With the caveat that I’m by no means an economist...
The table at the bottom puts this in context: reserve requirements, which have never been reduced by more than $2 billion across the economy in any year prior, are suddenly reduced by $200 billion - the entire regulatory program seems to have been unwound.
Presumably this will give late banks desperately needed liquidity and ability to lend, but it also increases systemic risk. Desperate times these are indeed, but this is an unprecedented measure.
It's completely insane that they describe this in linear terms. The effects of reducing the reserve requirement is inverse-linear with respect to the ratio. Since the money multiplier is 1/r, reducing the reserve requirement to 0 means that any dollar has an unbounded limit as to how far it can be re-lent. That is quite literally infinitely more unprecedented than a 100x bigger dislodging of the "reduction in the reserve requirement".
The reserve requirement limit is purely theoretical anyway, since the Fed is obliged to pump more reserves into the system to maintain its interest rate targets when commercial banks [net] lend in excess of their current reserves anyway. The UK hasn't had a reserve requirement since 1981.
Agreed (I nearly mentioned it in the original post), and stricter capital requirements now than for much of the period since 1981. (Capital requirements don't entirely restrict the capability of the commercial banking sector to expand the money supply either, but they do require undercapitalised banks to raise more equity funding or similar if they want to continue to expand their loan portfolio)
We typically assume that loans are taken for some immediate use (rather than just having cash on hand). Thus you get the following scenario:
Bank loans $money to person A. Person A uses the $money to buy from person B. Person B deposits $money into the Bank. Bank now has $money (less reserve requirements) available to lend.
If I understand it right this impacts the reserve kept for loans. It keeps banks from calling in loans for all sorts of businesses - particularly those that are owned by your neighbors and employ that vast majority of workers.
Yikes, this is kind of scary. This could magnify the losses dramatically as lenders start to implode due to the cascade of defaults. If anything, they should increase the reserve requirements to prevent instability and encourage a flight from risky assets. Yes, this will make the stocks go down now, but it would probably result in fewer people getting laid off and going broke in the future.
I'd rather see highly leveraged companies go under quickly, rather than postponing it. A small bang now is less bad than a massive explosion later.
It is bold of you to assume that there are any non-highly leveraged companies, or that their going under would not already cause a cascade of defaults.
In other words we, as a country, would be rise to rip the bandaid off. Instead, we're slowly tugging at the edges. This is going to be a long, and drawn out recovery. I hope everyone followed the general consensus and has their retirement properly adjusted to their risk tolerance. This recovery is probably going to take years, from the time we get the economy restarted.
What other way is there? Japan and Europe is a preview, but there are few paths available as your structural demographics change and your economy tilts towards services instead of manufacturing.
Civilization matures, the foundational economics change, this is the result. Past performance does not guarantee future returns [1]. We can't rip the bandaid off because there are still too many people desperately clinging to a model of growth and wealth that is running out of runway. The bandaid will be ripped off for us. How many of those over 55 are likely to keep their jobs through this economic contraction [2] [3]? 48% of those folks (55 years old and older) in the US have zero retirement savings [4], and will rely entirely on Social Security (which will exhaust its trust fund in 2035 [5], reducing benefits to 75%; Social Security keeps 15 million seniors out of poverty at current entitlement levels [6], not to mention over 1 million children). 10k people a day turn 65 in the US. This, fortunately, entitles them to Medicare, but their consumption pattern will be reduced for the remainder of their lives and our Medicare costs are going to skyrocket.
You need leadership, political and monetary, that will attempt bold changes to accommodate these realities. The longer we wait, the more radical the measures will need to be when the time for implementation is at hand. Change happens slowly, and then all of a sudden.
We, the national we, need to have hard conversations about what changes must occur to balance the needs of all with our ability to provide. This obviously means some people will see reductions, others will see increases. The net result is overall more equitable society. The longer we delay the more hardship we all will have to endure. The mere fact that we have gone decades kicking cans is evidence of a deeply broken society without foresight and without leadership. I am not saying we do not have foresight or leaders, merely that our government is failing to foresee and lead.
These changes should have happened decades ago. Every day we delay is another day picking the edges of the bandaid while the wound beneath is septic.
