October 25, 2008
The Federal Reserve's balance sheet
On Thursday, the Federal Reserve issued its weekly H.4.1 report, which provides details of the Fed's balance sheet. Once upon a time, this was one of the least interesting of the government's many releases of data. These days, it's become one of the most exciting.
The essence of the Fed's balance sheet used to be quite simple. The Fed's primary operations would consist of either buying outstanding Treasury securities or issuing loans to banks through its discount window. It paid for these transactions by creating credits in accounts that banks hold with the Federal Reserve, known as reserve deposits. Banks can turn those reserves into green cash any time they desire, so the process is sometimes loosely summarized as saying that the Fed pays for the Treasury bills it buys or loans it extends by "printing money". Before the excitement began, the Fed's assets consisted primarily of the Treasury securities it had acquired over time (about $800 billion as of August 2007) plus its discount loans (an insignificant number at that time). Its liabilities consisted primarily of cash held by the public (about $800 billion a year ago) plus the reserve deposits held by banks (which again used to be a very small number).
Bernanke's overriding goal since then has been to extend a huge volume of short-term loans to financial institutions. If he'd done that in the usual way, just creating new reserve deposits with each new loan, the supply of cash would have ballooned, bringing worries of inflation. The Fed didn't want to do that, and in fact there was no shortage of funds available for overnight interbank lending. The fed funds rate, an average overnight lending rate between banks, is already quite low, and further reductions seem unlikely to accomplish much. But longer term interbank lending rates remain quite high relative to the overnight rate.
Bernanke's first approach to this challenge was to "sterilize" the new loans from the Fed, basically selling off the Fed's Treasury holdings at the same time that it extended the new loans. When a counterparty buys the Treasury security from the Fed, the Fed debits the bank's account with the Fed, and these debits net out the credits that would be created as a consequence of the Fed's new loans. Reserves go up with the loans, down with the sale of Treasuries, so the net result is an increase in loans from the Fed but no change in reserve deposits. These new Federal Reserve assets came in many colors and flavors, including the Term Auction Facility, the Primary Dealer Credit Facility, currency swaps (which I presume is the biggest single item in the burgeoning "other F.R. assets" category), and the seriously non-acronymizable Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility.
|Aug 8, 2007||Sep 3, 2008||Oct 1, 2008||Oct 22, 2008|
|Other F.R. assets||41,957||100,524||320,499||519,713|
|Factors supplying reserve funds||902,993||939,307||1,533,128||1,839,042|
|Currency in circulation||814,626||836,836||841,003||856,821|
|Factors absorbing reserve funds||902,993||939,307||1,533,128||1,839,042|
|Off balance sheet|
|Securities lent to dealers||120,790||259,672||226,357|
But $800 billion-- the total stock of Treasuries that Bernanke originally had available for this purpose when he started down this path over a year ago-- only goes so far these days, particularly when you remember that a quarter trillion of those securities are now being used in the Term Securities Lending Facility, which the Fed records as an off-balance-sheet transaction. To enable it to extend more than $800 billion in loans without "printing more money," the Fed asked the Treasury to implement a Supplementary Financing Program in which the Treasury would sell securities directly to the public but simply keep the funds in an account with the Fed. The payments by the public for these securities then initiate a flow of reserves out of private banks, the same as if the Fed itself had sold Treasuries to the public out of its own holdings, so the SFP enables the Fed to sterilize a greater volume of loans than it could if it had to rely solely on its original holdings of Treasury securities. The Treasury supplementary account as of last week has provided the Fed with an additional $559 billion to play with. It appears from the latest balance sheet that the Fed has now asked the Treasury to do the same sort of thing with the Treasury's "general account" with the Fed. Historically, that account was just used to facilitate daily Treasury transactions, and was usually held to about $5 billion. Last week, it's up to $56 billion.
It's clear that the Fed is now also using yet another tool to balloon its balance sheet, namely, deliberately encouraging banks to sit on their excess reserve deposits. When these started to shoot up at the end of September, I initially attributed this to frictions in the interbank lending market. But with the announcement on October 6 that the Fed would begin to pay interest on those deposits, and the further announcement on October 22 that the Fed is now raising that interest rate to within 35 basis points of the target for the fed funds rate itself, it is clear that the Fed has now settled on a deliberate policy of encouraging banks to just sit on the reserves it creates, giving it another device with which to expand its balance sheet without increasing the quantity of cash held by the public. That's provided another quarter trillion for the alphabet soup of new facilities.
