The Wall Street Journal - 20.09.2019

B10| Friday, September 20, 2019 THE WALL STREET JOURNAL.**

composed of $3.8 trillion in

assets—primarily Treasury se-

curities and mortgage-backed

securities—and liabilities, in-

cluding the reserves that were

created to purchase the assets.

The Fed stopped buying

bonds to spur the economy in

2014 and began slowly shrink-

ing the holdings in 2017 to re-

duce the stimulus, which

drained reserves from the sys-

tem. Reserves have fallen to

less than $1.4 trillion from a

high of $2.8 trillion in 2014.

In the normal course of

business, the Fed’s balance

sheet should grow to keep up

with demand for the Fed’s lia-

bilities, which include cur-

rency in circulation and the

Treasury’s general financing

account.

The amount of currency in

circulation has grown to $1.7

trillion from less than $800

billion in 2007. During periods

when the Fed has held its bal-

ance sheet steady, reserves de-

cline if the Fed’s other liabili-

ties rise, removing cash from

markets.

The Fed’s balance sheet

doubled between 1994 and

2007—well before it started

its bond-buying stimulus pro-

grams, sometimes called quan-

titative easing, or QE.

“By expanding its balance

sheet, the Fed would simply

accommodate the market de-

mand for liquidity, not provide

excess liquidity, which is a

characteristic implicit in QE,”

said Roberto Perli, an analyst

at Cornerstone Macro, in a

note to clients Tuesday.

The decision to resume

growth of the balance sheet

isn’t a big surprise. Several

Fed officials said earlier this

year they didn’t want to re-

duce reserves to levels that

might fuel volatility in short-

term money markets. A sea-

sonal cash crunch on Monday,

however, did just that.

Corporate tax payments

and settlements of govern-

ment bond sales resulted in a

large transfer of cash from the

banking system to the Trea-

sury, fueling a spike in over-

night lending rates, including

the Fed’s benchmark federal-

funds rate.

The fed-funds rate traded

at 2.3% on Tuesday, according

to the New York Fed, rising

above the central bank’s target

range between 2% and 2.25%.

Separately, the Fed lowered

the range by a quarter of a

percentage point on Wednes-

day to cushion the economy

against risks from trade policy

uncertainty and slowing global

growth.

Tuesday’s rate jumps raise

the possibility the Fed mis-

judged the appropriate level of

reserves or that broader

plumbing issues are interfer-

ing with the ability of banks

and other broker-dealers to

move cash, which could re-

quire a larger volume of re-

serves to keep markets run-

ning smoothly.

Determining when to stop

the decline in reserves “is

probably more art than sci-

ence,” said Boston Fed Presi-

dent Eric Rosengren in an in-

terview earlier this year.

When it comes to determin-

ing the right point to stabilize

reserves, “we’ve always said

that the level is uncertain,”

Mr. Powell said Wednesday. “I

think we’ll learn quite a lot in

thenextsixweeks.”

Fed officials face other

thorny questions after that, in-

cluding whether to change the

mix of the Treasury securities

they are purchasing and

whether to become more in-

volved in money markets by

creating a new standing facility

that would reduce volatility in

participants’ demand for cash.

Treasurys every month
to prevent bank deposits,
known as reserves, from de-
clining; that is on top of
around $35 billion in Trea-
surys it is buying to replace
retiring bonds and mortgage-
backed securities.
Central bank officials said
this spring that they would
stop shrinking their Treasury
holdings, a decision that took
effect last month. But they
never said when they would
allow their holdings to grow
again.
The Fed’s balance sheet is

Continued from page B1

Fed Weighs

Small

Bond Buys

BANKING & FINANCE

York, obligated to bid at every

auction of U.S. government se-

curities. Others include Gold-

man Sachs Group Inc., JP-

Morgan Chase & Co. and

Barclays PLC.

Treasury Secretary Steven

Mnuchin last week said the

agency is very seriously con-

sidering selling 50-year bonds

next year, as the Trump ad-

ministration looks to lock in

low borrowing costs. The U.S.

budget gap through August

has surpassed $1 trillion for

the first time since 2012, and

budget analysts say it is likely

to remain elevated for years.

