The US Senate last Thursday rejected a possible two year extension of the Transaction Account Guarantee (TAG) program, which both provided insurance to $1.6 trillion in cash holdings (16% of US bank liabilities) and also charged a bps fee to banks. TAG had been extended by Dodd-Frank and has been run by the Federal Deposit Insurance Co (FDIC). Always somewhat controversial, TAG had the effect of keeping larger amounts of cash at banks and credit unions with a government guarantee in case the bank or credit union went bust. The end of TAG means new cash now in the market, with new impacts for securities finance.
At its heart, TAG has been a government sponsored insurance program, much like Federal Deposit Insurance Co (FDIC) insurance in the US for accounts under $250,000. The idea was to ensure confidence in large banks so that investors would not take out their money and run. Following 2008, this seemed like a good idea. It was even theoretically funded by an associated FDIC fee, but a US Congressional Budget Office (CBO) analysis said that the FDIC couldn’t actually cover the cost in case of a default. Any actual default would fall on taxpayers, making the TAG program an easy target for government cost-cutting. According to the CBO:
“The average size of a failed institution over the last few years was higher than the historical average; however, the government did not incur losses from a very large institution during this time. Because the largest instituions house the majority of deposits in noninterest-bearing transaction accounts (at of the end of fiscal year 2012, over 80 percent were held in institutions with $50 billion or more in assets), CBO expects that, using recent history, the FDIC and NCUA [National Credit Union Administration] would underestimate probable losses when setting fees to charge for this additional coverage.”
When it hit the US Senate for a vote, TAG was DOA (Dead on Arrival).
This $1.6 trillion in TAG-types of accounts represents about 51% of the cash held by major institutions, up from 23% in 2006, according to a 2012 Liquidity Survey by the Association for Financial Professionals. A later survey, the 2013 AFP Business Outlook, said that 51% of surveyed institutions expected to reduce their cash bank holdings as a result of the TAG program ending; 45% would take no action. This suggests that $816 billion may be on the move come January 1, 2013. But, the survey also noted that the median assets that institutions expected to move in practice was 20% of their total holdings, or $163 billion.
Where will that money go? According to the AFP survey, “Forty-two percent of organizations would move at least some of these funds into Treasury-based money market funds while 41 would invest in Treasury securities and/or agency bonds and 36 percent anticipate using prime money market funds as destinations for investments currently held in bank accounts.” Putting that into real numbers, $69 billion will go to Treasury-based money market funds, $67 billion directly into Treasuries or Agencies and $59 billion into money market funds. That’s a total of $136 billion for Treasuries and Agencies and $59 billion for other stuff.
The introduction of a possible $136 billion in new assets seeking Treasuries and Agencies will have some rate tightening affects, but let’s remember that this is less than four months worth of Operation Twist and just 0.86% of the value of the Treasuries market. Some cash will also find its way into unsecured 2a-7 funds that at least have a patina of stability around them. We look at this cash as analogous to the impact of the Federal Reserve lowering the interest rate paid on Interest on Excess Reserves by just a bit or any other cash movement from one sector of the the market to another. The formerly TAG cash will seek low risk, low duration assets, thereby pushing interest rates thinner. Returns for these institutions will be awful, perhaps prompting them to invest rather than hold unsecured assets.
Likewise, money market fund operators will be pleased to get an extra $59 billion – this is a 2.2% bump from the US money fund industry’s current $2.645 trillion in assets. Its nice but no real game changer for the amount of cash chasing assets, especially since some of the cash in TAG bank programs buys these same prime funds anyhow. The overhang of MMF reform may give pause to investors seeking a pure cash equivalent though, as money markets are still one step removed from cash with an overnight sweep.
The end of TAG should benefit large banks over small ones. Smaller banks have been helped since TAG gives their clients an extra guarantee. Losing that guarantee may push asset holders towards bigger, Too Big To Fail or SIFI institutions. That will continue to skew the holdings and size of the biggest US banks over the smallest. According to the St. Louis Fed, already big banks had 24% of their assets in TAG-sponsored programs compared to 6.7% for banks with under $1 billion in assets. The end of TAG means that even more money will head towards the bigger institutions. If assets move from small banks to large ones, a jump of any large portion of the $163 billion could hurt smaller institutions. That’s not where we want to be going for the stability of the US banking system. We think that fears of bank runs will be possible but limited.
On the fee side, banks will no longer have to pay the 15-25 estimated bps fee for the TAG program. For banks with money in the IOER program, that is just a bonus. Depositors including GSEs will give banks money and get paid Fed Funds or something similar, and banks can put money into the IOER and earn 25 bps. Until Dec 31, 2012, much of that earnings was wiped out by the TAG fee. Banks might even still be able to charge their clients for cash holdings (BNYM was charging 13 bps earlier this year). Now will Fed Funds and the IOER start to look more similar? It is a real possibility. Big banks without money in the IOER program that see money coming in from smaller rivals will also benefit.
Net net, we don’t think that the introduction of this cash will have a major effect on Treasury, money markets or securities finance. There is a lot of noise on the topic but the data don’t suggest that there will be big cash movements in the end, and as such no big rate moves. The main impact will be to favor big banks over small ones, which is not ideal but also the result of ending government intervention, hence maybe what the market wants anyhow.