I had a call from a reporter this week asking me to explain why the Fed raised the interest rate paid on reserves. I think she was expecting a 30-second sound bite, but instead we went back and forth for about 15 minutes and I'm not sure even then that I succeeded in getting the basic idea across. At that point she asked me, "Do you see it as an encouraging development that the Fed has taken this step to address the credit crunch?" My immediate answer was no. It's not an encouraging development because it means that the heroic efforts that the Fed has taken previously weren't enough. The Fed's first $100 billion didn't do it. The Fed's first $1 trillion didn't do it. Having the Treasury take over the $5 trillion in debts and guarantees of Fannie and Freddie didn't do it. The Treasury's $3/4 trillion rescue/bailout package didn't do it. And another quarter trillion will?
If the spread between overnight and 3-month interbank lending rates indeed results from pure illiquidity of the latter market, it seems to me it shouldn't have required too much grease to get that market lubricated. But if, as argued by John Taylor and John Williams, the spread instead represents compensation for counterparty risk, it doesn't matter how much term lending the Fed does. Its actions would only move that spread to the extent they reduce the counterparty risk itself. The primary consequence of the actions would not be to change the spreads but instead would just shift the risk onto the Federal Reserve's balance sheet.
There was another juicy morsel in the latest H.4.1. The latest report acknowledges that the Fed has taken some losses on some of these unconventional assets. The Fed last week wrote off $2.7 billion in losses on the loans to "Maiden Lane LLC," an entity created through the Bear Stearns package. The assets of Maiden Lane consisted of claims on certain troubled securities, and the liabilities consisted of a loan from the Federal Reserve. The Fed now admits that Maiden Lane won't be repaying all of the loan, so it had to reduce its claimed assets by $2.7 billion. This also required a corresponding imputed $2.7 B reduction in the "other" category on the liabilities side of the Fed's balance sheet, presumably in large part coming from debits to the "surplus" and "other capital accounts" entries in the Statement of Condition of the Federal Reserve Bank of New York, though I haven't traced through the details of exactly how that was implemented.
Regardless of the accounting, here's how those losses will show up in practice. When the Treasury auctioned the T-bills for the increase in its supplementary and general accounts with the Fed, and when the Fed sold off its existing holdings of Treasuries, the Treasury started making interest payments to the public. The Fed is also receiving interest on the loans it made, and returns that interest to the Treasury. As long as the loans are performing, it is a wash to the Treasury. But if some of the Fed's loans go bad, it means the Treasury is on the hook for the extra interest costs with no offsetting receipts. In other words, any losses by the Federal Reserve are equivalent to a fiscal expenditure financed by Treasury borrowing.
The notes to the H.4.1. seem to imply that the Fed's intention is to update its assessment of the "fair value" of its Maiden Lane holdings as of the end of each quarter, which would mean no new markdowns until January.
But that doesn't mean that the remaining $1,839 B in Fed assets will all continue to bring in their hoped-for receipts for the Treasury between now and then.
Posted by James Hamilton at October 25, 2008 08:19 AMdigg this | reddit
maybe I am a little thick this morning -- james I am not catching how this WONT (eventually) be inflationary? Isnt this (plus lower interest rates) just a different flavor or monetary expansion?
Posted by: andre at October 25, 2008 09:10 AM
I am new to coming to your site and find it very informative. I am glad I found it as I now have another person who understands this situation to talk to.
The H4 you posted made something pop out in my eyes. If I am correct in reading this the Fed says it has 6.7 billion dollars left to play with on their balance sheet. Compares to the 250 billion they had. As with any business this means their working capital is about to go negative on the books and this spells total disaster.
I FEAR the worst is about to happen as I see the equity markets going down hard in a very bad way!
Great BLOG, very informative!
Posted by: SantaFeguy at October 25, 2008 09:32 AM
How do you know that the Fed pays interest to the Treasury on its balances at the Fed? Is there any routine public source of information about how seigniorage profits are transferred from the Fed to the Treasury (I assume that they are).
I ask because from time to time one reads comments that explain Fed actions as a private institution trying to make money for its owners, and it would be useful to know where to direct such people for evidence that the Fed transfers its profits to the public. Thanks.
Posted by: RebelEconomist at October 25, 2008 09:33 AM
The Fed's data shows the adjusted monetary base to be exploding upward in an absolutely unprecedented way.
Is this intentional or does it mean that the Fed's attempts at sterilization are unsuccessful?
Posted by: Constantine at October 25, 2008 09:43 AM
This is an interesting counterpoint to all those claims floating around out there that because bank loans are still growing there is no financial crises.
The fact that bank loans are still growing does not demonstrate that there is no crises. Rather it demonstrates that the Fed has been doing a very effective job of offsetting the drop in bank money market borrowing that banks normally use to fund bank lending.
The people claiming that growing bank lending demonstrates that there is no crises are looking at the wrong side of the banks balance sheet.
They should be looking at the other side of the banks balance sheet that shows how the banks raise the funds needed to finance continued bank lending. They essentially have three sources of funding. One is deposits. Two is borrowing in the money market by issuing CDs, commercial paper, etc.. The third is borrowing from the Fed.