That puts pressure on offi-

cials to find ways to mitigate

rising interest costs. Those

have already climbed to a re-

cord $538.6 billion in the cur-

rent fiscal year, which closes

at the end of this month.

The average maturity of

U.S. debt is almost six years,

about one year more than its

average since 1980. The aver-

age maturity had fallen to

roughly four years in 2008,

andgrewintheyearsoflow

rates following the financial

crisis.

Interest expense as a per-

centage of the economy was

1.6% last year, according to the

Federal Reserve Bank of St.

Louis. While that is more than

in recent years, when bond

yields reached record lows, it

remains lower than in the

1980s and 1990s.

Some analysts have said

that the Treasury Department

should be moving more

quickly to take advantage of

this year’s surge in demand

for long-term debt.

As investors have plowed

into bonds, the yield on the

benchmark 10-year Treasury

note has fallen to about 1.8%,

or almost by 1 percentage

point since the start of the

year. That yield is less than

the rate the government pays

to borrow for three months,

roughly 2%.

Advocates for ultralong se-

curities, as 50- and 100-year

debt is known, say that lock-

ing in current low long-term

rates now would reduce the

risk of the government having

to refinance shorter-term debt

at high interest rates at some

point in the future. That could

save taxpayers money, they

say.

“The government should

act more with the mentality of

an investor, of an asset man-

ager,” said Campbell Harvey, a

finance professor at Duke Uni-

versity and a partner and se-

nior adviser at Research Affili-

ates. “There hasn’t been a lot

of innovation by the Trea-

sury.”

Yet a decision to sell 50-

year or 100-year debt could

set the agency at odds with

the bond dealers who help sell

the debt to investors, along

with the Treasury Borrowing

Advisory Committee, a group

composed of large financial in-

stitutions that advises the

government on bond-market

issues. On several occasions in

recent years the TBAC, as the

group is known, has advised

against selling securities with

those maturities.

“There is little evidence of

strong or sustainable demand”

for such long-term securities

in the U.S. market and 100-

year securities were “not

worth considering,” according

to a 2017 letter sent to Mr.

Mnuchin by Jason Cummins,

then chairman of the TBAC.

The Treasury said at the

time that it would continue to

study selling the securities.

Last month, the Treasury

said on its website that it was

conducting broad outreach to

assess market appetite for 50-

and 100-year bonds, though no

decision to sell them had been

made. A department spokes-

man this week declined addi-

tional comment.

The Treasury has tradition-

ally avoided adjusting its debt

sales to try to take advantage

of shifting market demand.

The agency’s policy of selling

bonds on a predictable sched-

ule has helped hold down bor-

rowing costs for the U.S. by

ensuring a regular supply of

liquid, risk-free debt, said Dar-

rell Duffie, a finance professor

at Stanford University.

This year dealers have pur-

chased slightly more than one-

fourth of notes and bonds with

maturities ranging from two

to 30 years, down from

roughly half in 2013. That is

the lowest proportion since

the government began releas-

ing such data in 2006. The de-

cline reflects greater competi-

tion for the securities from

investors, who have increas-

ingly bid for Treasurys at auc-

tions rather than buying them

through dealers.

The Treasury Department
wants to take advantage of
falling interest rates to borrow
long term, selling bonds that
don’t mature for a half-cen-
tury. Wall Street may not want
them.
While the Treasury could
attract demand for an occa-
sional sale of ultralong-term
bonds, some dealers said that
could siphon demand from its
regular sales of 30-year
bonds—currently its longest
maturity.
That could lead the govern-
ment to pay higher interest on
its 30-year bonds, of which it
sells almost $200 billion each
year. And in the context of a
$16 trillion debt load, the po-
tential savings from locking in
low-interest rates would be
fairly modest, dealers said.
Some dealers also perceive
business risks from ultralong
securities.
“It could stress already
stretched dealer balance
sheets and put more pressure
on trading desks,” said Gen-
nadiy Goldberg, a government-
bond strategist at TD Securi-
ties. The firm is among a
group of 24 domestic and for-
eign banks, overseen by the
Federal Reserve Bank of New

BYDANIELKRUGER

Dealers See Risks in Ultralong Treasurys

Insurance executive Greg

Lindberg asked a federal judge

to dismiss charges that he

tried to bribe North Carolina’s

insurance commissioner, with

his attorneys saying that his

actions fell short of criminal

conduct in light of recent Su-

preme Court rulings.