I can suggest my ignorant idealsof potential solutions and delve into the weeds over things but that's a waste of effort. The people have spoken, and they are saying they would rather suffer more than consider how else the country could function.
I think the general consensus is that it's fine for bad companies to go under. But we have a situation here where a lot of reasonably good companies could go under just because of the social distance on a global scale.
The 2008 crunch was almost purely financial. Let's get past this pandemic and then see where the businesses shake out financially.
The CEOs will probably just take the money and use it for more stock buybacks and pay themselves bonuses. It's 2008 all over again.
They put themselves in this position by being fiscally irresponsible in order to pump and dump their stock. They should be held responsible by experiencing the joys of bankruptcy.
There's a point where:
1)traditional policy tools are ineffective because as rates get to zero, cutting them doesn't really provide any kind of incentive any more
2)interventions get more and more extreme and reach the point where they actually can increase panic rather than reduce it
It's pretty clear we're well past #1 and could be at #2.
The problem that policy-makers are facing here is the real economic impact of this crisis as unknowable but is very likely to be very large. So it's hard to incentivise lending.
For example if you're a bank in this environment it's pretty tough to have the courage to go out and lend to small businesses knowing the next few months are going to be brutal for their cashflow. The fed is going to have some difficulty convincing them to lend even in the presence of a zero reserve requirement ratio given that those banks will look at very serious potential writedowns on their loans in any downside scenario.
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.
"It helps to understand that the dollar has two layers:
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)."
No it won't. Reserve ratios are commonly modified, sometimes by a decent amount. Banks have been able to move money among accounts to effectively reduce reserve requirements nearly at will. And banks have always been able to lend past the reserve requirement, as long as they soon (after the fact) borrow to cover it, usually short term via the Fed overnight lending rate.
The average person has zero idea that this happens, but it's not going to somehow be impossible (or even hard) to undo it.
This is a major major change though. How do we know this isn't some kind of Klein-esque "Shock Doctrine" type of change to start undoing banking regulation as a whole?
Because we have models that have been tested, and we have evidence from hundred of countries for around 100 years.
Your question seems to imply that around every corner there are likely dragons. There are not. Mankind has extensive experience with central banking at this point, including this case and beyond.
There have effectively been zero reserve requirements for a long time. Go read on the difference between endogenous and exogenous money creation, and the resulting literature. Your understanding is far outdated, as the world has moved effectively to endogenous money over the past 40 years, as can be seen in the literature on the topic.
For net transaction accounts, i.e. “demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less”.
This isn’t a wholesale elimination of reserve requirements.
They are trying to keep banks liquid to avoid a panic and closure. People are already starting to pull cash.
This is a 9/11 like event, except the impacts are nationwide, not just in the NY Metro area. Companies and people are just going to stop paying bills. I'd guess you're looking at 2-4 million people out of work in the next week. The only saving grace is that this season is a low business period for retail and other sectors anyway, but they'll start dying in the summer.
> Can somebody clarify as to how this is a sensible move at all / what the intention is?
It's sensible because it's low risk. The intention is to alleviate pressure on the short-term lending markets, e.g. the repo and Fed Funds markets. This is about preventing a credit crisis moreso than juicing the taps.
Do you have an example of an account type that still has a non-zero reserve requirement? Because that list sounds quite a bit like the list of accounts where reserve requirements (used to) apply. IIRC there were no minimum reserves for time accounts like savings accounts or CDs.
It would seem that the logical response to this announcement is go run the banks right now, before March 26, and before anyone on Fox and Friends thinks to mention to their viewers what this really means.
Dropping reserve rates to zero massively increases FDIC's and NCUA's risk exposure, and simultaneously increases the size of craters that individual banks can make.
FDIC and NCUA are not bottomless pits of money, and I expect that, with a key safeguard removed, banks and credit unions now have the power to discover their bottoms more quickly than anyone should care to contemplate.
I should disclaim: I am not a banker, I am just a completely random person on the Internet, possibly a troll, and certainly someone who occasionally posts with a trollish twinkle in their eye. Don't take this as financial advice. Anyone who assumes I know what I'm talking about will get what they deserve for their efforts.
