(Bloomberg) -- William Dudley, who used to oversee the Federal Reserve’s interaction with financial markets, said the central bank should introduce a long-discussed but never implemented tool to ensure U.S. cash markets remain calm.
In a column published Monday by Bloomberg Opinion, the Fed Bank of New York’s former president recommended creating a standing repurchase-agreement facility, joining a chorus of proponents. It should be open, he argued, to a broad set of counterparties and accept Treasury and agency mortgaged-backed securities as collateral.
“Such a facility would effectively cap repo rates,” Dudley wrote. “It would also address the potential problem of the Fed providing liquidity to primary dealers but primary dealers not lending the funds to other market participants that might need short-term repo financing.”
Fed Needs to Look Forward, Not Retreat to the Past: Bill Dudley
A standing repo facility would let participants convert securities into cash on demand, helping keep short-term rates stable by limiting the potential for sudden cash shortages.
Dudley proposed other overhauls to the Fed’s monetary policy toolkit, including “de-emphasizing the federal funds rate” as the central bank’s main policy benchmark. His contribution to the debate comes as John Williams (NYSE:WMB), who succeeded Dudley in 2018, and other central bankers contemplate how to keep short-term funding markets under control following the chaos seen in mid-September.
Rates for repurchase agreements, which surged to 10% from around 2% during the turmoil, have since returned to normal, but not without major Fed intervention. And it remains unclear whether the central bank can extract itself without problems resurfacing. Dudley, for his part, isn’t worried about larger implications.
“The spike in the fall was not a ‘canary in the coal mine’ signaling bigger problems in the financial system,” Dudley wrote. “Instead, it reflects the difficulty in forecasting the demand for reserves given the changes in regulations.”
The Fed’s authority to pay interest on reserves allows it to maintain control of short-term interest rates even with a lot of excess reserves, Dudley wrote. This is “far better” than the pre-financial-crisis rate-control regime of that saw the Fed having to conduct intervene via open-market on a high-frequency basis, he said in an interview on Bloomberg Radio. A standing repo facility will improve the new regime, and the Fed could communicate more clearly about it, he said.
Dudley isn’t the only person to endorse a standing repo facility. Two other former Fed officials, Brian Sack and Joseph Gagnon, wrote in a September blog post that one should be implemented, continuing a campaign they began years ago when they worked at the central bank. Less than two weeks after the mid-September repo turmoil, former Minneapolis Fed President Narayana Kocherlakota endorsed the idea in a Bloomberg Opinion column.
Current Fed policy makers have discussed the merits of such a tool, and it was brought up at the December Federal Open Market Committee meeting as something to discuss at a future gathering.
“That’s an intriguing idea,” said Cleveland Fed President Loretta Mester, speaking Friday about a standing repo facility during a Bloomberg TV interview. “I would be supportive of the Fed really doing the hard work to assess whether that’s needed going forward,” she added. “But, at this point, we can take our time there, because things do seem to be settled down in those markets.”
(Updates with comment from Dudley in eighth paragraph.)
