Treasury Minutes Suggest Fed to Remove $1 Trillion in Excess Reserves by March 2010

EB's picture

This morning, Treasury released the quarterly Minutes of the Meeting of the Treasury Borrowing Advisory Committee Of the Securities Industry and Financial Markets Association, which is

[A]n advisory committee governed by federal statute that meets quarterly with the Treasury Department. The Borrowing Committee’s membership is comprised of senior representatives from investment funds and banks. The Borrowing Committee presents their observations to the Treasury Department on the overall strength of the U.S. economy as well as providing recommendations on a variety of technical debt management issues. The Securities Industry and Financial Markets Association does not participate in the deliberations of the Borrowing Committee.

Though the Committee had some interesting things to say about 30 Year TIPS and inflation expectations, we will focus on the statements of one member’s presentation regarding the Federal Reserve’s exit strategy (with respect to the >$1 trillion in excess reserves held by banks on its balance sheet).  We are not told just who the presenter is, but the Committee members comprise the most highly influential firms on Wall Street, including representatives from JP Morgan (Chairman), Goldman Sachs (Vice Chairman), Soros Fund Management, and Pimco. From the minutes:

The Committee then turned to a presentation by one of its members on the likely form of the Federal Reserve's exit strategy and the implications for the Treasury's borrowing program resulting from that strategy.

The presenting member began by noting the importance of the exit strategy for financial markets and fiscal authorities.  It was noted that the near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies, and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield.  Treasury securities have benefitted from the resultant increase in demand, but riskier assets have benefitted even more.  According to the member, the greater decline in the indices for investment grade and high-yield corporate debt relative to 10-year Treasuries and current coupon mortgages displays this reach for yield.  A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero.  [This is a shot off the bow to HY and, especially, CRE—more on this in another post.]

Here’s where it gets interesting:

The presenting member then looked at the likely sequence of the Federal Reserve's exit strategy.  The member acknowledged that the central bank must address the uncertainty and fragility of the economic recovery and the dependence of the housing market on low rates.  It was suggested that the most likely sequence would be the [1] draining of excess reserves from the banking system, [2] the cessation of the mortgage-backed securities purchase program, and [3] only then raising the Fed funds target rate.

Several members at this point asked why draining reserves before ending the MBS program made sense. The presenting member noted that the program was already set to expire, and other measures, such as a revival of the Supplementary Financing Program, could be utilized by the Federal Reserve at the same time.

The Fed’s $1.25 trillion Agency MBS buyback program is set to expire at the end of March, 2010, according to the last FOMC Announcement from September 23, 2009.  The point of the “several members” is valid, because why would the Fed drain reserves, only to continue adding them as a result of MBS purchases?  The presenting member points out that the Fed can avoid adding reserves after they are first drained through a revival of Treasury’s Supplementary Financing Program (SFP).

By way of background, the SFP is a special account maintained by Treasury at the Fed and is financed by cash management bills.  Says Treasury on September 17, 2008, “Funds in this account serve to drain reserves from the banking system, and will therefore offset the reserve impact of recent Federal Reserve lending and liquidity initiatives.”  Once the Fed gained the ability to pay interest on excess reserves in October 2008, Treasury announced that SFP would be gradually wound down as it was no longer necessary to sterilize the Fed’s balance sheet.  [As an aside, no where does the presenter mention the ability of the Fed to pay interest on excess reserves, a fact of which it is highly unlikely he would be ignorant.  Given the Fed’s recent statements regarding the use of other tools to manage excess reserves, we infer that the Fed does not view this as a viable option for managing excess reserves–perhaps because it is too costly, or too impotent a strategy.]

The big picture point, however, is that at least according to the presenting member (that we presume to be Fed-connected), the Fed currently envisions draining the >$1 trillion in excess reserves currently on its balance sheet by next March.  This is close to criminally insane, as the Fed has been deflationary with respect to M2 money supply since April 2009 and draining reserves would only further deflate the general economy.  If credit is hard to come by now, it will be immensely more so should these actions come to pass.

