New York Fed President: Excess Reserves at the Fed Are Put to Good Use

This video was one of the three that were posted on Zero Hedge on Monday. It is a video of CNBC's Steve Liesman interviewing the New York Fed president Bill Dudley.

About 3 minutes into the interview, the NY Fed president admits that the Fed is using the excess reserves to purchase Treasuries, agency bonds, and mortgage-backed securities for its Open Market Operations.

The Fed is doing what?

The excess reserves belong to the member banks (national and regional commercial banks). Since the near-collapse of the financial system last September, banks park their excess reserves at the Federal Reserve instead of lending them out as loans, and earn interest. The excess reserves sit on the LIABILITIES side of the Fed's balance sheet. The banks are "lending" money to the Fed by parking their reserves, but it is an extremely short-term lending: 24 hours.

Now the NY Fed president says they've been "borrowing" this short-term money and "lending" it to the Treasury Department, by purchasing Treasury notes, bonds, agency bonds (that no one in the world wants to touch at this point), and MBS. They are all longer-term investment, the shortest being 2-year note, the longest 30-year Treasury or agency bond.

Naturally, he downplays the risk of higher "borrowing" cost. He doesn't seem to think that the economy will recover in a meaningful way any time soon for the short-term rate to rise.

Why do they need to do this? They can simply print money to buy Treasuries, and a lot of people already think that's what they've been doing. Just to technically avoid the dreaded word "monetization"?

Borrowing short and lending long is what banks do, and what killed Bear Stearns and Lehman Brothers when the short-term liquidity simply vanished from under them. And they didn't have $2 trillion balance sheet that the Federal Reserve has.

Does Tim Geithner know that the Federal Reserve has been using the excess reserves to buy Treasuries? Do the member banks know? They must and they must have agreed. They just didn't bother telling us, because there's nothing to worry about. Right? (Bear Stearns? Lehman Brothers?)

Between the Fed acting like a highly leveraged investment bank and FDIC outdoing AIG with its paltry $10 billion (reserve ratio of 0.22%) to cover nearly $5 trillion deposits (not to mention hundreds of billions of dollars of loan guarantees and loss-sharing agreements), we are somehow supposed to feel secure that we're in good hands.

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