Cool Video: Federal Reserve and Repo Market

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This Cool Video comes from the Financial Times.   Patrick Jenkins, the financial editor, discusses the shadow banking sector in three minutes.  He provides a big picture overview. Two additional points should be noted.  

First, Jenkins talks about shadow banking without specifying the types of firms that are involved.  He does cite the collapse of the SIV structure that a conduit for banks.  He talks about concerns in China, the US and Europe.  He talks about their activity in direct lending.  What may be lost in translation is that the off-balance sheet activity of the banks themselves is an integral part of the shadow banking sector.  Accounting rules and regulations allow banks and other financial intermediaries to move or keep activities off their balance sheets. These off-balance activities and exposures lies behind most of the modern financial crisis, beginning with the Latam debt crisis of the late-1970s and early-1980s, running through the Asian financial crisis 1997-1998 and the Great Financial Crisis.  

Second, Jenkins hints at a quid pro quo.  The shadow banking operators should face greater regulation in exchange for access to the liquidity backstop of the central bank.  Jenkins' video is embedded in a article that uses data from Fitch to show the US money market funds that invest almost exclusively in government paper have replaced banks as the Federal Reserve's biggest counter party for reverse repos. The reverse repos allow the central bank to manage liquidity as it exits QE and near-zero interest rates.   

Between September 2013 and the end of May, government money market funds increased their activity with the Federal Reserve to $87 bln from $65 bln.  During the same period, dealer-bankers saw their share fall to $38 bln.  Currently, the Fed's self-imposed rules limits its exposure to any one counter-party to $10 bln in reverse repo operations. This is likely to increase as the Fed goes from testing to implementing the reverse repos as liquidity management tool.  

The relationship between the government money market funds and banks needs to be examined closer. Some banks, after all, run their own money market funds.  Meanwhile, some banks have reduced their reliance on money market funds as a source of wholesale financing, while other banks, especially a few foreign banks, appear to have increased their activities.

(click here for the video)