The mechanics of the draining are then discussed as follows:

The presenting member then addressed the options for draining reserves from the banking system.  The problem of excess reserves could persist through the end of 2011 with up to one trillion in excess reserves remaining after liquidity facilities and on balance sheet securities have rolled off.  One approach, raising the Fed funds rate to increase the opportunity costs of banks using their reserves, carries the attendant problems of increasing interest rates too soon in the economic recovery.  A second option, taking in term deposits, lacks a clear mechanism for rate setting and bank use.  Selling assets may run into difficulties if the public appetite for debt at that time is sated, especially considering the impact on the housing market and the major role the Federal Reserve currently plays in the market.  [Keeping up the public’s appetite for debt is the Fed’s de facto third mandate.]

According to the presenting member, these less than optimal solutions leaves the Federal Reserve the option of reverse repurchase agreements (reverse repos) as the most likely option although the potential of the mechanism for draining reserves is unclear.  If it is to undertake these reverse repos, the selection of counterparty is important.  Depending on how the program is designed, whether it is made to work with dealers or money market funds or to pursue a TALF model with banks as agents, there will be different impacts on the scope of the program, the ease with which it can be set up, and the term of the contracts.  In all cases, the program will compete with other short-term investments and put upward pressure on Treasury bill rates according to the presenting member.  Moreover, draining excess reserves may dampen the demand for Treasury securities by banks given that banks are investing in securities – particularly Treasuries - in the absence of loan demand. [Whether it’s the “absence of loan demand” or absence of banks willing to loan is a point for another post.]

Several members noted the graph discussing net fixed income supply in 2009 and 2010, and how issuance will ramp up dramatically in 2010. Federal Reserve purchases have taken an enormous amount of supply out of the market this past year across fixed income markets, but next year, financial markets should expect even greater issuance with no support. Such an outcome could pressure rates.

At this point, we must consider the possibility that the presenter is acting on behalf of the primary dealers and issuing a thinly veiled threat against the Fed and its deflationary policies.  QE has certainly been a profitable endeavor for them and the (recent) cessation of Treasury QE puts the primary dealers on the hook for any extra supply.  We hope we’ve simply read too much into this or that the presenting member at the TBAC minutes simply does not know what he’s talking about.  However, if the Fed is truly contemplating a drain of all excess reserves in such a short period of time, with the view of tightening shortly thereafter, we implore it to reconsider.

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Anonymous's picture

Lets assume that they do get back $1T.
We then raise the alternate minimum income so it tapers off ~ $60k. Whatever it takes to absorb that $1T.
Oh Boy - that Obama is the one for me! +
The urban poor spend on consumption. Good for economy, China. +
The lower middle class spend some, save some. If banks are iffy they buy bonds. +
Inflation encourages those with liquidity to buy safety, -bonds or inflation resistant investments. Property or Blue Chips? +
Inflation drives up the dollar denominated value of housing. +
Drives down the real cost of existing debt. +
Pro union stand drives up wages of sheeple. +
China upset by inflation. Threaten to include imports under current runaway product liability laws. +/-
Import prices up. Blame d**n furiners. Americans must unite against ----- +/-
Energy prices up. Blame Arabs. Build renewable. +
Fiscal conservatives, Zerohedge readers die of stroke. +

The plusses will help the electability of the current political process.

Bills come due in the future.

Sound possible?

Anonymous's picture

Time to sell your gold and...
Go long the USD.

Anonymous's picture

Deflation is nirvana

Anonymous's picture

If the Fed is really going to try to withdraw the trillion or so of excess liquidity it has injected, it would be a very good thing in the long term. No pain no gain! Yes, it will make the depression worse, but we will come out of this thing without a "Fall of Rome" scenario. We shall see.

time123's picture

Wow! If it is actually $1T they will remove, it is big!



Assetman's picture

My line of thinking has been:

(1) finish MBS puchases;

(2) drain excess reserves from the system;

(3) raise interest rates.

... so this is a pretty singificant revelation to me.

The problem with draining reserves is that banks are reluctant to do so in an environment where: (a) residential loan demand is still very weak; and (b) commercial real estate will has a long ways to wind down.