The crises is because the banks capacity to borrow in the money market has dried up. All the Feds actions to substitute borrowing from them to replace the normal money market borrowing is what you are showing and it is the reason the banks are able to continue lending.
My question is do the people spreading this analysis do not really understand what is happening or do they have their own political objective to spread such poor economic analysis even though they know better.
Posted by: spencer at October 25, 2008 09:44 AM
I'm with Constantine, Professor Hamilton, I took the exploding monetary base as a sign that the Fed is no longer sterilizing. Or at any rate, not completely.
I'm thinking now, perhaps I don't really understand this.
Posted by: Daniel Dare at October 25, 2008 10:45 AM
Nice integration, Professor.
I sense logical pessimism in your tone.
None of these liquidity aids will work. Holders of debt must come to the realization that they will be repaid mere fractions of face value, and book the losses, now. Holders of equities and homes must come to the realization that they hold things valued at mere fractions of prior market values, and accept the losses.
Until then, we will have the protracted downward spiral to true, defensible values for debt, equity, and other assets.
Posted by: jg at October 25, 2008 10:57 AM
Can that Treasury supplement line simply grow with no consequences?
Can the fed "run out of ammo"? If so, when and what happens? And if so, what indicator would you check to see if people are betting on this outcome?
Posted by: paddyd at October 25, 2008 11:36 AM
Where's the recent $600B for the money-market accounted for?
Posted by: paddyd at October 25, 2008 11:42 AM
Constantine and Daniel, the monetary base includes the excess reserves discussed here, which is the exploding component.
Posted by: JDH at October 25, 2008 11:49 AM
"But if, as argued by John Taylor and John Williams, the spread instead represents compensation for counterparty risk, it doesn't matter how much term lending the Fed does. Its actions would only move that spread to the extent they reduce the counterparty risk itself. The primary consequence of the actions would not be to change the spreads but instead would just shift the risk onto the Federal Reserve's balance sheet."
What worries me is that TARP is also shifting risk, or outright losses, to the treasury, which is why the banks are loathe to lend. They're recapitalizing themselves, or, to put it another way, shifting the losses to the government. Either we'll pay too much for their assets, or the money we get back won't compensate for the losses. Do you have any opinion on this?
Posted by: Don the libertarian Democrat at October 25, 2008 12:47 PM
By the way, excellent post. Please keep it up. It's very helpful.
Posted by: Don the libertarian Democrat at October 25, 2008 12:49 PM
JDH didn't say the Fed pays interest on Treasury balances.
The Fed remits its annual profit to the Treasury.
So it doesn't have to pay interest on Treasury balances. It amounts to the same thing.
Posted by: JKH at October 25, 2008 02:23 PM
Currency in circulation increased by about 5% Aug 07 to Oct 08. If currency in circulation continues to grow at 5% next year, but aggregate output falls by 2% to 5% then will we ultimately bid prices up by 7% to 10%? Or is that an overly simplistic way to look at inflation?
Posted by: tj at October 25, 2008 05:08 PM
"In other words, any losses by the Federal Reserve are equivalent to a fiscal expenditure financed by Treasury borrowing."
Wouldn't it be correct to say then, that the FED has become the U.S. banking system's laundromat of questionable assets?
If so, it would be interesting to know the precise conditions on which the FED is accepting these doubtful assets as collateral for bank loans - if it accepts them at face value, and it turns out that eg. 50% have to be written off, the US Treasury will have to do quite a bit of borrowing.
Their timing could not have been better though, as all this coincides with a global breakdown of stock markets that has caused unprecedented demand for US Treasury bonds, which in turn has caused a strong increase in demand for the US dollar. It's the perfect climate to export some more of its inflation.
Posted by: Daniel at October 25, 2008 06:43 PM
The large increase in excess reserves, while causing the base to rise also causes the money multiplier to fall.
Using weekly money stock data and biweekly monetary base data from FRED:
The M2 multiplier fell by by 10.1 percent from the beginning of the 2nd week of October of 07 to the beginning of the 2nd week of October of this year (roughly -- the dates do not exactly coincide). In other words, even though the base grew by about 18.8 percent in that time period, M2 only grew by 6.8 percent.
From 2006 to 2007 (roughly the same period in October), the growth in M2, the base, and the M2 multiplier were 5.8, 2.5 and 3.3 percent, respectively).
I'm will to argue that the increase in the M2 growth rate has more to do with the Fed lowering the Fed funds rate than anything else (see JDH's prior post on this topic). In other words according to the data, the Fed is still sterilizing.
Posted by: smg at October 25, 2008 09:24 PM
It seems to me that this cannot go on like this.
The Treasury is issuing new debt, and the proceeds from those purchases of debt end up as increases in reserve balances at the Fed, and the Fed is paying interest on reserves in order to keep the funds there and thereby prevent inflation. But by paying interest on reserves, the Fed is shutting down the credit system, because banks no longer lend to each other if they can earn interest on their reserves at the Fed.
