Wednesday, April 1, 2009

Treasury Cash

An arcane sign of how much economic conditions have changed is worth noting. Treasury’s cash management has changed. It had been the practice until September of last year for Treasury to maintain about $5 billion at the Federal Reserve and the remainder at commercial banks in Treasury Tax and Loan Accounts. This began to change last September, when Treasury and the Federal Reserve announced that Treasury would issue bills in order to deposit cash in a special “supplementary financing account.” As I discussed in the first post to this blog, this was intended to help the Federal Reserve with it monetary policy operations.

Beginning in late October, the balances that Treasury holds in its general account at the Federal Reserve began increasing, along with cash in the supplementary financing account that topped $500 billion. Subsequently, the amount of cash that Treasury held at commercial banks began decreasing to the $1 to $2 billion level. Currently, holdings of $60 to $70 billion in the general account are typical along with somewhat under $2 billion in Tax and Loan Accounts. Also, as of the end of March, Treasury had almost $200 billion in the supplementary financing account at the Fed. (The Treasury has continued with this program; the latest cash management bill to finance this account was announced on March 30 to be auctioned on April 3. Treasury is offering $35 billion of 56-day bills.)

Treasury does not appear to have made any statements concerning the change in cash management practices. Here are some reasons that come to mind that may explain the changes.

  • The amount of collateral banks are willing to pledge as collateral to accept Treasury deposits may have decreased.
  • The interest rate on TT&L accounts is set at 25 basis points lower than the fed funds rate. This means that Treasury is not be getting any interest on its TT&L deposits. While deposits at the Fed do not explicitly earn interest, they do drain reserves from the banking system. The Treasury may figure that Fed earnings increase because of the offsetting actions the Fed takes. Since increases in Fed earnings increase the amount the Fed pays Treasury as “interest on Federal Reserve notes,” this is the equivalent of receiving interest on the deposits. If this is a factor in the change in Treasury cash management practices, it is not clear how much implicit interest the Treasury considers it is earning on its deposits at the Fed. Complicating the analysis is the interest that the Fed pays on required reserves and excess reserves since last October.
  • Treasury may be holding substantial amounts of cash in order to have it ready in order to be able to respond to financial developments quickly.

By way of background, when interest rates began climbing in the 1970s, Treasury began holding higher balances at the Fed since at the time there was a prohibition on banks paying interest on demand deposits. Increases in Treasury deposits at the Fed forced it to take offsetting actions in the repo market, which served to increase Fed earnings and consequently the amount it paid to Treasury periodically. (The Fed remits its earnings above its expenses to the Treasury.) The Fed was not happy about the operational difficulties of offsetting Treasury cash balances, which can fluctuate considerably. Legislation was passed in the late 1970s that enabled banks to pay interest to the Treasury on its deposits. The Treasury set the interest rate at the fed funds rate minus 25 basis points, which at the time was a good proxy for the overnight repo rate. To help the Fed out with its operational concerns with fluctuations in Treasury cash balances, Treasury targeted a fixed cash balance at the Fed. There continued to be times when the balance at the Fed was over the target level. A principal cause of this was the amount of collateral the banks wanted to pledge to accept Treasury cash was limited. Over the years, Treasury has broadened the types of collateral it will accept in order to increase the amount of cash the banks would be willing to accept in TT&L accounts.

(Data on Treasury cash balances are reported in the Daily Treasury Statement.)

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