require to be plausibly stable. Capacity was hard to find during the crisis and could be hard to find again in the near future. Sooner or later, investor confidence in equity portions of retirement portfolios will enter a correction phase. Participants will want to reallocate to cash product options, pouring billions of new dollars into the stable value product. If the fund can't keep up with capacity, where will those dollars go?"
Finally, former FDIC Chairman William Isaac writes in American Banker on "A simple fix to brokered-deposit battle." He comments, "The American Bankers Association recently released a report from a major law firm detailing the legislative history of the Federal Deposit Insurance Corp.'s battle against bank purchases of deposits from money brokers, continuing a policy debate that began over 30 years ago when I was chairman of the FDIC. The ABA report suggests that over time the FDIC may well have gone further than necessary in addressing the underlying problems with the practice."
Isaac says, "I believe the ABA report is responsible and helps illuminate a possible solution to the issues that have arisen with the FDIC's rules. That said, I'm concerned that the rhetoric of some bankers paints the FDIC's restrictions on brokered deposits as antiquated vestiges of a bygone era of no value in today's rapidly evolving internet era."
He tells us, "[B]anks, including highly rated ones, that rely extensively on brokered funds should be cautious. Brokered funds tend not to be as loyal and stable as funds raised directly from bank customers located in the bank's community. If a bank's condition deteriorates, funds purchased from investors without loyalty to the bank are more likely to flee."
The letter adds, "All banks, including those that make little use of brokered funds, should participate in this debate. We learned during the banking and thrift crises of 1980-1992 and the senseless panic of 2008-2009 that even the best of banks will be forced to bear the cost of any necessary government cleanup." See also, the American Banker op-ed, "FDIC crackdown on brokered deposits goes too far: ABA report."