It seems to me that the Fed has a choice: it can continue to prop up banks while shutting down the credit system, by paying interest on reserves, or it can restart interbank lending by not paying interest on reserves, at the cost of igniting inflation. I think eventually inflation is inevitable, if phrased in these terms.
Posted by: Dale C. at October 25, 2008 10:38 PM
The Worldwide DEBT is the problem.
The best solution for the present economic crisis would be a REBOOT or restart of the entire debt system for the ENTIRE WORLD.
1. A data base listing ALL DEBT, government, business and personal needs to be created. The list would need to list the debt and debt holder with a bank that could make an accounting of the debt. Included would be all national debt of all nations, all mortgages car notes and credit cards for individuals. All outstanding bond and other debt for corporations, The idea is to list ALL DEBT of any kind owed.
2 . Every government on the planet would need to call a special session of it�s legislature.
Using the same authority that governments have to use or create FIAT CURRENCY the legislatures and Central Banks need to authorize the creation of ACCOUNT CREDIT in an amount equal to all the listed debts in the world.
3. The Various governments and Central Banking Systems then need to make an accounting change equal to the debt in the form of an ACCOUNT CREDIT or CREDIT zeroing out ALL THE DEBT in the entire world, and crediting all debt-holders in the world.
The following day the economy of the entire world would restart and the Stock Markets of the world would react to the new renewed capital in the banking systems, the Capital now available to restart all business and the disposable income to the individual people would restart and grow the retail sectors and the manufacturing sectors of the entire world.
Allen Charles Report
Posted by: Allen Charles Report at October 26, 2008 12:01 AM
I see; I interpreted "The Fed is also receiving interest on the loans it made, and returns that interest to the Treasury" as meaning that the interest was passed back more directly. Thanks, but I am still left with the question of where to refer for information about the Fed handing over profits to the US Treasury.....I assume that this information must be published somewhere.
Posted by: RebelEconomist at October 26, 2008 04:59 AM
I strongly suspect it's on the Fed web site somewhere (probably the Treasury site too). There's a lot of stuff buried there beneath the surface. I'll look for it when I get a chance (sometime) and pass it on when/if I find it.
Posted by: JKH at October 26, 2008 05:43 AM
btw, this is the best review of the Fed balance sheet out there.
Posted by: JKH at October 26, 2008 05:52 AM
Rebel, from the Federal Reserve's FAQ page:
After paying its expenses, the Federal Reserve turns the rest of its earnings over to the U.S. Treasury.
You can find these receipts detailed as an item in the U.S. Budget here.
Posted by: JDH at October 26, 2008 06:58 AM
tj, your logic is ok, but as an empirical matter the velocity of money wanders significantly from year to year, making predictions like this not as useful empirically as you might have supposed a priori. Certainly the Fed should be doing what it can to stimulate the economy at the moment, and I have no problem with modest rates of increase of the monetary aggregates. But this increase in excess reserves is so extraordinary that I view the latest development with some concern.
Posted by: JDH at October 26, 2008 07:04 AM
Don, the question of the moment is indeed how much of a loss the Fed will take on these assets. I do not have the answer.
Posted by: JDH at October 26, 2008 07:08 AM
I wouldn't be so concerned about the increase in excess reserves, except that it partially correlates with a more general expansion and credit risk deepening of the Fed's balance sheet. It's an indirect indicator of this, and only partial at that (increased government balances are the other factor).
The excess reserve increase is matched by a 1:1 M1 increase in its creation. But the so called "multiplier" concern is absolutely irrelevant. Banks won't be undertaking massive lending and additional M1 creation simply because they have excess reserves. Accordingly, the concern about sterilization insofar as it is supposed to relate to "multiplier" control is irrelevant as well.
Sterilization is relevant for a different purpose and in a different way. The concern about excess reserves is not that of the "multiplier" but rather control of the Fed funds rate on the downside. The Fed has instituted payment of interest on reserves for this purpose (i.e. "sterilizing" the effect of excess reserves on the funds rate) and has already fine tuned the interest rate discount once, in order to attain the desired level of control.
Posted by: JKH at October 26, 2008 07:22 AM
Thanks, most helpful. I shall refer conspiracy theorists to these links.
Those who are concerned about the inflationary implications of the expansion in reserve balances could consider the examples of Japan and Britain. Japan demonstrates how the additional demand for safe and liquid central bank money during a banking crisis can be accommodated without inflation. At the height of quantitative easing, banks balances at the BoJ rose to about Y35tn, and have since fallen back to Y9tn without problems. In fact, not to accommodate such demand would probably be deflationary. Britain demonstrates how the demand for reserve balances at any given price level increases when interest rates are paid on reserves. From end-April 2006, just before the Bank of England began paying interest on reserves, to end-April 2007, before the credit crisis got going, reserves balances at the BoE grew from �3bn to �18bn without an explosion of inflation. Both precautionary and interest factors have expanded the demand for Fed reserves balances in recent weeks.
