The Fed is running into a wall of its own making

MW The Fed is running into a wall of its own making

By Charlie Garcia

Charlie Garcia responds to readers concerned about their money and interest rates

You can lead a bank to liquidity, but you can't make it lend.

Editor's note: Columnist Charlie Garcia shares select emails and online comments from his virtual mailbag each week.

Dear Charlie,

You make the Fed slowing QT sound ominous, but isn't that good news? They saw a problem and they're addressing it. That's what we want central bankers to do, right?

And if I should be worried anyway, what specifically should I be watching to know if things are getting worse?

Bill

Dear Bill,

You're technically correct, in the way that a pilot announcing "We've decided not to fly into that mountain" is technically good news. The question you should be asking is: Why was flying into the mountain ever on the itinerary?

The Fed didn't slow its quantitative tightening (QT) program because everything is fine and they felt like being cautious. The Fed slowed QT because the standing repo facility, their emergency lending window, started lighting up like a pinball machine. Banks that are supposed to have plenty of reserves were showing up at the discount window with their hats in their hands. That's not prudent central banking - that's a fire department that smells smoke and can't find the fire.

You want the Fed to address problems - agreed. But there's a difference between a doctor who catches something early on a routine checkup, and a doctor who runs into the waiting room yelling, "Cancel my afternoon appointments." The Fed just canceled its afternoon appointments.

Read: Replacing Jerome Powell won't solve the Fed's problems

Foreign demand has been softening. The 'marginal buyer' of Treasurys is increasingly the Fed itself - which is like a restaurant reviewing its own food.

As for what to watch, here's your dashboard:

Secured overnight financing rate $(SOFR)$: This is the heartbeat of overnight lending. It should hum along quietly, a few basis points above the Fed's target. When it spikes 10 to 15 basis points above target, especially not at quarter-end, someone important is having trouble borrowing. September 2019 saw the SOFR spike 300 basis points (3%) in a single day. The Fed had to invent emergency facilities on the spot. Nobody saw it coming, except the people who did.

Standing repo facility usage: The SRF is supposed to be a backstop nobody needs, like the fire extinguisher in your kitchen. When banks start using it regularly, especially midmonth and away from the quarter-end stress that's become "normal," that means reserves aren't as ample as the Fed keeps insisting. October usage spiked. The Fed noticed.

Quarter-end repo rates: Dec. 31 and March 31 are when banks dress up their balance sheets for regulators, which means they stop lending in repo markets and rates spike. This is now considered "normal" - which tells you everything about what passes for normal. If quarter-end stress starts showing up in mid-December or mid-March, the disease is spreading.

The spread between SOFR and the Fed's interest on reserve balances (IORB): This should be tight. When it widens, it means banks prefer lending to each other at worse rates than parking money at the Fed, which means someone needs cash badly enough to pay up for it. Desperation has a price, and this spread measures it.

Treasury auction bid-to-cover ratios: When the government sells debt, how many buyers show up? Ratios above 2.5 are healthy; below 2.0, and you're watching a party where the guests are eyeing the exit. Foreign demand has been softening. The "marginal buyer" of Treasurys is increasingly the Fed itself - which is like a restaurant reviewing its own food.

The Fed slowing QT isn't reassurance; it's an admission that the patient can't handle the full dose. They wanted to shrink the balance sheet to $6 trillion. They're stopping at $6.5 trillion and praying that's enough. That's not a plan - that's a hope.

When someone tells you not to worry because the lifeguard is paying attention, the relevant question is why the lifeguard looks nervous.

Vigilantly yours,

Charlie

P.S. The Fed addressing a liquidity problem by slowing QT is like an alcoholic addressing a withdrawal problem by slowing down sobriety. It works, technically. But it suggests the underlying condition is worse than advertised.

Read: Everyone's waiting for a rate cut - but the Fed's already shown its hand

Banks have decided that the most profitable thing they can do is absolutely nothing.

Dear Charlie

"You cannot make banks lend reserves they would rather hug."

