Monday, June 22, 2009

The Fed: shifting focus

On the surface, the Fed's balance sheet indicates that the Fed has slowed down; total reserve bank credit extended in the week ending November 6, 2008 topped $2 trillion, and in the week ending June 17, 2009, it rested just under $2.1 trillion. However, the Fed is only shifting its focus from a liquidity policy (buffering bank reserves directly) to an asset purchase policy (quantitative easing). The balance sheet is expected to grow further.

The chart illustrates reserve bank credit by type since the beginning of the year. All of this information can be found using the Fed's weekly H.4.1 statement, Table 1. Notice how total reserve bank credit has stabilized at the $2 trillion mark. However, the composition of the portfolio is in flux - transitioning toward "securities held outright", including mortgage-backed securities (MBS) and direct Treasury obligations and away from direct lending (TAF, Repos, discount window).

In the week ending June 18, 2009, the Fed held the following securities on balance:
  • $566.9 billion in Treasury notes and bonds, up $154.5 billion since last year
  • $87.8 billion in agency bonds (Fannie Mae and Freddie Mac), up $87.8 billion since last year.
  • $455.3 billion in agency MBS, up $455.3 billion since last year.
The Fed has appropriated (does the Fed really need to "appropriate" printed money?) $1.25 billion to purchase agency MBS, $200 billion for agency bonds, and $300 billion for Treasuries. Compared to what has settled on balance, the Fed has promised to buy up to another $1.05 trillion more in MBS ($794.7 billion) agency bonds ($112.2 billion) and Treasuries ($145.5 billion). And that does not include the $1 trillion coming through the Term Asset Backed Securities Loan Facility (TALF), which has only just begun, lending $25.2 billion to date.

The Fed is still very much engaged in its quantitative easing policies, and the Federal Reserve Board members probably agree with Alan Blinder. Based on the announced purchase programs to date, the balance sheet could approach $4 trillion by the end of the year (note: it does not have to). If that happens, rates are unlikely to rise next year, as the Fed must unwind its new asset positions first!

Rebecca Wilder


  1. “It’s almost worth the Great Depression to learn how little our big men know.”
    ~ Will Rogers

  2. "If that happens, rates are unlikely to rise next year, as the Fed must unwind its new asset positions first!"

    Hi Rebecca - would appreciate if you could expand on this please? e.g. when you say "rates", what do you mean a bit more precisely please? Supposing "rates" (let's say shorter-term rates) NEED to rise next year - are you saying they can't, and if so, then what would be the consequences if they can't be raised? What if they do rise anyway -what would the consequences of that be please? Thanks!

  3. Wouldn't this also mean inflation is a no-go for quite a while?

  4. Hi. Thanks for all your posting about matters financial, but perhaps you could explain this in words of one metaphorical syllable for those of us who are trying to figure out what the Fed is doing but don't really "get" it. a) Why exactly is the Fed buying all these securities? How exactly does this benefit the banking system? b) What price is being paid for these things? Wasn't a major aspect of the crisis last fall the fact that buyers weren't willing to pay as much for MBS's as the banks had them booked for? If that's the case, surely the purchase only makes sense for the banks if the Fed is paying more than they could get on the open market. Or is that not what's going on? What happens if these securities turn out not to be worth as much as was paid for them? c) Where exactly does the money for this come from? Is it still from the Treasury's Supplementary Financing Program? But how exactly does that help, since that just means that the money to purchase the securities is borrowed from someone else (i.e., it's just a matter of shifting money around within the economy)? Is it because the money comes from abroad? d) In reports about the Supplementary Program last November (including here if memory serves), it was said that this program wouldn't lead to a monetizing of the debt because the money is retained by banks in the Fed as additional reserves and wasn't being converted into money. Okay, but why are the banks retaining these huge sums as reserves? Why do they need more reserves now than they did before?

    Seemingly, this is an entirely new policy that was come up with as a result of the losses suffered through the bursting of the housing bubble and the implosion of securities based on reckless lending. The banking system has apparently been stabilized as a result of parking a lot of money in the Fed. Okay, but what next? One hears talk about how the Fed is supposed to have some "exit strategy" to avoid inflation. What exactly is this strategy, and given the complete mismanagement of the financial scene in the years 2005-2008, why should anyone have the least confidence that they could even diagnose what's going on accurately, much less figure out when exactly to "unwind"?

    Any attempt to explain this to the plebs would be much appreciated! Thanks.

  5. your posts are unusually clear and organized

    Bernanke is treasure

    Unfortunately the FOMC won't be able to combat the stagflation (business stagnation accompanied by inflation) that will begin c. Aug-Sept.

  6. Hi Stevie,

    I am talking about the policy rate. Clearly, if the Fed wants to raise longer term rates, they will start selling assets back onto the open market - that could do it. If they want to raise short-term lending rates (i.e., the ff rate), then they will raise interest on reserves and/or allow TAF loans to expire. But when I was saying that they wouldn't "raise rates" until the end of next year, I was referring to the ff rate. They need to unload their assets first.


    Hi Aunt Jane,

    Yes, it doesn't seem like inflation is a go for a while...capacity utilization is at 68.3% (its lowest EVER) and credit is still not even close to flowing freely. For the time being, the added liquidity is doing not much more than keeping the financial markets afloat...

    Good to hear from you! Rebecca

    Hello Keyser (love the blogger identity):

    You say: What happens if these securities turn out not to be worth as much as was paid for them? c) Where exactly does the money for this come from?

    The answer to c) is easy: they simply add value electronically to a line on both their and the counterparty's balance sheet (i.e., they print money). The answer to b) is a little more difficult. Who knows. Theoretically, the Fed should write down these assets like everybody else. They have written down value on the Bear account. But look at the "collateral pledged" table at the fed's website:

    It gives no mention of what "value" means. I suspect that it is the value of the collateral at the loan origination....which we all know, has likely depreciated for a lot of these assets.

    I will try to address your questions in a coming post. Do you have any suggestions for making my website more accessible to the average reader?

    Thanks for commenting! Rebecca

  7. Hi Flow5

    You say: stagflation (business stagnation accompanied by inflation) that will begin c. Aug-Sept.

    Stagflation? I doubt it (as you well know). The Fed's printed money is going nowhere...and I imagine that with house prices falling throughout 2009, banks will be equally reluctant to lend. Still nowhere in my book.

    Thanks, as always, for your comments.