An interesting difference between the Fed and the BoJ is that the assets that the Fed has bought to expand reserves balances (basically, repo against increasingly dodgy securities) involve more credit risk and less interest rate risk than the assets bought by the BoJ (government securities across the curve). The BoJ has been able to allow its balance sheet to contract considerably without incurring significant losses. Hopefully, the present credit crisis will soon recede, and we will see whether the Fed will be able to contract its balance sheet back without losses.
Posted by: RebelEconomist at October 26, 2008 08:45 AM
Interesting contrast with the BoJ. Here's hoping on the credit side. Given the relatively late cycle entry of the Fed and Treasury into the credit positioning game, the risk of their losses has almost certainly been overstated by exuberantly pessimistic fat tail lovers.
Posted by: JKH at October 26, 2008 09:36 AM
"The Federal Reserve Board on Monday announced that it will begin to pay interest on depository institutions' required and excess reserve balances. The payment of interest on excess reserve balances will give the Federal Reserve greater scope to use its lending programs to address conditions in credit markets while also maintaining the federal funds rate close to the target established by the Federal Open Market Committee. "
So, unless the Fed paid interest on these reserve balances on deposit, they couldn't be used in their special lending facilities to combat the credit crunch.
Posted by: Les at October 26, 2008 05:10 PM
Its not clear why you are concerned with the explosion in reserves. You have argued before the Fed can simply take them back later, voiding any inflationary consequence.
Secondly, there remains an important unasked normative question in your analysis: Should the Fed desire inflation?
The balance sheet of the Fed represents a dangerous dynamic. The Fed is cushioning de-levering by encouraging cash hoarding by the banks. The dynamic allows the Fed to expand its balance sheet and the monetary base. However, importantly, it also shrinks velocity. One might even argue that velocity is "crashing", such that any increase in the money supply is unimportant.
How can the Fed encourage cash hoarding and still expect to fight deflation? It seems an implausible policy. One can make the case that the Fed should NOT pay interest on reserves, and that it should instead PENALIZE cash hoarding by creating inflation by any means. Only by fighting deflationary expectations directly, with inflation, can velocity turn.
Finally, it seems to me economists these days are wary of the concept of velocity. Its something that is psychological in nature; and it is not subject to econometric analysis (which practically renders it invisible!).
Posted by: David Pearson at October 26, 2008 07:41 PM
If there's one thing I hope to ever get clear from all this credit and finance, it is exactly this matter of "printing money." The polemical and partisan twists on the phrase are maddening. So please help. In the above you write: "Banks can turn those reserves into green cash any time they desire, so the process is sometimes loosely summarized as saying that the Fed pays for the Treasury bills it buys or loans it extends by 'printing money'". But at http://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html I read:
"Each Federal Reserve Bank is required by law to pledge collateral at least equal to the amount of currency it has issued into circulation. The bulk of the collateral pledged is in the form of U.S. Government securities and gold certificates owned by the Federal Reserve Banks." Does this imply that if Treasury stopped issuing bonds/bills etc (yes, this is a thought experiment) that there would be an absolute limit on how much currency could be printed? (Only as much as there is accepted collateral...)
Posted by: Dave Raithel at October 26, 2008 09:27 PM
Seems to me that the Fed is playing an aggressive hand: seize money velocity so banks are ready for credit events, which causes foreign central banks to then use their own dollar reserves to free up credit in their own markets, thereby giving Fed room to eventually retrench and tighten.
Posted by: phil at October 26, 2008 10:47 PM
I think the most danger for the Fed to lose control is when the loans it makes default. There you have a quantum jump down on the asset side, with no compensating decrease on the liability side. To sterilize this the Fed would have to sell the same amount of treasuries. Perhaps this is what the reserve is for?
Frankly I don't understand why people are still buying treasuries. With the Fed's request and the $700B bailout, you're looking at $1T+ sudden increase in total treasuries outstanding. The number may exceed $2T when the dust settles. There is no way for the price to go up in the foreseeable future, especially considering decreasing appetite from Asian governments.
As to inflation, just looking at the base money (M1) is insufficient. Credit and velocity of money are more important. Right now, banks and hedge funds are deleveraging. But as soon as the housing market and economy stabilize (and stabilize they will), leverage will no doubt creep up. With the significantly expanded base money in the system (including those in Euro and most all currencies), it'll be impossible for central banks to reign in inflation.
This is my basis for long-term inflation. Your insights would be most appreciated, Prof. Hamilton.
Posted by: Bo Peng at October 27, 2008 01:49 AM
Bo, perhaps people are buying treasuries because they consider them safe. It's capital preservation time. Just about all kinds of assets are losing value, so someone looking to preserve capital has no choice but to choose safety over return and/or yield.