"FDIC insurance is backed by the full faith and credit of the United States government." [1]
Given that FDIC insurance is backed by the United States government, if the FDIC system is unable to cover its losses, wouldn't that represent the United States defaulting on its obligations?
I'm not saying that's impossible, but it seems like FDIC could represent a...pretty large bit of money.
I mean the FEd is currently considering what will amount to a near $1T aid Package as well, so I don't know how much the fed has on hand bit it really can't be much much more than 2T or so. So maybe.
The FDIC can get as much currency as they need from the Treasury to cover their obligations, so in that very technical sense they aren't likely to default. However, in the event this were ever actually tested they might as well have defaulted since the resulting inflation would be so high that currency would be worthless. Going from "can't get your money out of the bank" to "your money can't buy anything" isn't exactly an improvement.
(I realize this is pretty old, but I just came back to look at this, sorry)
> However, in the event this were ever actually tested they might as well have defaulted since the resulting inflation would be so high that currency would be worthless. Going from "can't get your money out of the bank" to "your money can't buy anything" isn't exactly an improvement.
While I could see this being true, I don't see how pulling cash from my bank and storing it under a mattress helps this scenario at all. Inflation hurts every dollar equally, regardless of whether it's stored in my bank, under my mattress, or is sent to me from the FDIC.
This is what I'm pondering at the moment. First would be the issue that this announcement is going to cause panic withdrawals (if it hasn't already) which I would guess has its own negative side-effects. Then it makes me wonder if printed paper would be worthless in a worst-case scenario anyway.
Or is this going to turn into Greece where all banks will close or limit the amount that can be withdrawn.
What a shit-show this has become
EDIT: another thing to consider is where to store all this cash if you withdraw. For those that have 6 figs in cash sitting in their banks, exposing that large sum of money in physical form poses an enormous risk (e.g. natural disasters or accidents being a big one)
True. It might dilute right quick if the banks get to start printing it, too. I suspect the Nash equilibrium may be for them to do so with reckless abandon.
One would hope that the Fed wouldn't actually allow that to happen. But how does one re-impose reserve requirements without causing even more problems?
It's like in that one song: "And I don't know why she swallowed the fly. Perhaps she'll die."
On the upside, I suppose we'll now get to have an empirical test to settle that age old debate over whether the number of people allowed to print money should be one or many. Pity Bitcoin's in such a shambles, so we can't with clean conscience make it a test among zero, one and many.
Banks don't print money. They give out depositors' money to borrowers. If those depositors all demand their money back, then the FDIC covers it, so the borrowers owe the governemnt (taxpayers) money. If they pay back, crisis averted. If they don't, then it's a wealth transfer from taxpayers to the people who borrowed the money and spent it on consmption or waste.
If you're a company who invested in a great workforce, and is getting nuked due to demand destruction, borrowing to keep paying them is a savvy long-term bet.
If you can't borrow, you'll have to let them go. That not only creates human misery. It also destroys the human capital you carefully built.
With most of currency being digital, this change of reserve ratio requirements has almost no effect in the way banking and economy works. Added a Wikipedia reference which has more references to empirical studies.
“ Many economists and bankers now realize that the amount of money in circulation is limited only by the demand for loans, not by reserve requirements.”
it will be absolutely great for the economy, rocket fuel, for about 5 years. Eventually will lead to some insane fundamental that will require a bail out.
I am no economist. What is being solved here? Allowing loans? Who will take out loans in the economy as it is?
I'd think a reserve at the banks is a good protection of solvency, and should be increased instead of decreased. Is my layman interpretation completely wrong? It feels like they ran out of bullets and have thrown the gun.
Typically, For every dollar a bank "keeps" in your bank account, they are allowed to loan out some fraction of the dollar. Let's say that this is usually 90 cents. The amount of cash your bank actually has on-hand is 10 cents. This process is known as fractional reserve banking. Now, with 0 reserve requirement, the bank can lend out the whole dollar.
Fractional reserve banking has produced a tremendous amount of wealth for the world over recent centuries. It encourages assets to be used in a productive manner rather than hoarded, which is essentially wasteful.
Typically, the loans get paid off to the bank over time, and the bank originates new loans to continue to make a profit. Currently, there are two systemic risks:
1. If borrowers begin to default, the bank still must cover its expenses. Under stressful circumstances, they would normally not be allowed to draw down their reserve to meet their expenses. This change allows this. Once the economy recovers, the reserve requirements will be reimposed.