On the upside for the Fed, marketing and selling off Treasury-based reserves will certainly be easier than marketing the MBS crap that absolutely no one wants (regardless how its packaged).  All one needs to do is engineer a sell off in risk assets to get a flood of ready Treasury buyers.

It's draining MBS-based liquidity that is going to be a huge problem, and the reverse repo plan is risky on a number of fronts.  I'd be a very skeptical buyer of these reverse repos... and if they did work, the Fed is (again) kicking the can down the road.

As far as the political issues are concerned, if Uncle Ben gets Senate approval by the end of the year as expected, Obama will have less influence that the TBTF member banks to which the Fed appears to serve.   Uncle Ben may not have the ammunition to give Obama what he wants for the 2010 elections anyway, let alone 2012.

I still don't quite buy into the idea that the Fed will pull in reserves before ending the MBS program.  Perhaps the recent message from the Fed to the banks was... "you better start loaning out money, and creating velocity in the system-- or else". 

I just can't see Bernanke making that ultimatum to the oligarchs. 

nicholsong's picture

He cannot make such an ultimatum to the oligarchs because he is their stooge.

Assetman's picture

Exactly.  But he has been Obama's stooge as well.  At some point, the objectives between this administration and the oligarchs will diverge.

My money is on the oligarchs. 

That probably explains why the Treasury is aiming for another "blank check" bailout 2.0 authorization sometime next year.

brodix's picture

 I'd actually put my money on the politicians. When the bubble does pop, the capos are going to find their hit men gunning for them. Law of the jungle is like that. Honor among thieves is a fragile thing. The politicians do have two masters, money and votes. Since it's easier to squeeze out some money when you have a little power, the politicians gravitate in that direction. When the system crashes, they are going to run back to the votes and point fingers at the bankers. I suspect Obama will make that pivot faster than the eye can see.  The king is dead. Long live the king.

MsCreant's picture

Hi Assetman,

I have been wondering, just because interest rates go up, why should we assume people will not borrow? Back in the day I borrowed @ 9% for my student loan consolidation (to get the payments down, it is gone now) and 11.35% for my first car (a $7,000 Hyundai). I was indeed ignorant of just how bad those rates were, but in the final analysis, everything worked. The payments in both cases matched my ability as a grad student and later new professor to pay my bills. My house is modest and paid for, it was originally financed at 9%, then 7, then 5, then 1.99 (it too is paid). Do you see what I am getting at? I am fine because I did not go for big ticket items. People can qualify for loans that match their ability to pay, even if the interest gets high.

I remember my Grandmother getting 17% on some Cds...

I think more people would borrow less money and set their sites lower and we would recover sooner with higher interest rates, going to people who can afford it.

What am I missing?

Anonymous's picture

An aside -- it brings back great memories of when I took out a student loan (even though I did not need it) at 8% and parked in 18% money market. Ahhhh - using stupid government money - doesn't get any better than that.

It is why we need to shut down the government -- they are beyond stupid and frequently have no idea what is going on or the consequences of their actions. They arrogantly think they know best how to do everything......

Anonymous's picture

You are missing the current leverage ratios and collateral rates of return that would have been unthinkable in those days. A rise of rates to such levels would cause a collapse of asset prices to bring rates of return to levels that would adequately cover the interest rates. Call it Armageddon and you would still be conservative.

That is assuming we are not in a Ponzi economy of course.


Assetman's picture

You bring up a question that's very very important, MsCreant.

Here's what you are missing...

Imagine you know a student who has gotten a string of student loans over the years, and has rolled them over every couple of years to "get a better deal".

The irresponsible student makes it through school just fine, but decides to do post-graduate work and finds more loans, adding to the principle balance & still doing short term loans.

To top it off, the post-grad hits it off with another student that has even worse loan problems.  They get married, and he consolidates those loans so the inherited loans don't go into default.

The "irresponsible student" is our very own U.S. Government.  The bottom line is that the finanacing needs of the U.S. Treasury (just from the rolling over of notes about to mature) is HUGE.  The Treasury desperately needs to keep rates on new issues as low as possbile-- becuase we are getting that much closer to being unable to make those interest payments.  Higher rates means making those interest payments will become much more difficult.

