Thursday, December 4, 2008
The Fed is unwinding the temporary Treasury Supplemental Financing Program (TSP), while at the same time, planning to purchase direct GSE (government sponsored entity, mainly Fannie Mae and Freddie Mac) obligations. Interestingly, the Fed is sterilizing the TSP flows back to the Treasury – at least on paper and for now – but it will not sterilize the purchase of GSE debt. This illustrates the Fed’s move away from traditional policy – reducing the short term interest rate – and toward new policy: quantitative easing and changing the composition of its balance sheet.
The chart illustrates the contribution of the Fed’s liabilities to the total factors that absorb reserve balances (Table 1 on the H.4.1 statemet). Most of the components have remained rather stable except for the creation of the TSP account (currently $479 billion), which was created for the sterilization of Fed’s massive liquidity operations (see this post for details).
On November 19, the Fed started to unwind the TSP account as the bonds/bills came to term, and there question as to the sterilizization of these funds. The Treasury will pay back the initial bond buyers, but at the same time, the Fed is reducing reserve balances, so the flows are (at least on paper) sterilized. Since November 19, factors that absorb reserve balances (the chart above) fell $89.8 billion - mostly from the unwinding of the TSP account – while contemporaneously, factors affecting reserve balances fell by more, or $104.3 billion.
The Fed seems strangely concerned about sterilizing the flows back to the Treasury (public). As the unwinding of the TSP account continues, it will be interesting to see how this works on the Fed's balance sheet.
Also affecting the Fed’s balance sheet is the planned purchase of $600 billion in GSE debt and MBS (mortgage-backed securities) - I call this FARP (Fed Asset Relief Program). The Fed is expected to initiate its purchase of $100 billion in GSE direct obligations as soon as this week (here is the Fed’s FAQ page), and some have asked how the Fed will pay for this.
The Fed will create reserves (straight out of the horse’s mouth) and hold the GSE securities in the SOMA account.
The SOMA account is currently valued at $488.7 billion (2nd line of Table 1 on the H.4.1 statement), which includes $12.3 billion of GSE debt (line 8 Table 1). The SOMA account (line 2 Table 1) of the Fed’s asset holdings will rise by $100 billion in new GSE debt without an offsetting transaction on the liabilities side (chart above). Therefore, reserve holdings will rise by $100 billion, and this will not be sterilized.
The Fed has changed strategies to quantitative easing – adding non-sterilized reserves balances to the banking sector to keep the money supply afloat. The Fed is also altering the composition of its balance sheet – raising agency debt relative to its Treasury holdings and adding MBS holdings. Both tactics are anomalous policy measures used when standard policy – reducing the short-term nominal interest rate – has reached its limits (the zero bound). The Fed is desperate, but doing the right thing.