How the Federal Reserve drained the financial system of deposits
to understand how money gets destroyed in a traditional bank run. Picture the men in top hats yelling at clerks in “Mary Poppins”. The crowds want their cash and bank tellers are trying to provide it. But when customers flee, staff cannot satisfy all comers before the institution topples. The remaining debts are wiped out. did not ask for notes and coins. They wanted their balances wired elsewhere. Nor were deposits written off when the bank went under.
The answer begins with money-market funds, low-risk investment vehicles that park money in short-term government and corporate debt. Such funds, which yield only slightly more than a bank account, saw inflows of $121bn last week asfailed. According to the Investment Company Institute, an industry outfit, in March they had $5.3trn of assets, up from $5.1trn a year before.
And that is what used to happen. Yet there is one new way in which money-market funds may suck deposits from the banking system: the Federal Reserve’s reverse-repo facility, which was introduced in 2013. The scheme was a seemingly innocuous change to the financial system’s plumbing that may, just under a decade later, be having a profoundly destabilising impact on banks.
But use of the facility has jumped in recent years, owing to vast quantitative easing during covid-19 and regulatory tweaks which left banks laden with cash.creates deposits: when the Fed buys a bond from an investment fund, a bank must intermediate the transaction. The fund’s bank account swells; so does the bank’s reserve account at the Fed. From the start ofin 2020 to its end two years later, deposits in commercial banks rose by $4.
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