I'm not so sure about this.

The Fed can be awfully persuasive, and there are also some common interests that'll lead banks to cooperate. And the Federal government can be awfully persuasive when it needs to; power isn't just who has the most cash.

And let's not forget who gets to print the cash.

Jerry

Dear Jerry,

I appreciate the civics lesson, but you're confusing the power to force a man to eat broccoli with the power to make him enjoy it.

Yes, the Fed can be "persuasive." So can a mother-in-law with a rolling pin. But persuading banks to hug their reserves less tightly requires persuading them that lending money is more profitable than parking it. And right now, with the yield curve doing interpretive dance and credit spreads twitching like a politician's eye during a deposition, banks have decided that the most profitable thing they can do is absolutely nothing.

You mention "common interests." Banks and the Fed do share common interests, the way a tick and a dog share common interests: Both want the dog alive. Beyond that, negotiations get complicated.

As for printing cash, the Fed has been printing cash like a counterfeiter with a fresh cartridge since 2008. The problem isn't the quantity of money; it's where money goes when it's scared. And scared money doesn't lend. Scared money sits in a vault and pretends to read the Wall Street Journal.

Power isn't just who has the most cash, you're right. But in a financial crisis, power is who has the most nerve. And the Fed just admitted they flinched.

You can lead a bank to liquidity, but you can't make it lend.

Stay unpersuaded,

Charlie

P.S. The Fed printing money to make banks lend is like a zookeeper printing steaks to make a lion vegetarian. The lion will take the steaks. He's still not eating the salad.

Read: The Fed may need to act as potential trouble brews in a key corner of the financial market

Choosing a prime money-market fund for the extra yield is like choosing a car for the complimentary air freshener.

Dear Charlie,

Can you explain why prime money-market funds are undesirable? Is it the risk of breaking the buck, lower yields or volatility? I always thought money-market funds were supposed to be safe.

Sally

Dear Sally,

You asked whether prime money-market funds are undesirable because of breaking the buck, lower yields or volatility. The answer is "yes" - the way a doctor answers, "Is smoking bad because of the cancer, the emphysema or the yellow teeth?"

Breaking the buck isn't a hypothetical risk dreamed up by pessimists with too much time and not enough sunlight. The Reserve Primary Fund actually did this in September 2008. They were owners of Lehman Brothers paper; then Lehman Brothers became a cautionary tale instead of a company, and investors got 97 cents on the dollar - this in a vehicle specifically designed to be as exciting as watching paint dry on a Treasury bill.

Liquidity gates are the real snake in the garden. After 2016, the SEC gave prime funds permission to lock the exit doors and charge you a fee for trying to escape during a panic. Your "cash" becomes "cash we'll think about giving you later, maybe, if we feel like it." This is like a fire extinguisher that requires a 48-hour waiting period.

Yields? Prime funds pay maybe 20 to 40 basis points more than government funds. You're accepting the risk of a bank run for the privilege of earning enough extra interest to buy a slightly nicer sandwich once a year. That's not compensation - that's an insult with a bow on it.

Government money-market funds own Treasurys and Fed-backed repo. No corporate paper. No liquidity gates. No excitement whatsoever. When the plumbing starts making noises that plumbing shouldn't make, boring is beautiful.

The extra quarter of a percent isn't worth finding out your "liquid" savings have become "gel."

Stay in the shallow end,

Charlie

P.S. Choosing a prime money-market fund for the extra yield is like choosing a car for the complimentary air freshener. You're focusing on the wrong feature.

Charlie Garcia is founder and a managing partner of R360, a peer-to-peer organization for individuals and families with a net worth of $100 million or more. He holds gold and bitcoin in his personal account.

Agree? Disagree? Share your comments with Charlie Garcia at charlie@R360Global.com. Your letter may be published anonymously in the weekly "Dear Charlie" reader mailbag.

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-Charlie Garcia

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December 05, 2025 17:23 ET (22:23 GMT)

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