The U.S. Federal Reserve is attempting to create another way for them get money out of the banking system: the program would be called the term deposit facility. Essentially it would enable banks and other financial institutions to ear interest on loans to the central bank. Right now banks can loan money to the Fed overnight, and earn interest on that overnight loan- A term deposit facility would allow them to make loans of much longer duration and earn more interest on those loans.

"Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy," said the Fed.

Last year when things were really bad the Fed was talking about approaching Congress to see if they could get the authority to actually issue their own bills- a sketchy proposition at best, from my vantage point. This new proposed term deposit facility does something very similar, but as Tom Simons, a money market economist at Jeffries, says, “This is more of a politically acceptable way of getting the same thing done.” Why is it more politically acceptable? Well, they don’t have to get Congress to approve it- which is better for everyone, in the sense that it has a much better chance of actually happening. It would be politically challenging for anyone to be behind this if it were actual legislation, and we have seen how quickly (ahem) the senate moves debatable bills through their chambers.
And so, the Fed will work with loopholes and back doors, similar to the way the rest of us try to deal with our taxes.

Term loans would have maturity of between one and six months or so and would entail some sort of competitive auction between financial institutions- essentially, banks would bid against each other to loan the Fed money so that they could get secure, guaranteed interest. The money would be locked in once loaned, and federal deposit insurance would be available to the financial institutions that are eligible.

This sounds a little crazy to me. How exactly are we getting money back from the banks if the idea is that they loan money to the Fed and then get it back six months later plus more paid for interest?

According to Reuters, the Fed has loaned out $2.2 trillion to banks over the course of the recession. And now, as things are stabilizing somewhat, people are afraid that there will be inflation due to all of this extra money moving around in the system.

The idea is that getting that money out of the system at just the right time is critical to keeping inflation at bay.

"The proposal is one component of a process of prudent planning on the part of the Federal Reserve and has no implications for monetary policy decisions in the near term," said the Fed.

They are putting the proposal out to the market and asking for feedback- if you want my feedback, it sounds like just another version of scamming the banking system. Take money back in in the short term and give it back in a way that creates more money.

Again, this seems like a short-term solution to what is a long-term problem brewing- we created another $2+ trillion in money and now it’s not going to go away. Apparently we are going to create even more and call it the opposite.

Photo Credit: TW Collins (via Flickr under CCL)