Given that we 'married' into a Fed that is buying and keeping toxic debt on its balance sheet, those eventual losses will likely mean more new Treasury debt to issue.   Well, until our taxes are jacked sky high to pay for all this stuff.  That will certainly come when the economy is back on track.

The other thing that, perhaps, is missing is that YOU are responsible.  Our goverment, on the other hand, IS NOT.

EB's picture

I was skeptical for the same reasons.  To drain liquidity, the Fed will pobably just sell or repo Treasury's from the SOMA.  I don't think the Fed thinks for a second it could sell or even repo its Agency or Agency MBS holdings.  Those will die in the SOMA as Treasury guarantees Freddie who guarantees the Fed who prints to guarantee Treasury.  Certainly, this is a much better plan.

Assetman's picture

EB, you're certainly on the right track.

Given what we know about the relative scarcity of agency debt, the Fed might have a window to pawn that off.  The $300 billion of Treasuries will be sold off with no problem... they might even see at a premium if they engineer a "scare shitless" risk migration episode.

As anon posted near here, the Fed will then be left with a lot of crap after that... and that's the stuff that will likely be reverse repo'd. Ugh.

Anonymous's picture

As far as I could tell here:

Fed holdings of Treasuries vs Agency Debt was roughly equal. If they drain liquidity out of the system that leaves the Fed basically insolvent with nothing but garbage on the books. No?

MyKillK's picture

ZH, you missed highlighting a very important line where the presentor says:


"The problem of excess reserves could persist through the end of 2011 with up to one trillion in excess reserves remaining after liquidity facilities and on balance sheet securities have rolled off."


I think he is essentially admitting that it's not going to be possible to drain these excess reserves in any timely fashion. But they want to make at least the appearance of doing so without having to resort to raising rates. Therefore, the only viable option are reverse repo programs which won't actually drain them, only temporarily move them back onto the banks' balance sheets.


Anonymous's picture

i wonder if this is why Buffet took all of his money out of cash and into BNI....he knows that the Fed is going to take all of that GARBAGE and take the MMF funds in "reverse repo's" and then default on them after the election in 2010....they will say oops ...sorry we thought they were worth SO much more when we did the repo but we will pay you 2 cents on the dollar on your repo.......get your cash out of these banks now....this is your final warning....

Anonymous's picture

which banks? (i started moving my cash out last week)

wesa's picture

This committee is, by name, an Advisory committee.  As such, it would not be in a position to do anything except advise.  Reading these minutes and thinking about all the possible permutations due to the committee members, politics, Obama, Ben, and on and on is like trying to figure out how a Le Carre' novel will play out.

Right now it looks more like some kind of head fake than an established plan.

I think we need to keep watching and waiting.  Ongoing results will tell the tale.

Anonymous's picture

No rate change...


SDRII's picture

the fed can't drain without tanking bond market - the PDs will fight it tooth and nail - consider the WFC article in the journal (not new news) about housing loans for the comeback in real estate. it is pure fiction to assume the money laundering via the Fed/treasury and PDs will end. The outcome here isnt even binary. yet again Whitney says sell the banks into earnings now saying as ghost has been screaming the MBS buying end spells gloom.

Perhaps the solution is much more imaginative - like a wholesale deflating of the dollar for greener pastures

Steak's picture

Selling the dollar might well be the best idea they can come up with.  On top of it supercharging risk assets, foreign central banks have to do something with the dollars that carryers trade in.  So the short dollars can easily end up back in the treasury complex via foreign central banks.

Methinks we'll see more than a few dollar down, treasury prices down days, since FCBs will likely want more of a yield concession.

trillion_dollar_deficit's picture

Obama owns Bernanke now. There's absolutely no way he will do anything that will disrupt the markets before the midterms.  

Anonymous's picture

Down is the new up. See any reference to "green shoots." Might the above ownership be backwards?

Ivanovich's picture

I dunno, I thought that Bush wouldn't allow a collapse either, but he did or couldn't stop it. 

mock turtle's picture

drain excess reserves from the system in 2010?

im not buyin it

this is a head fake from the fed

aka ....  fed fake

ghostfaceinvestah's picture

ZERO probability of MBS purchases ending in March.  ZERO.