I'm trying to understand the implications of all the money pumped into the sytem to guarantee everything. The Fed ****ed up big time by unleashing a massive moral hazard and it continues to print more money to up its moral hazard bet. What does it mean to work hard and earn a moderate annual salary when your tax money is commandeered to bailout reckless banks and preserve the dividends and share price of bank shareholders?
Posted by: rational at October 27, 2008 02:12 AM
Allen Charles Report states:
"3. The Various governments and Central Banking Systems then need to make an accounting change equal to the debt in the form of an ACCOUNT CREDIT or CREDIT zeroing out ALL THE DEBT in the entire world, and crediting all debt-holders in the world."
What? How exactly? With what existing accounting method? With what "credit"?
Posted by: Babinich at October 27, 2008 03:00 AM
I hereby acronymize "Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility" as ABCP3MFluff.
Posted by: Alphabet Fluffy at October 27, 2008 05:58 AM
It seems to me that those of you who are confident in the effectiveness of the Fed's sterilization capabilities are heavily dependant upon the ultimate, realisable values of the collateral presently being accepted, as well as the relative stability of treasury instruments.
Posted by: Amortised Intellect at October 27, 2008 06:47 AM
What about guarantee of interbank lending, should that not eliminate the problem of counterparty risk? The FDIC is supposedly doing this, despite that we are not seeing a reduction in spreads.
Posted by: Asha at October 27, 2008 06:52 AM
The Fed's payments to the Treasury are documented in Table 4 of the Monthly Treasury Statement and on each Wednesday of the Daily Treasury Statement (table 2). Those payments traditionally include two pieces, net interest and revaluation of its foreign exchange holdings. It may also include the revaluation of Maiden Lane and the like, but I do not know if that is true.
Posted by: rana at October 27, 2008 07:01 AM
Excess reserves do have macro effects and aren't necessary sterile. It is the excess reserves in the banking system that is keeping the effective fed fund level below target everyday. The lower effective fed fund daily is keeping treasury general collateral lower than it would be otherwise.
If you netted out the balance sheets of the Fed and Treasury, it wouldn't hard to argue that the government is printing money to pay for its own expenditure with the banking system intermediating with a rather risk-less arbitrage.
Posted by: Fullcarry at October 27, 2008 08:04 AM
The fed can 'print' as much money as the public demands, as long as the money (a FED liability) is backed by corresponding assets (usually US treasuries).
My concern, and I would really love to hear others' comments on this, is on the inflationary aspect of backing FED liabilities by assets of increasingly dubious value. If $1 issued from the fed is backed by Maiden Lane LLC assets paying out $0.80 on the dollar, then the Fed has, in fact, 'printed' a dollar worth only $0.80.
Whereas $1 issued by the fed backed by $1 in guaranteed US treasury is truly 'worth' $1.
This line of thinking is sort of "real bills"-ish, but now that the Fed has begun to accept questionable assets for collateral, shouldn't this be an issue?
My guess is this would ultimately result in increased currency volatility (based on the murkiness of the Fed balance sheet) and higher rates for Treasuries (required to fill the unknown hole on the asset side of the sheet)...or eventually price inflation.
Others please weigh-in here...
Posted by: Keith at October 27, 2008 08:14 AM
Much of the detail of these writings is beyond me. I do remember a few curiuos terms, "off balance sheet", financing. An ENRON tool that I thought we all found to be illegal. Isn't a balance sheet supposed to balance? Did the privately held companies now seeking bailout (and the Fed), use that same ENRON trick to get where they are now without everyone seeing their "balance sheet"?
The savings and loan collapse from, was it in the eighties, how did that go? Wasn't that some group of lenders who did what I will call "cross lending" designed to get them rich then let the S&L institutions, which were backed by the government, go under. Did the lenders all agree from the start that that was the game, pass the trash? So are some of these loans today and loan sale-offs the same preplanned route to individual wealth?
Lastly, the taxpayer rebate ($160 B), and the cash flow to foreign nations just due to the crude oil doubling in price ($220 B), my math shows that buying crude at $140 per bbl was a net de-stimulus to the economy and a definite part of the equation for economic downturn.
Help wanted, not a bailout, answers to questions, does anyone really understand how this all works?
Posted by: ben claassen at October 27, 2008 08:54 AM
rana, thanks for your further information on details of the Fed's payments to the US Treasury.
Keith, apart from the issue of Fed independence, which has been marginalised by the magnitude of the present crisis, the value of the dollar is ultimately backed by the taxation powers of the US government. If some of the Fed's secured loans default and their collateral turns out to be insufficient to cover the loss, the US government can make the Fed whole again by transferring government debt to the Fed free of payment, and the government can obtain dollars to service this debt from taxes.