2. It encourages banks to continue issuing new credit to borrowers. This keeps economic activity flowing and prevents a situation where borrowers have nowhere to turn to find money to keep their business afloat until profitable times return.
Reserve requirements are typically made more stringent while the economy is doing well. The history of these changes by the Fed is available at the link below.
> Doesn't this eliminate the protections from 2008?
No, it doesn't. Broader capital requirements are still in place. This move just removes reserve requirements for certain categories of transaction accounts.
> this is a defacto reduction in capital requirements no, if reserve requirements are lowered?
Nope, though that's a reasonable assumption.
Reserve requirements regulate the fraction of deposits banks must hold at the central bank. Reserve requirements focus on liquidity.
Capital requirements regulate the fraction of assets banks must hold as equity (or other tiers of risk-absorbing capital). Capital reserves aren't held in a vault, and are more of an accounting fiction than reserves. Capital requirements focus on solvency.
Put another way, if half a bank's mortgages turn out to be shit, its total reserves won't change. It's total capital will.
So reducing reserve requirements could reduce banks' capital, if the freed reserves are dumped into risk assets. Or it could leave them virtually unchanged, if the freed reserves are dumped into safer assets. Systemically, if the freed reserves support a continuation of orderly payment systems, they could increase banks' capital by defending the value of their assets. (Bank balance sheets have a confusing circularity about them.)
I would think it depends on how much you trust your bank to maintain solvency through the downturn. For what its worth I'm staying with who I was banking with in the last downturn, because they were one of several banks that remained solvent and healthy through the downturn. They did this by making conservative financial decisions, which they continue to do, so I'm not worried about them.
Probably a good step but it won't have much effect. Lending today is primarily limited by lack of credit-worthy borrowers, not by reserve requirements.
Just like anything else, diversify to reduce variance. But global catastrophes are hard to 1) see in advance and 2) do anything about because you're still buy trying to live your normal life without day to day concerns about solvency.
Say you have a bank account with $100 in it. At 100% reserve requirements, the bank must have that $100 actually in its possession at all times. This is very safe, because you are guaranteed to be able to withdraw your money in the event of a bank run. However, an economist might believe this is suboptimal because the $100 is just sitting there doing nothing rather than "circulating in the economy". Thus the concept of the reserve ratio is born: banks don't keep that $100 around, but instead lend a percentage of it out or do whatever weird trades they want to do to make money. This is called fractional-reserve banking.
Before this change, reserve requirements in the US were at 10% which means the bank could lend out $90. Now in general this is problematic because if everyone were to try to withdraw their money at once, the bank could not produce it. Thus we have the FDIC, which is a government program that insures bank account deposits up to $250k so people don't lose all their money if a bank run happens. A cynical way of looking at this is that taxpayers are on the hook for the bank's bad behavior if they go bust, and the lower the reserve ratio the more likely the bank is to overdo it.
Things also get really weird when other banks are in the picture. If you deposit $100 at bank A which has 10% reserve ratio, it will lend out $90 - so total money in the system is now $190. That $90 might end up deposited at bank B, which also has a 10% reserve ratio, so it lends out $81 making the total amount of money in the system $190 + $81 = $271. This process continues until it approaches the value of principal * (1 / reserve ratio), so in our case $100 * (1 / 0.1) = $1000 [0]. At 0% this means technically infinite money can be lent/created, although banks will presumably keep some percentage as reserves due to internal risk requirements (interesting assumption, I know).
Reserve requirement ratios are viewed as one of the levers the government can use to help steer the economy. Reducing the reserve requirement ratio has the effect of increasing the overall money supply, which has some nonlinear effect on the economy that the government wants to happen. This move to 0%, in addition to various other recent moves by the federal reserve, are all geared toward flooding the economy with cheap easy money to prop it up. They will all fail.
> However, an economist might believe this is suboptimal because the $100 is just sitting there doing nothing rather than "circulating in the economy".
