Lou Crandall & Joseph Wang: A Monetary Plumbing Masterclass

Episode Summary

Executive Summary: The episode centered on Fed plumbing, bank deposit flight, and whether the Fed’s reverse repo facility (RRP) is destabilizing banks. Lou Crandall and Joseph Wang argued the main driver of deposit outflows is rate and confidence dynamics, not QT alone, and that cutting the RRP would damage rate control and money-market stability. They also discussed debt-ceiling risks, reserve scarcity, and upcoming bank earnings as a gauge of stress.

Main Topics: Bank deposit outflows and the risk of a 1980s-style banking crisis (Priority: 5/5): The hosts compared today’s environment to the S&L crisis and debated whether higher rates and low-yield assets could pressure banks through negative carry. Lou said stress tests did not adequately model this scenario, but argued the current situation is more nuanced because of larger liquidity buffers and modern supervision. Why deposits are leaving banks (Priority: 5/5): Lou distinguished between rate-driven deposit migration and panic-driven runs, arguing most recent outflows were initially rate motivated and then became confidence driven after Silicon Valley Bank. He emphasized that banks allowed runoff because they preferred preserving margins until deposit levels became too low to ignore. The reverse repo facility, rate floors, and monetary policy control (Priority: 5/5): A major debate focused on whether the RRP should be cut to drain pressure from banks. Lou and Joseph argued the RRP is essential for overnight rate control, and that lowering it would simply shift the whole money-market complex lower rather than solve underlying bank-funding issues. Treasury bills as a public good and consolidated Fed-Treasury balance sheet (Priority: 4/5): Lou framed Treasury bills and the RRP as safe short-term assets that satisfy public demand. He argued that, viewed on a consolidated government basis, Fed balance-sheet operations effectively transform Treasury duration into floating-rate exposure, changing the taxpayer’s interest-rate risk profile. Reserve scarcity and the minimum comfortable level of reserves (Priority: 5/5): The discussion revisited the 2019 money-market spike and the concept that reserves can be abundant in aggregate but still insufficient due to maldistribution. Lou argued the Fed and banks may disagree on the true lowest comfortable level, and that sudden bill issuance after a debt-ceiling resolution could rapidly drain reserves. Debt ceiling, tax season, and Treasury cash management risks (Priority: 4/5): Lou warned that April tax receipts, debt-ceiling negotiations, and potential post-ceiling bill issuance could create major shifts in reserve balances and the Treasury General Account. He said payment prioritization or prolonged standoffs remain real risks, with technical market effects extending into late 2023 or 2024. What to watch in upcoming bank earnings (Priority: 4/5): Both guests said bank earnings will reveal whether regional-bank turmoil is spreading into credit conditions, leverage constraints, and lending behavior. Lou especially wants to see whether large banks are getting temporary inflows and whether supervisors allow flexibility on leverage ratios.

Key Arguments: Deposit outflows are driven first by interest-rate competition and then by confidence shocks; QT is not the primary explanation. The RRP is not the cause of bank stress; it is a symptom of money seeking safer, higher-yielding short-term assets. Cutting the RRP rate would not selectively help banks; it would lower the whole money-market rate structure and undermine the Fed’s ability to control overnight rates. Treasury bills and the RRP satisfy a genuine public demand for safe, liquid assets; restricting supply can create instability elsewhere. The Fed-Treasury should be viewed as a consolidated balance sheet because Fed purchases effectively convert fixed-rate Treasury debt into floating-rate exposure. Reserve balances can be high in aggregate yet still be functionally scarce if they become poorly distributed across banks. A sudden post-debt-ceiling bill flood could drain reserves quickly and create plumbing stress even if the system looks comfortable beforehand. Bank technology and apps were expected to make deposits sticky, but they also enabled extraordinarily fast outflows once confidence broke. Recent money-fund inflows look more panic- and safety-driven than purely rate-driven, especially because prime funds saw outflows while government funds gained. The most useful near-term indicator of broader stress is how large banks describe deposit inflows, leverage ratio pressure, and lending standards in earnings calls.

Data Points: Fed funds target range: 4.75% to 5.00% - Discussed as the current administered policy range during the interview. Reverse repo rate vs IORB spread: 10 basis points - Lou said the spread was only 10 bps and suggested a wider spread could steer funds differently. Possible wider IORB-RRP spread: 25 basis points - Lou suggested returning the spread to 25 bps might reduce pressure on reserves over time. Potential RRP cut proposal: to 2% - Joseph described a proposed dramatic reduction in the RRP rate by some commentators. Treasury bill yield example: 4.8% - Used in the sponsor read to illustrate attractive cash yields on T-bills. Estimated reserve floor in 2019 stress episode: about $1.5 trillion - Lou said September 2019 revealed the true code-red reserve threshold. Fed survey estimate of comfortable reserves: about $1 trillion - Lou referenced pre-2019 survey answers that underestimated the needed reserve level. Fed commentary estimate of comfortable reserves: about $2.5 trillion - Joseph noted the Fed’s rough current view of the comfortable reserve level. Current reserve level referenced: $1.9 trillion - Used in the discussion of why reserve balances can still be tricky despite appearing large. Potential extra bill issuance: $500 billion to $1.5 trillion - Lou said an additional half-trillion to 1.5 trillion in bills could materially alter RRP and reserve dynamics. Treasury cash balance desired by Treasury: $600 billion to $700 billion - Lou said Treasury would prefer a much larger cash buffer for resilience and operational risk. Potential reserve drain after debt-ceiling reset: about half a trillion in 6 to 8 weeks - Lou warned reserves could fall sharply after heavy bill issuance. Historical public debt average maturity series: Fed portfolio treated as one big floating-rate note - Lou described Treasury’s newer accounting framework for consolidated maturity exposure. September 2019 liquidity event: previous instance of reserve-stringency stress - Referenced as the closest analog to today’s plumbing concerns. Large bank deposit beta assumption: very low in this cycle - Lou described pre-cycle expectations that banks would pass through only a small share of rate hikes.

Pivotal Quotes: "“the fact that they continue to be optimistic about, they knew that was an issue when they decided to raise interest rates another quarter point last month”" — Lou Crandall: On the Fed’s awareness of bank vulnerability while continuing to hike rates. "“banks have been willing to see the deposit runoff because they would much rather maintain the wide interest margins”" — Lou Crandall: Explaining why banks initially tolerated deposit outflows. "“If you start thinking about trying to force money out of the RRP facility by having smaller limits, then what you're essentially saying is that the facility will work as a floor pretty much all the time except when you really need it.”" — Lou Crandall: On why reducing RRP capacity would undermine monetary policy backstops.

Implications: The conversation suggests near-term risk lies less in the RRP itself than in sudden shifts in deposits, reserves, and Treasury bill issuance. Listeners should watch bank earnings, debt-ceiling outcomes, and the Fed’s willingness to keep the overnight rate floor intact.