Tuesday, February 10, 2009

What's going on with the Fed balance sheet?

There are some interesting bits of news coming from the Fed balance sheet. It has fallen almost $400 billion since December 10, 2008, but a closer look reveals the following: (1) the big ticket reductions in bank credit likely signal some revived health in the credit markets; (2) the Mortgage Backed Securities purchased by the Fed have not settled on balance yet; and (3) the Fed has lost even more on assets from the bailout of AIG and Bear Stearns (JP Morgan).

The reduction in bank credit is likely a good thing

Over the week, bank credit extended by the Fed fell $149 billion. These big ticket items account for most of the week's loss of bank credit:
  • $56.9 billion of commercial paper has come to term. The Fed has not added, in net, to its commercial paper funding facility (CPFF) since 1/21/09.
  • $77 billion in foreign currency holdings - these swaps lines of credit were originally introduced to enable foreign central banks to finance dollar needs.

The unwinding of the CPFF account reflects overall relief felt in credit markets - at least in nonfinancial.

(Chart Source: Federal Reserve)

The chart illustrates the spread on A2/P2 to AA nonfinancial 30-day commercial paper (see Calculated Risk for a short description of this market in September). The spread is returning to normal levels, indicating that investor confidence is returning - at least in nonfinancial paper. This is a good thing, especially since the Fed has unwound 22% of its holding of commercial paper since 1/14/09, when it held $334.6 billion of the commercial paper market.

The MBS program has not hit the balance sheet yet

What is not shown on this statement - yet - is the full breadth of the Fed's Mortgage Backed Security (MBS) purchase program. To date, the Fed has purchased $91.7 billion in MBS, but only $7.4 billion is listed on balance. According to the Fed, outright purchase of MBS takes months to settle, so the current balance sheet now represents the full credit extended by the Fed at a lag. One more thing to monitor.

Oops - another loss from AIG and Bear

Is this the future of the bank bailout plan? Losses? Back in October, the Fed was forced to writedown $2.7 billion in losses (over two consecutive weeks) related to the Fed's financing the takeover ofBear Stearns by JP Morgan. Well, in the last two weeks, the Fed has written down another $1.35 billion on the Bear assets plus $0.84 billion on AIG (CDOs purchased) for another $2.2 billion writedown.

Don't worry, the balance sheet will grow again; eventually, the MBS purchases will hit. Furthermore, the Fed will announce the start date of its new Term Asset-Backed Securities Loan Facility (TALF), where $200 billion $1 trillion has been appropriated to this program so far.

Rebecca Wilder

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