Posted by: RebelEconomist at October 27, 2008 10:12 AM
Rebel - that makes sense. Do you think this process would result in higher currency volatility and/or higher rates for Treasury debt?
as for inflation, what I am hearing is that you think there is no inflationary aspect to questionable collateral, since the treasury can just issue more debt. is that what you mean?
Posted by: Keith at October 27, 2008 11:03 AM
Where would the $120 Billion sent to AIG show up? Because AIG said they might need still more.
Where can we find out who AIG is writing checks to on CDS, particularly any naked CDS on Lehman?
Follow that money, because until we get a grasp on where that money is going, we are still in a fog. Corporate CEO compensation gets all the publicity, but this is where the real money is. Did CDS betters drive Lehman down? Did Lehman people use CDS to bet against their own company?
Posted by: Randy Miller at October 27, 2008 11:10 AM
The announced currency swaps amount to significantly more than the Other total.
If they are accounting for them in some other way than by the notional amount of the swap, this would be helpful to know.
In my opinion, the losses incurred, if using the obvious Market accounting, are considerably larger than for the Maiden Lane Portfolio and should be made public. Of course, probably the only reason the losses for Maiden Lane are broken out and published is that the Congressional hearings obtained this commitment, and , so far as I am aware, there has been no comparable Congressional interest in what has become the Fed's costly foreign aid program.
Posted by: Terminal at October 27, 2008 11:16 AM
Of all the things to worry about during this crisis, the true roots of the problem and the need to er ... "coordinate" a smart response via Washington and a G.O.P. Treasury, the Fed's actions hold the least worry for me, both short and long term.
If there is anything we have learned (cf. Mankiw's article on the weekend), it's how to deal with the monetary side of crisis!
I think it is a good thing, unequivocally, that the Fed is expanding it's balance sheet during a time of crisis. That they have the easy expertise to shift methods of managing monetary policy, with the alacrity that they have shown, is positive indication that a skipper is at the helm, there.
Maiden Lane's "loss" on the b/s will be a rounding error, compared to the eventual economic cost of this crisis. It's gets press, but it's not "important".
The drop in the Fed's agency holdings, some have remarked, is a concern, IMHO, until we know what is driving that shift, if it is not just a temporary one.
Otherwise, the focus ought to be on two policy initiatives, in my estimation only:
1. Coming up with *targeted* policy initiatives to unwind / terminate such structures as synthetic CDOs, so that the contracts support those structures ... "delever", until such time as the system has the risk bearing capacity to take such things on again. Anything else along those lines that helps to remove uncertainty about bank asset quality or off-balance sheet leverage.
2. Coming up with clever policy designs that address the housing markets *directly* (and, thereby, the value of the securities that reference them - CDOs, CDS, general mortgage pools, etc.).
Posted by: Amicus at October 27, 2008 12:13 PM
This is important information.
The question of understanding the actions of the FRB as they relate to inflation and ultimate taxpayer liabilities is very difficult because these events will take place in the unknowable future.
I would hope someone would focus on the pre-crisis tendency of all govenmental agencies to pass on the costs of current decisions to future taxpayers. Is that tendency still present?
Posted by: W. Raymond Mills at October 27, 2008 12:24 PM
I was using Maiden Lane as an example. Of course it is a rounding error, at 1.4 of Fed assets.
The real issue I was getting at is that about 66% of the Federal Reserve's Assets now carry genuine counterparty risk of an entity other than the US Government. Does that matter at all?
Also, who audits the Fed's balance sheet? Are they required to follow the same write-down rules on their assets as corporations?
My theory is that the clouding of these asset values by counterpary risk will result in higher currency volatility and higher rates for government debt.
Posted by: Keith at October 27, 2008 01:02 PM
While the actions by the Fed would not be as inflationary if the treasury covered the losses on thier dodgy assets, there is a limit to how many treasuries the government can issue. Eventually even the government has to pay its bills, which means inflation.
Inflation would actually not be so bad for a debtor nation. The alternative is a much worse version of what happened to Japan.
Posted by: dave at October 27, 2008 01:22 PM
It's not an encouraging development because it means that the heroic efforts that the Fed has taken previously weren't enough. The Fed's first $100 billion didn't do it. The Fed's first $1 trillion didn't do it. Having the Treasury take over the $5 trillion in debts and guarantees of Fannie and Freddie didn't do it. The Treasury's $3/4 trillion rescue/bailout package didn't do it. And another quarter trillion will?
You are making it harder and harder to disagree with you! :-)
Posted by: DickF at October 27, 2008 01:34 PM
66% of the Federal Reserve's Assets now carry genuine counterparty risk
Eh. Borrower's pledge collateral, right? The Fed's collateral people are pretty good at knowing what and how much of it to ask for.
[My comments were meant to be in general, not directed toward any poster/person. I frequently write more quickly than I should - my apologies if I came across as curt.]
