Fed reverse repo does not solve overhang

The Fed has a problem, what to do with the huge amount of Treasury securities on its balance sheet. We are talking about trillions and if the Fed is going to normalize policy, this inventory is going to have to come down.  There has been more talk about the policy tool of reverse repos by the Fed where it will sell securities to primary dealers to control rates and adjust funding.  Nice try, but the market will still know that the inventory is on the Fed balance sheet, so although it will have a tool to drain reserves it does not change the fact that its balance sheet is bloated.

The shadow banking system is now the biggest users of the repo market, more so than banks. The repo has been a shrinking market since 2008 with banks being smaller players. Non-banks are bigger players because they all want to add yield. Most of this is outside the main role of the Fed. So the Fe dis going to use reverse repos as a means of controlling the shadow banking system. 

A strong reverse repo program would have a strong impact on the shadow banking system. First, it can set the rates to any level it wants because it has the balance sheet to do it. Second, it can set the terms of collateral at anything it wants because it has the balance sheet to do it. Some say this is a good thing because the Fed will be able to control the shadow banking system to an extent not possible before the financial crisis.

 Let's just say that the private markets will not be able to set short rates outside the banking system when there is a an 800 lb gorilla which want to determine macro prudential policy on the shadow rate market. So, this is a good thing?