Mr. Lindberg was arrested

in April and charged with at-

tempting to bribe Commis-

sioner Mike Causey with cam-

paign contributions, allegedly

to gain more favorable regula-

tory treatment for his insur-

ers. Three other people, in-

cluding the then-chairman of

the state’s Republican Party,

were indicted. All have

pleaded not guilty.

Mr. Causey secretly re-

corded meetings with the de-

fendants after going to federal

officials with suspicions that

Mr. Lindberg was trying to

bribe him, prosecutors have

said.

Criminal prosecutions of

public officials and corporate

executives involving “honest

services fraud” or related stat-

utes have been controversial,

and the U.S. Supreme Court

has narrowed the interpreta-

tions of such laws in recent

years.

Recent Supreme Court

cases limit such prosecutions

to cases involving an “official

act,” Mr. Lindberg’s attorneys

said in a filing late Wednes-

day. Mr. Lindberg asked Mr.

Causey to replace the senior

regulator overseeing his insur-

ers to provide fair regulation,

they said, which doesn’t meet

this threshold.

Mr. Lindberg’s attorneys ar-

gued that the executive be-

lieved the regulator he sought

to replace was biased and thus

replacing her wasn’t part of a

plan to corruptly influence

oversight of his insurers. Also,

they maintain that Mr. Lind-

berg agreed to make campaign

contributions only after being

solicited to do so by Mr.

Causey.

A spokeswoman for the U.S.

attorney’s office in Charlotte,

N.C., declined to comment. Mr.

Causey said in an interview

that the deputy criticized by

Mr. Lindberg was “an ideal

employee” who “was simply

doing her job.” He said he

couldn’t comment further be-

cause of the continuing federal

investigation.

The candidate Mr. Lindberg

initially suggested for the job

was one of his own senior ex-

ecutives.

Mr. Lindberg, 49 years old,

acquired a group of life insur-

ers starting in 2014 and even-

tually lent at least $2 billion

of their assets to his other

businesses in a strategy since

restricted by North Carolina

legislators at Mr. Causey’s

urging.

BYMARKMAREMONT

ANDLESLIESCISM

Financier

Seeks to

Toss Bribe

Indictment

count to the central-bank ac-

count of the ordinary bank

used by the person or com-

pany who is getting the

money. That bank then in-

creases the value of the de-

posit in the accounts of work-

ers or cruise-missile suppliers.

The government can get

some of those reserves back

by selling a Treasury bond to

investors, which is done via

primary dealers, banks who

have a special role acting as

market makers for govern-

ment bonds. The bond sale is

paid for, or settled, using re-

serves from the banks that

have the deposit accounts of

those investors.

Where does QE come in?

The whole point of QE—

quantitative easing—was to

ease the pain of the financial

crisis by flooding the financial

system with money, which

would make all kinds of bor-

rowing significantly cheaper.

Central banks did this by

creating trillions of dollars (or

euros or Japanese yen) worth

of reserves to buy back gov-

ernment bonds from investors

via banks. This gave banks

vast amounts of reserves. In

turn, the banks gave those

and coins in our wallets.

What are reserves for?

The main day-to-day func-

tion of reserves is for banks to

make payments to each other

that reflect transactions be-

tween the rest of us. When

one person transfers money to

another person, it looks like

private money moves from

one bank account to another.

But that isn’t what really

happens. In fact, the first per-

son’s bank reduces the amount

in the person’s checking ac-

count, which is really just a

record of money the bank

owes that person. It then

sends an equivalent amount of

reserves to the second per-

son’s bank. That bank now

owes the second person more

money and so it increases the

value of their deposit with pri-

vate money.

Where do reserves come

from?

One way reserves find their

way into the banking system is

when a government spends

money. Whether it wants to

pay government workers’

wages or buy cruise missiles,

it sends reserves from a gov-

ernment’s central-bank ac-

selling the bonds equally vast

amounts of new private

money. That private money

could then be spent in the

economy or used to buy risk-

ier corporate bonds, for exam-

ple. The higher demand for

other forms of debt would

make that debt cheaper for

borrowers.

