WASHINGTON — Federal Reserve Board Chairman Ben Bernanke reiterated the central bank's commitment Thursday to unwinding its massive injection of liquidity into the system during the financial crisis, but offered no new hints on how fast it plans to move.
Still, the central bank chief made it clear that banks remain central to that strategy. Among its options for draining cash from the system are using reverse repurchase agreements and creating a term deposit facility for financial institutions, Bernanke said during a House Financial Services Committee hearing.
"The use of reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so," Bernanke said.
After Congress authorized the Fed to pay interest on reserves held by banks in October 2008, it has become an increasingly important part of the central bank's monetary policy. But with $1.1 trillion now held in reserves, the Fed may soon seek to reduce that level, in part to prevent inflationary pressures.
Bernanke said to drain reserves quickly, the Fed has been expanding its range of counterparties for reverse repurchase operations beyond the primary dealers typically relied on by the Federal Reserve Bank of New York.
In a reverse repo, the Fed sells a security to a counterparty with an agreement to repurchase the security at a later time. The counterparty's payment to the Fed has the effect of draining an equal amount from the banking system.
A second tool the Fed is developing involves term deposits, a sort of certificate of deposit for banks. Bank depositors would get a separate account at the Fed that would earn interest and mature within a year. Like the other proposals, these accounts would help shift money out of the financial system. Bernanke said he plans to conduct test transactions this spring on the facility.
"We have been working to ensure that we have the tools to reverse, at the appropriate time, the currently very high degree of monetary stimulus," Bernanke said. "We have full confidence that, when the time comes, we will be ready to do so."
Exiting at the right time is the Fed's biggest challenge, according to observers. "The Fed is operating in unchartered waters: It has never had such a challenging exit. Don't expect the Fed to be perfect," said Laurence Meyer, vice chairman of Macroeconomic Advisers, one of the panelists testifying at the hearing.
Bernanke said that the sequence of steps and the combination of tools the Fed will use as it exits from its liquidity program will "depend on economic and financial developments" and the central bank's "best judgment" on how to meet its dual mandate of maximum employment and price stability.
The Fed has already ended buying Treasury securities and will exit the market as the largest buyer of mortgage-backed securities next week. The central bank announced last week that it plans to complete its last purchase of $1.25 trillion of agency MBS and $175 billion of agency debt by the end of this month. To date, the Fed has bought $300 billion of Treasury securities.
As the economy improves, Bernanke said he expects the Fed will gradually sell the huge amount of assets on its balance sheet, returning to its all-Treasury portfolio within a "reasonable amount of time."
"At some point we will, in fact, have a gradual sales process so that we can begin to move our balance sheet back to its precrisis condition," said Bernanke, who suggested it would be under a $1 trillion.
While the Fed has already closed most of its liquidity facilities, the only one left in operation, which provides credit to multiple institutions, is the Term Asset-Backed Securities Loan Facility, which has supported the market for asset-backed securities. Bernanke said because market conditions have gotten "notably better" Talf is scheduled to close March 31. That would not include newly issued commercial mortgage-backed securities. The Fed also set a deadline of June 30 for loans backed by newly issued CMBS.
While Bernanke said the asset-backed securities market is not back to normal, it has seen "considerable improvement."
