Bank Non-borrowed Reserves

There was a recent opinion piece by Carolyn Baum on Bloomberg: How Non-Borrowed Reserves Became a Sexy Subject.  While I agree with the basic facts presented by the author, I also think she leaves out a couple of important points, including why the TAF was created in the first place.

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In reference to the fact that non-borrowed reserves for US banks have recently gone negative, she said:

Reserves can be borrowed (from the Fed's discount window) or non-borrowed (supplied via the Fed's daily open market operations). It matters not one whit to the Fed where the banks acquire the reserves they require. If they borrow directly from the Fed, they don't need to tap the interbank, or fed funds, market.

Right. The Fed Funds market and the Discount Window both count as borrowed reserves. Non-borrowed reserves come from open market operations, where the purchase of treasury securities in the open market injects cash into the economy, which, when deposited into banks becomes reserves, since it's backed by government debt rather than commercial debt.

When the proceeds from open market operations are deposited into the banking system, they don't have a choice about whether to call those funds reserves. That's what they are, period. So the first thing that's interesting here is that banks needed to borrow more of their reserves than they have received through open market operations. Why would that happen?

The answer comes with a statement near the end of the article:

Some of the concern is justified, he said, given banks' massive losses and writedowns on subprime loans.

Exactly. Those losses destroy reserves. The only option banks have to replace the lost reserves is to borrow them. But other banks weren't lending much through Fed Funds, and the Discount Windows requires short-term, high-quality (AAA) assets, which were in short supply. So the TAF was created to fill the gap.

Open market operations probably could have been used to ultimately achieve the same effect, but the effect isn't instant, and the Fed has no control over which banks the resulting funds are deposited in. The fact that some banks have bigger problems than others was, I'm sure, another contributor to the creation of the TAF.