Tuesday, January 13, 2009

Banking crisis is still afoot: Fed balance sheet to rise

Admittedly, there are some signs of relief in credit markets. One of these signs, as noted in the Econbrowser article, is: that the Fed's balance sheet is falling. I don't think that this is a sign of thaw, rather just a technical consequence of the Treasury unwinding its supplemental financing with the Fed. Furthermore, there are several big-ticket items that have yet to be recorded on the Fed's balance sheet. It will rise again.

It is kind of hard to believe that the Fed would start to pull back in the wake of headlines like this:
Bonds Rally, but Banks Are Still Bruised
UBS needs to stem client withdrawals to turn corner
Royal Bank of Scotland May Face LyondellBasell Losses
WellPoint sees 4Q investment losses of $349M
Deutsche Bank Trading Losses Reveal Industry Setback
TIPS Irresistible to Gross as Protection Is ‘Cheap’
U.S. 10-Year Treasuries Little Changed Before Economic Reports

And Bernanke's speech today: The Crisis and the Policy Response

The Fed is just getting its various new programs underway, which have not appeared on the balance sheet yet; these programs will raise the Fed's balance sheet.

  • The Fed is already purchasing MBS in support of AIG (already recorded on the balance sheet), but it only just started purchasing MBS on the open market; its holdings of MBS (likely in the SOMA account) will be recorded on future balance sheet statements.
  • The Fed made changes to its Money Market Investor Funding Facility (MMIFF), which currently holds a balance of $0. If newly-eligible participants bite, then the balance sheet will rise.
  • The Fed has only just announced its Term Asset-Backed Securities Loan Facility (TALF), which will be initiated in February. This will raise the Fed's balance sheet.

Originally, the Treasury Supplemental Financing Account (TSP) was created to sterilize the Fed's massive liquidity flows into the banking system. And now that the Fed has no intention of sterilizing its flows, and with the Treasury liquidating its account, the funds are returning to the banking system as reserves. Therefore, the Fed has not increased its lending programs in recent weeks.

The Fed balance sheet has been rather stable since the week ending November 19 2008, when the Treasury started liquidating the TSP account. Spanning November 19, 2008 to January 7, 2009, the balance sheet has been reduced by just $1.3 billion; the TSP account decreased by $249.7 billion; and total reserves increased by $199.4 billion (through the week ending December 31). It doesn't look like the Fed is pulling back its liquidity programs. It's on a holding pattern both until the new programs get underway, and while the Treasury calls back its funding.

It seems to me that a better proxy of a healing banking system would be a reduction in the massive amounts of excess reserve holdings. Admittedly, the rate of increase is showing signs of decline; but the level of excess reserves stood at $799 billion, or roughly $794 billion greater than the level just four months ago. That sounds like a still very stressed commercial banking system.

Rebecca Wilder


  1. Does it occur to you that this is like trying to hit a moving target? Just as you get a handle on what the Fed has in its quiver, it takes out an arrow and replaces it with two, or enlarges it and changes the feathers. Until there is stability in the Fed's approach, understanding the position will be very difficult.
    By the way, Vegas is very nice this time of year! aj

  2. An individual bank can create loans-deposits up to an amount approximately equal to its EXCESS RESERVES. And while an individual bank is limited to its EXCESS-RESERVE position, the system as a whole is able to create deposits by a multiple of the total EXCESS RESERVES in the system.

    As the banks expand their loans-deposits, EXCESS RESERVES are diminished with each successive purchase of investments, or extension of loans (until there are no excess reserves in the system - until the banks collectively expand up to their theoretical maximum).

    (1) The reserve ratio on net transactions accounts depends on the amount of net transactions accounts at the depository institution.

    (2) Net transaction accounts in excess of the low-reserve tranche are currently reservable at 10 percent

    (3) The amount of net transaction accounts subject to a reserve requirement ratio of 3 percent is the "low-reserve tranche.

    (4) Reserve requirements are imposed on commercial banks, savings banks, savings and loan associations, credit unions, U.S. branches and agencies of foreign banks, Edge corporations, and agreement corporations.

    (5) Total transaction accounts consists of demand deposits, automatic transfer service (ATS) accounts, NOW accounts, share draft accounts, telephone or preauthorized transfer accounts, ineligible bankers acceptances, and obligations issued by affiliates maturing in seven days or less.

    Other things being equal, a growth in required reserves would ordinarilly reflect an increase in reservable liabilities (net transactions accounts). I.e., the the distribution of accounts in varying deposit classifications remain approxiately the same.

    Thus the growth in required reserves $15,415b reflects a very easy monetary policy (expansion of the money stock).

    But the growth in excess reserves of $811,896 has absolutely no impact, or represents no increase in the money stock.


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