No, the Fed Is Not Cutting a Check to Banks

POLITICS & POLICY
Federal Reserve in Washington, D.C. (Kevin Lamarque/Reuters)

Today the Fed announced a $1.5 trillion liquidity provision to the interbank lending market — primarily in the form of “repurchase agreements.” The interbank lending market comprises the federal-funds market (in which the Fed actively participates on a daily basis) and the repurchase-agreement (or “repo”) market (in which the Fed intervenes primarily when there is a lack of liquidity). In the repo market, one financial institution temporarily trades securities to another institution, with the understanding that it will repurchase those securities in the near future (usually the next day). Banks with large balance sheets often need access to quick cash to conduct regular operations, and the most practical way to get that cash is through repos. Otherwise, managing their balance sheets would be needlessly onerous. 

In times of crisis, the securities exchanged in the repo market become more volatile, and the “counterparty risk” of trading repos (the risk that the bank you’re doing business with won’t be able to buy back their securities when the time comes) suddenly increases. Usually, counterparty risk in repos is close to zero, due to the short-term nature of the market. The upshot of all this is that when markets are volatile, otherwise solvent financial institutions may not be able to fund regular operations. That creates massive distortions in financial markets, and trickles down to consumers and businesses that rely on banks for credit. 

So the Fed sometimes transacts in repos, lending banks cash overnight in order to ensure that the financial system remains healthy.

You Might Like

But after today’s announcement, observers on the left immediately balked at what they saw as the government giving handouts to banks instead of hard-working Americans. Alexandria Ocasio-Cortez, the beloved representative from New York, asserted that “the amount that the Fed just injected almost covers all student loan debt in the US.” “Why not bailout indebted students instead?” she implies. In the interest of correcting that misunderstanding, dear reader, I have decided to remain in Manhattan writing this blog post instead of buying canned foods and absconding to the countryside. 

The Fed is not cutting a check to financial institutions

It is engaging in short-term transactions with banks to ensure financial stability. If the Fed bought your house today and sold it back to you tomorrow, it wouldn’t be doing you a huge favor. The Fed’s intervention in the repo market, while a boon to the U.S. financial system, is far from a handout. 

Articles You May Like

Tesla car battery ‘spontaneously’ bursts into flames on California highway, firefighters need 6,000 gallons to put it out
NY Times Smears Scientist on Front Page for Daring to Defend Gas Stoves
Yes, Ilhan Omar Had to Be Punished — and Democrats Know This
Black Swan financial manager is preparing for “mega-tinderbox timebomb” event that will crash economy
DeSantis admin targets liquor license after venue allegedly allowed minors to attend raunchy drag show

Leave a Reply

Your email address will not be published. Required fields are marked *