N.Y. Fed seeks to get cash out of economy

The New York Federal Reserve Bank is trying to set up some new pumps to cope with more than $1 trillion of excess cash pooling up in the nation's money markets.

In an obscure and highly technical announcement earlier this month, the New York Fed said it will ask money-market funds to do what are called "reverse repos" with the bank. The financial-market transactions have the effect of moving cash out of the money markets.

"The issue is, how are we going to drain all this money," said Kent Engelke, managing director of investment firm Capitol Securities Management.

"Excess reserves are nearly $1.4 trillion - we've got more bank reserves than C&I loans out," Engelke said, using the term for commercial and industrial loans. "We've never been in this situation before."

The big cash buildup came as the Fed and the U.S. Treasury pumped funds into the economy to bolster ailing financial institutions and to finance thousands of stimulus projects.

And at some point, Fed officials will have to figure out how to walk a tightrope. If they don't drain that money out of the system, they run the risk of setting off inflation.

If they don't do enough, economists say, it could rekindle inflation. If they move too fast, it could make it hard for companies and individuals to borrow money and spend in the way that keeps the economy growing.

"This is another tool in the toolbox," said Alan Gayle, senior investment strategist for RidgeWorth Investments, a $63 billion investment management firm.

"It gives the Fed a way to influence policy through more participants, particularly in the very short-term area" of the financial markets, he said.

For decades, the New York Fed has limited its securities repurchase and reverse-repurchase deals to the 19 big securities firms and banks designated as primary dealers in U.S. government paper.

The money-market firms that might now deal with the Fed are all large players - so far, there are no signs any Virginia-based firms will be big enough to participate.

But getting excess reserves down to a more normal $1 billion to $2 billion range is a huge job, Engelke said.

"You just can't do it with 19 primary dealers," he said.