Re: Federal Reserve Report
You raise a point which has actually been getting quite a bit of press on blogs, forums, etc. as this is the first time that this has happened in about as long as anyone can remember. One of my finance professors recently even touched on this. On its face value, it's an accounting gimmick...but underneath, it's an indication of some special actions the Fed has had to take because of the dire situation in the banking sector.
Normally, banks could borrow from the Fed through what is called the "discount window" at the Fed's discount rate. This shows up in borrowed reserves. This type of borrowing is also normally limited as banks are normally reluctant to rely heavily on it for short-term liquidity as it signals a "red flag" to everyone at large. So when banks began having a lot of losses, the Fed improvised another direct lending program to banks called a Term Auction Facility (TAF). Basically, this let banks cheaply borrow for short-term liquidity needs (in aggregate up to levels of $200b) using those crappy subprime mortgage assets as collateral - the ones that no one else will touch right now. This not only provides banks with liquidity, but also helps boost the [I]quality[/I] of assets on their balance sheets. It also protects major banks' reputations as it reduces your transparency to see who is exactly in the worst shape right now.
Why did the Fed do this? Because in these kinds of perilous times panic tends to set in, which is exhibited by a refusal among financial institutions to deal with each other. The Fed can't allow liquidity to dry up in the [I]entire system[/I] as banks and other financial intermediaries basically stop performing their essential functions. And so the Fed, as "lender of last resort" with the power of the US Treasury behind it, will always come up with all kinds of ways to grease the skids in these situations.
So anyways, the reason we're seeing negative non-borrowed reserves is because of this TAF activity. As the Fed puts it:
[quote]The H.3 statistical release indicates that nonborrowed reserves of depository institutions have declined substantially since mid-December to a level that is now negative. This development reflects the provision of a large volume of reserves through the Term Auction Facility (TAF) and has no adverse implications for the availability of reserves to the banking system.
By definition, nonborrowed reserves are equal to total reserves minus borrowed reserves. Borrowed reserves are equal to credit extended through the Federal Reserve's regular discount window programs as well as credit extended through the TAF. To maintain a level of total reserves consistent with the Federal Open Market Committee's target federal funds rate, increases in borrowed reserves must generally be met by a commensurate decrease in nonborrowed reserves, which is accomplished through a reduction in the Federal Reserve's holdings of securities and other assets. The negative level of nonborrowed reserves is an arithmetic result of the fact that TAF borrowings are larger than total reserves.[/quote]
So what the Fed is saying is that the [I]baseline level[/I] for "total reserves" includes only regular holdings for the standard lending procedures; it does not factor in this new mechanism of extraordinary TAF funds. When you account for this TAF stuff based on those regular holdings levels, you will by definition end up negative.
I certainly don't think that this negative number means that the sky is falling. But it does show in a way how bad things have gotten. It also underscores the fact that despite its modernities, the financial system is always be fundamentally based on mutual trust and willingness of the players involved to engage in a market. This willingness can be quickly compromised when large shocks occur, and so you need a Federal Reserve to ensure that market liquidity remains and the whole system doesn't break down.