Sancho Ponzi's picture

...unless they know something about the future of the USD we're not privy to. 

Hephasteus's picture

fuck off the FED sounds better to me.

Anonymous's picture

Let's make an assumption here, that Ben Bernanke is not on the take, and in general has good intentions and believes he is doing the right thing, and has been. If so, essentially what the premise is, is guys, i've saved you for two years it is now time too stand on your own two feet. With all these green shoots, the administration will no longer hold your hand. All those mortgages etc. that you so dearly loved and wanted to hold, well now you have to finance them yourselves. Sorry, I can no longer do it, I am right on the line of criminality and enough is enough.

The reality is at some point he hsa too stop. All of those dates have been posted for over a year, they know the time is coming.

It makes you think, Whitney is as usual right as rain.

Anonymous's picture

when you assume you make an ass of U and Ben

MsCreant's picture

Iba beba Assumeben...

Like that?

(Bill Cosby joke, modified for the aughts)

MsCreant's picture

I wonder if they had the info about the price of gold going up so recently factored into these remarks? One would think so...

Could they be rattling the chains loud to scare it back down? I know this is a very gold-o-centric post, but still...

Bit Bucket's picture

MsCretin MsCreaunt. And how do you like HGSI??????????????

U trashed me and I am up $184K on that position.

The Bit

Miles Kendig's picture

Bit of whatever you are, you might be used to talking trash to passer by else where.  However, that dog won't hunt here.

Happy trails

theadr's picture

bb, Better liquidate that position but quick or us 10,000 tylers will naked short your gain!!!

nicholsong's picture

Congratulations on your trade.


Short Man Syndrome much?

Miles Kendig's picture

Let's all give Bit of what ever it is the waving pinky finger salute for sure.  LDS POS.

MsCreant's picture

Marla, Tyler, this kid needs a time out.

Child, I did not trash you, I attempted to give you guidance regarding your conduct. I posted a link for you to look at regarding ZH's stance on using things here to make money. I also left a post for you upthread, where you left one for Cognitive Dissonance. I will surely NOT rewrite it here.

It seems you are not done streaking. Oh well, some folks are so profoundly hurt and deprived they cannot help what they do, the need is a gaping, vast, bottomless, crater of emptyness that can never be filled because they never attached to anyone properly as a kid.


I am sorry for you.

Streak away. But it won't fill your needs or take care of what is wrong with you.

nicholsong's picture


Thank you for this comment and for the one above. You hit the nail on the head.

This guy is a gutless turd.

lsbumblebee's picture

"Turn on the giant vacuum cleaner!"

Just more bluff in another lame attempt to contain the gold market.


Hondo's picture

Seems to me the banks are doing nothing with their excess reserves but buying treasuries anyway (certainly this helps recapitalize the banks........slowly).  But I don't see how the Fed can be expected to be the financer of all debt issuance both public and private.  At some point the cards will have to fall and those that can't survive will fail.......the sooner the better for the long term health of the economy.


We should have never gone down this road in the first place.  It has not helped and only delayed the eventual fallout of high and unsustainable leverage in the system.  We’re beginning to look like the Chinese and Japan in propping up companies and programs that should fail.



Anonymous's picture

The banks excess reserves were created by the Fed buying MBS and the Special Lending Programs. They just sit there at the banks earning the Fed Funds Rate. Banks cannot invest reserves in Treasuries.

Anonymous's picture

Oxygen level must be very thin on the grassy knoll. Amongst the crazy conspiracy theories hatched here this one one of the nuttier.

hank_rearden's picture

if you angle your head and squint, you can kinda see the virgin mary in the release.

starfish's picture

nice one Hank.  I'm keeping my eyes on mom, instead of the FED...

mgarrett84's picture

Are we sure the draining of excess reserves has the impacts suggested above.   That is stagnent capital isn't it?   would a draining of the er's possibly push it into risk assets and speed up money velocity??   I have been wrestling with this idea for a few weeks now.