- Reuters/Finbarr O’Reilly
- The Federal Reserve should implement a standing repurchase-agreement, or repo, facility to better stabilize overnight lending markets, former New York Fed chair William Dudley wrote in a Bloomberg Opinion column.
- The former central bank president argued that, though the Fed’s capital injections have pulled its key lending rate back into its intended window, more steps should be taken to ease money markets.
- A standing repo facility would let borrowers convert securities into cash reserves whenever they see fit, instead of relying on scheduled repo offerings to adjust their reserves, Dudley wrote.
- The former Fed chair also called for additional transparency around the effectiveness of its policy tools and a “de-emphasizing of the federal funds rate” as a critical benchmark.
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The Federal Reserve should implement a standing repurchase-agreement, or repo, facility to better stabilize overnight funding markets, former New York Fed chair William Dudley said in a Bloomberg Opinion column published Monday.
The former central bank chief argued that, while the Fed’s capital injections have keep interest rates in their intended window, several steps should be taken to further support its new monetary policy toolkit. The central bank’s autumn rate spike led many to fear the Fed lost control of money markets. That event should guide the bank in the tough task of adapting to the post-financial-crisis lending environment, Dudley said.
“The spike in the fall was not a ‘canary in the coal mine’ signaling bigger problems in the financial system,” he wrote. “Instead, it reflects the difficulty in forecasting the demand for reserves given the changes in regulations.”
A standing repo facility would effectively replace the central bank’s capital injections and let lenders convert securities into cash reserves whenever they see fit, according to the former Fed chair. An open cash pool would decrease the potential for a last-minute cash shortage, and Dudley isn’t the only expert to endorse the idea. Former Fed officials Joseph Gagnon and Brian Sack backed a standing facility in a September blog post, saying it would serve as a “guardrail” for unexpected events.
“The most important lesson from the recent episode is that, even in a regime with ample reserves, unexpected developments can occur that put upward pressure on money market rates,” Gagnon and Sack wrote.
The proposed facility would also solve an issue raised by JPMorgan analysts in late October. The analysts pegged smaller banks, or non-primary lenders, as “the most acute source of stress in repo markets,” as the Fed’s repo operations would directly cater to bigger firms. Non-primary lenders were left with little additional liquidity, according to the analysts.
A standing repo facility would “address the potential problem of the Fed providing liquidity to primary dealers but primary dealers not lending the funds to other market participants that might need short-term repo financing,” the former bank chief wrote.
Rates for repurchase agreements soared to 10% from the 2% intended window on September 17, prompting concern around whether the nation’s money markets were far less stable than previously thought. The Fed began repo operations soon after to calm the key funding rate, and started Treasury-bill purchases weeks later to further ease overnight money markets.
The September crisis isn’t likely to be a one-off stumble, the Bank for International Settlements said in a December 8 report, and the spike was exacerbated by big banks and hedge funds.
Dudley proposed a handful of other updates for the bank, including additional transparency around the effectiveness of its policy tools and a “de-emphasizing of the federal funds rate” as a critical benchmark. He expects the Federal Open Market Committee to complete a review of its policy tools in 2020, and hopes central bank officials will “more enthusiastically endorse” the Fed’s framework for utilizing monetary policy.
Dudley served as the New York Fed’s president from 2009 to 2018 and as the FOMC’s vice chairman.
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