Or, Uncle Al's Revenge....
Readers of this blog know that way back in 1992, Uncle Al
and the gang eliminated or greatly reduced reserve requirements
on a variety of large and jumbo time deposits ostensibly to
provide extra liquidity as the commercial banks stepped in
to the mortgage market in place of the S&Ls which had failed
or were being merged out. This was a legitimate response by
the Fed at the time.
As the economic expansion progressed and the Fed started to
raise rates, the banks quickly learned to reduce the cost of
funding by switching to the reserve-exempt deposits to fund
lending operations. By 1995, the Fed should have reversed
course and re-imposed the reserve requirements on the big
deposits. It did not and the banks used this loophole for
years to feed the economic and stock market booms. The banks
also began to use the RP market more aggressively to fund
FX traders, hedge fund managers and the mutual fund industry.
They also started using RPs to fund lending out of the pot,
a cheaper way to raise money than Fed Funds where other banks
will charge 20% or more in a tight Funds market.
Rather than re-claim the control that is rightly theirs, Uncle
Al has decided to stop reporting the data and to leave analysts
to scramble to find appropriate proxies.
There will be a vigorous and vocal protest from a number of
economists. The Fed might spin an explanation, but many will
be unhappy and only time will tell whether the Fed will relent.
There are proxies that can be used in place of M-3, although
I will dearly miss the Repo data (now a $550 billion item).
Uncle Al has whipped a digit on his detractors in his final hours.
M-3 is slated to dropped starting 3/23/06.
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