The Federal Reserve risks moving beyond its role as a lender of last resort to a prop markets need to function even in normal times, with pressures likely to increase as U.S. presidential candidates look set to add trillions more to deficits.
But two banking sources who requested anonymity to speak candidly and a market expert told me there was no liquidity problem that day, and indicators of financial stress were below normal levels. Already, the Fed and market participants are floating ideas that would pull the central bank even deeper into markets, ranging from centrally clearing some transactions to broadening who can borrow from it and offering the SRF earlier in the day.
Viral Acharya, former deputy governor of the Reserve Bank of India, said the problem was beginning to morph into an emerging-market type of situation “because deficits are soaring, the borrowing calendar is too aggressive, and there are mismatches - but importantly, frictions - in the private demand and supply for liquidity.”
The SRF was set up after one such panic moment in September 2019, caused by a sudden spike in interest rates in the repurchase agreement, or repo, market, where institutions borrow short-term funds against Treasuries and other collateral. Over the next few years, the SRF lay dormant, with use limited to banks testing access.
The fact that banks didn’t borrow more from the SRF to lend at the higher rates pointed to their balance sheet constraints rather than liquidity problems in the financial system, according to Duffie and the banking source.