The expansion of the Federal Reserve’s portfolio of Treasury debt and mortgage-backed securities has a bigger impact on the credit markets than paying banks interest on excess reserves.
there is a considerable debate in the world of economics and finance about the efficacy of the Federal Reserve’s payments of “interest on excess reserves” held at the central bank. Norbert Michel at the Heritage Foundation and George Selgin at the Cato Institute, vociferous critics of the practice, claim that the 1% now paid in interest on excess reserves (IOER) is constraining bank lending. In fact, there is nothing that supports this thesis.
Properly viewed, the Federal Reserve System is the alter ego of the U.S. Treasury. The Fed does not earn “profits” from its holdings of Treasury debt, but simply forgives part of the obligations of the United States, subtracts its operating expenses, and remits the balance back to the Treasury.
In 2008, when Congress gave the Fed the power to pay IOER deposited with the Fed, it was simply creating a new short-duration, risk-free asset class. Excess reserves compete with Treasury obligations and other short-duration investment assets with low or zero risk weighting for bank capital purposes. The 1% that the Fed now pays on IOER is a bit higher than the 0.8% available on T-bills maturing in the next four weeks, but does this constrain bank lending? Absolutely not.
In the theoretical realm of economics, the Fed’s 1% payment of IOER may seem significant. But, especially since it is a true risk-free asset, the relevant comparison for this rate is against other short-term investments with similar risk profiles. Excess reserves on deposit with the Fed are cash, so if the bank finds a better use for the funds, there is nothing to prevent a change in asset allocation.
When considering the asset-liability management of a bank, there are basically three buckets: lending, investing and trading. The fact that the bank can earn 1% on excess reserves with the Fed — with a zero capital weight — is certainly relevant to the investment function of the institution, but the lending side of the house is unlikely to even consider it. More important to lending are the internal exposure risk limits for different asset classes, the overall leverage of the institution versus regulatory limits, and the net runoff of existing loans.
This is not to say that Fed monetary policy has no effect on lending. In fact, the vast expansion of the Fed’s $4.7 trillion portfolio of Treasury debt and mortgage-backed securities has a significant impact, resulting in a distortion of the credit markets. These purchases of securities by the Fed were funded with excess reserves essentially created by the Fed as part of its radical policy of “quantitative easing,” or QE. The result has been a sharp contraction in credit spreads that has effectively suppressed the true cost of credit.
Far from constraining bank lending, the Fed’s QE has encouraged a great deal of lending and, most important, securities issuance to inferior borrowers at investment-grade credit spreads. Investment grade debt issu- ance is at record levels. The fact that the Fed pays banks 1% on IOER balances in return for longer-duration Treasury debt and even Ginnie Mae MBS acquired via QE is hardly a good trade-off. Indeed, one might well ask why the Fed does not pay banks more than 1% in IOER!
Ultimately, most of the growth of excess reserves at the Federal Reserve is driven more by QE than the relative rate paid. When the Fed belatedly declares success and winds down its massive portfolio, credit markets will start to normalize and the considerable credit risk created by QE will also start to subside, though this process will take many years. Although some view the Fed’s payment of IOER as a subsidy to banks and an inflationary threat, others maintain it keeps interest rates and inflation in check.
Christopher Whalen is chairman of Whalen Global Advisors.
Properly viewed, the Federal Reserve System is the alter ego of the U. S. Treasury.
Parkside Lending has expanded into New York with the addition of Rich Bloom as Northeastern regional manager and Katie Plezia and Elizabeth Nichols as senior account executives.
Bloom has been in the mortgage business for 31 years, 24 as a sales manager, and will be covering the East Coast from Virginia to Maine.
Plezia has over 30 years of mortgage experience in the New York market and Nichols has over 20 years of experience as a wholesale and correspondent account executive in downstate New York, specializing in jumbo, conventional, FHA and VA loans.
LBA Ware has hired industry veteran Finn Klemann as director of business development.
Prior to joining LBA Ware, Klemann was vice president of sales for the Northeast territory at LoanLogics, a mortgage technolo y and outsourced services provider.
He has also held several high-level sales positions with - nancial services companies such as Interthinx (now First American Mortgage Services), Ascendant Capital Partners, Haverford Financial Services, Envestnet and Lincoln Financial Distributors.
Aries/Conlon Capital said that Francisco Nacorda has joined the rm as senior vice president and will lead the boutique commercial mortgage banking rm’s originations business in Orlando, Fla.
In his new role as SVP, Nacorda will be responsible for arranging bridge and permanent debt on be- half of owners of all commercial property types nationwide.
He has nearly 25 years of experience in the commercial real estate industry and prior to joining Aries/ Conlon Capital, he served as senior executive vice president of LD Capital for six years, where he sourced, originated, underwrote and structured debt and equity for mid-to-large balance commercial transactions.
Wells Fargo Home Lending has named Liz Bryant to lead the company’s retail sales organization.
Bryant has 25 years of experience in mortgage originations and operations, and has been with Wells Fargo since 2003, most recently serving as head of home lending retail ful llment operations.
Prior to joining the company as a regional sales manager, she served with GMAC Mortgage, where she was responsible for retail loan production and operations in 17 Western states.
The Cooperative Bank, a full- service community bank specializing in commercial real estate and business lending throughout eastern Massachusetts, has hired Jim Picciotto as senior mortgage loan originator.
In this role, he will generate quali ied residential mortgage business in The Cooperative Bank’s CRA lending area and surrounding communities.
Picciotto has almost 30 years of experience as a mortgage banker and prior to joining The Cooperative Bank he held positions at United Bank, EverBank and Cambridge Mortgage Group.
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