A short-sighted economist, maybe. What needs to circulate is goods and services, not money. If you have $100 in the bank (or stuffed in your mattress), that means you produced stuff worth $100 more in total than what you consumed. Those extra goods are already being put to productive use. If your savings stay safely locked away and out of circulation that just means prices will be a bit lower due to the decrease in the money supply, which benefits everyone else. And when you take that saved money and spend it later your prices will be a bit lower, too, which is your reward (interest) for basically letting everyone else borrow the value of your money for the time you had it out of circulation.
If you can take your savings and invest them in some venture likely to provide a real return—after factoring in inflation and overhead—that would obviously be better than just stuffing the money in your mattress. However, taking money out of circulation is still better for the economy as a whole than "investing" it in something that can be expected to lose value, because that would divert goods and services away from better investments. If the money supply were held constant than you could treat price inflation or deflation as indications that we need more or less targeted investment, respectively. Unfortunately that isn't the case, so we're missing a key economic signal.
> Fractional-reserve banking is the most common form of banking practised by commercial banks worldwide. It involves banks accepting deposits from customers and making loans to borrowers, while holding in reserve an amount equal to only a fraction of the bank's deposit liabilities. Bank reserves are held as cash in the bank or as balances in the bank's account at the central bank. The minimum amount that banks are required to hold in liquid assets is determined by the country's central bank, and is called the reserve requirement or reserve ratio. Banks usually hold more than this minimum amount, keeping excess reserves.
It's a mighty pillar of our global economic systems or the biggest scam ever or both depending on who you ask.
Anyway, if I understand correctly (and I don't, IANAEconomist), now the fraction is zero. But I don't know what that means and I suspect few do. It sounds like it means that banks can just write loans all day long and "poof" money into existence, but I've been told that that is somehow not the case. Higher economics is indistinguishable from numerology (in terms of semantic analysis) to me, so I shouldn't comment further. Hopefully someone more knowledgeable will show up and read the tea leaves for us.
It's now legal for a bank with $1,000,000,000 in deposits to have absolutely zero cash available to pay out those deposits if people want their cash out.
One day people are going to look back to today and wonder why we have essentially given a license to print money to a privileged group of people with close to nil accountability. First to central bankers, and now to private bankers (which collect a profit from literally creating money out of thin air and lending it out). Our entire fiat monetary system really is incredibly bizarre and borderline fraudulent when you think about it in close enough detail, and yet it is still seemingly immune from mainstream criticism.
End central banking and you've single-handedly fixed systemic wealth inequality in the United States.
>Our entire fiat monetary system really is incredibly bizarre and borderline fraudulent when you think about it in close enough detail
I mean, almost every social construct is bizarre and borderline fraudulent when you get into it in granular detail. Why does someone paid by taxes working in a government created 200+ years ago get involved in my choice on who I marry or live with? Why does an arbitrary marker on a map indicating someone 'owns' a piece of the earth mean I can't walk across the actual physical ground?
They're social constructs. They're not natural. They're supposed to be bizarre. That's the point.
I doubt that the VC boom would have ever reached the heights it has without easy money policies and quantitative easing from global central banks. You would likely still have homeless people, but you would certainly have far less rich people.
Sure, we would certainly have less wealth in the absence of easy money. But we had paupers, merchants and nobility for several millennia's worth of limited quantities of precious metals being the only money, so it stretches credulity to pretend that hard money has any kind of egalitarian upside other than levelling down.
>Bank regulation is open to be criticized. But it's far from "nil".
Bank regulation is political and is regularly criticised, I'll give you that. However, the Federal Reserve and central banking is borderline immune to any form of criticism from the electorate partly due to a lack of understanding but also due to the widespread perception that central banking is somehow a necessity in a well-functioning economy and that its operation and development should remain firmly in the domain of "experts" like economists and others. I blame out-of-control scientism in economics for this one.
>Money was originally printed by private parties, then by banks, and most-recently by central banks.
Apologies, I phrased my sentence badly. It was more of a figure of speech rather than a historical account.
The table at the bottom puts this in context: reserve requirements, which have never been reduced by more than $2 billion across the economy in any year prior, are suddenly reduced by $200 billion - the entire regulatory program seems to have been unwound.
Presumably this will give late banks desperately needed liquidity and ability to lend, but it also increases systemic risk. Desperate times these are indeed, but this is an unprecedented measure.