And then the Fed started

to reverse QE?

Yes, the Fed stopped buying

Treasurys when it felt the

economy was on solid footing.

When the bonds that it owned

matured, the government had

to repay the Fed. The govern-

ment did this by handing re-

serves back to the Fed which

the Fed then destroyed, re-

versing the process when it

bought the bonds in the first

place.

Reserves also leave the

banking system when the gov-

ernment sells new Treasurys

to private investors or when it

collects taxes. Tax payments

are special because govern-

ments, unlike companies or

private citizens, deal directly

in reserves. That means a tax

payment involves reserves be-

ing transferred from an ordi-

nary bank to a government ac-

count at the central bank. An

equivalent amount of private

money in the taxpayer’s bank

account disappears.

The upshot: New sales of

Treasury bonds and tax pay-

ments take reserves out of the

banking system.

So why does this all

suddenly matter now?

This is the trillion-dollar

question. The answer, accord-

ing to some analysts, is that

the Fed isn’t sure how much

reserves banks need these

days. New rules since the cri-

sis and the stress tests that

banks have to beat have to-

gether increased the amount

of reserves they want to hold.

But reserves have been

shrinking because of the re-

versal of QE, increased gov-

ernment borrowing in the

Treasury market and a recent

wave of tax payments, among

other things.

One key cause of the crunch

in overnight lending markets

is that there are more Trea-

surys around than banks want

to own, but some banks are

still being forced to buy them.

These are the so-called pri-

mary dealers who buy Trea-

surys from the government

and then sell them to inves-

tors.

If banks don’t want to

spend their own reserves to

buy Treasury bonds, they have

to borrow those reserves from

elsewhere. They can do that

directly in specialist bank-only

markets, or they can try to

borrow private money in over-

night lending markets, where

rates spiked this week.

That is why the short-term

fix has been for the Federal

Reserve Bank of New York to

offer to take some of those

Treasurys in exchange for new

reserves.

The longer-term solution

could be a more permanent

arrangement where the Fed

conducts regular auctions—

unless it turns out that the

problem isn’t just with banks,

but that there is a real need

for funding coming from

somewhere else in the system

that hasn’t yet been identified.

Bank reserves are normally
obscure, even to bankers and
professional investors. But this
week they have hit the news
when a shortage of them
caused a key measure of bor-
rowing costs—known as the
overnight repo rate—to spike.
That is a worry because typi-
cally these more wonky areas
of finance become interesting
only when something is going
wrong.
The overnight repo rate,
which is what banks and other
financial players charge each
other to lend cash in exchange
for supersafe bonds, should be
close to 2%, but it shot up al-
most as high as 10% on Tues-
day. One of the underlying
causes of this is a scarcity of
reserves compared with the
amount of Treasury bonds in
the market. That has made
banks less willing to lend to
each other even in exchange
for safe government bonds.
To settle markets down, the
Federal Reserve Bank of New
York has dipped into this mar-
ket, conducting three auctions
this week where banks could
swap Treasurys (or bonds
from institutions like Fannie
Mae) for new reserves. It con-
ducted a third auction on
Thursday morning and offered
$75 billion in repos.
Here is a simplified run-
down of what reserves are and
how they have come to matter.

What are reserves?
Not many people realize
this, but there are two basic
types of money in the world.
There is central-bank money,
which is known as reserves,
and there is money that the
rest of us use.
Central-bank money can be
used only by banks, govern-
ments and some government-
linked institutions. They have
this money in accounts at the
central bank, where it is called
“reserves.” The money that
the rest of us use is private
money created by ordinary
banks. There is also some spe-
cial central-bank money that
everyone can use: The notes

BYPAULJ.DAVIES

Shortage Draws Focus to Bank Reserves

The Federal Reserve Bank of New York had to intervene in overnight borrowing markets this week.

CLAUDIO PAPAPIETRO FOR THE WALL STREET JOURNAL

StevenMnuchin said the U.S is considering selling 50-year bonds.

SARAH SILBIGER/REUTERS