Remember how the Fed was testing reverse repos with money market funds as a potential way to drain QE liquidity out of the system further down the line?
Well, some blogosphere talk (Zero Hedge, ahem) appears to suggest the Fed may now be backing away from the idea of using non-traditional participants like money market funds altogether, after a bad experience with its October test.
In a reverse repo (reverse repurchase agreement) the Fed sells assets such as Treasury securities to dealers for cash, with an agreement to buy them back later at a slightly higher price. In the process, bank reserves are drained from the financial system.
In the latest twist, though, primary dealers are allegedly making some rather unconventional demands for stepping in to help.
Note the following report from Market News International picked up by Zero Hedge:
After growing somewhat frustrated with the feasibility of doing large-scale reverse repurchase agreements with non-traditional counterparties, the Federal Reserve has begun to focus more on doing these reserve-draining operations with the primary dealer community when the time comes, Market news International understands.
The Fed has been informed by dealers that they would be willing to enter into very sizable amounts of reverse repos with the Fed, if asked to do so, provided they could get some relief from Tier I capital constraints, MNI also understands.Both Zero Hedge and the Market Ticker blog equate this sort of Tier 1 relief demand to nothing short of “extortion” by the banks.
Whether the above is true or not is yet to be seen. We in the meantime would draw attention to the fact, as the Alea blog reminded us via Twitter, that primary dealers are not regulated by the Fed. This means the Fed is no position to cut any such Tier 1 deal with the dealers. Although, presumably, that doesn’t mean the regulators can’t.