Posted by: Amicus at October 27, 2008 01:44 PM
I question the entire desire by the Fed to fully sterlize its programs. In normal times (and at the margins) the monetary authorities' programs should be as neutral as possible. However, in the present case we have the real economy shrinking at a dramatic and highly recessionary rate, due to a collapse in the money-like credit created during the boom years. The Fed's righteous insistance on pursuing a fully sterlizable program in such a case is actually exacerbating the flight of credit out of the "real" economy and banking system and into the Fed's open arms. Surely, what the Fed and Treasury need to do is have a good, big dose of inflation, to "reprice" the remaining debt in the economy to more manageable levels? I know that it would annoy foreign creditors and increase borrowing costs, but it would start to "normalise" the situation and is really the only way out (unless you want to sit pat until the entire world delevers back to scratch).
The other problem I have, is what happens at the other end of this process, when the Fed decides it's time to gradually shrink their balance sheet? They can't do that immediately; they'd need to do it gradually, over a very long time. I don't think it's as clear as Rebel Economist indicated above, that the real economy effects of the BoJ shrinking its balance sheet from Y35tn to Y9tn was so benign.
Posted by: Brad_M at October 27, 2008 03:53 PM
Rational: "What does it mean to work hard and earn a moderate annual salary when your tax money is commandeered to bailout reckless banks and preserve the dividends and share price of bank shareholders?"
If I have the fed's machinations down correctly, it is just taking on risk by trading Treasury debt for riskier private debt. If all goes well, it can reverse the process in future and it will have made a profit for taking on more risk. No inflation fears need arise. But I think Rational is right (I would have added preserving ridiculous bonuses for overpaid rascals to his or her lament) and the fed is not taking on risk at the appropriate price, but subsidizing it, probably massively. When the exchange is reversed, it will turn out to have a huge price tag that the government cannot afford. That is when the inflation risk will happen - when the Treasury can't make good on interest payments and begins selling Treasuries to the fed to cover payments.
Something called "Maiden Lane" on the fed's balance sheet? I rest my case.
Posted by: don at October 27, 2008 06:34 PM
Thanks for the response don.
Posted by: rational at October 27, 2008 10:22 PM
Don - that was my point exactly. The value of the "dollars" on the asset side of the Fed's balance sheet are now questionable. Therefore, the money supply "dollars" on the liability side are now questionable too. Only US Treasury backed dollars can hold their value because they alone carry no counterparty risk. I am still very suspicious of the potential impact of the Fed's new facilities on the value of the dollar.
Posted by: Keith at October 28, 2008 06:42 AM
This entire debate misses the wntire point: the US consumer/borrower/saver is not the Japanese consumer/borrower/saver. You either make the argument that the US changes to the Japan model or you don't. in the case of the later, you have serious problems with yet another bubble as it represents the only way for a return to the equilibrium the Fed is desperately trying to hold. The Fed program is plain and simple about recaping the banks and relies on the idea of trickle down will solve all woes. Inflation will be the most pernicious of all solutions as the only thing not inflating is wages, which drives the neg feedback loop into why debt is so front and center as a stopgap in the first place. The business model of the US is broken. if you start the analysis from here you realize pretty quickly that the Fed is really not all that central to this debate. it is a sideshow to the creative destruction that is ongoing. Unless the Fed is going to unveil a new business plan for all this money, call me unconvinced.
Posted by: S at October 28, 2008 09:24 AM
Umm... maybe I'm off, but isn't the Fed trying to buy time until the G20 meeting? It's pretty clear Paulson wants to stuff BRICOPEC with some Reno mortgages, and BRICOPEC wants to secure new trade concessions, and so there appears to be a satisfactory middle ground.
Posted by: phil at October 28, 2008 01:52 PM
I suppose there is would be some weakening of the US public sector creditworthiness if the Fed sustains losses on its assets, and to the extent that that makes the US slightly more likely to opt for an inflationary solution to its debt burden, it is somewhat negative for the dollar. But the Fed's balance sheet is small compared with the entire value of the US public sector including the discounted value of future taxation, and given the short maturity of the Fed repo loans, the low likelihood of one of their borrowers defaulting, and the value of the collateral protection as enhanced by a large haircut, I would not expect the changes in the Fed's balance sheet to have a significant impact on the internal or external value of the dollar, and its volatility.
Posted by: RebelEconomist at October 29, 2008 02:26 PM
Maybe I'm wrong, but I thought that in times when pump-priming was required, the Fed pumped the banks and the Treasury goosed the real economy, including direct stimulus to taxpayers. However, ex-banker Hank can't see past his previous career, and seems to have decided that Ben can't do his job properly (or sufficiently), so we have both monetary and fiscal stimulus directed to the banks.
We have an academic economist in charge of the central bank, and an ex-banker in charge of the Treasury. Does that strike anyone else as an issue?
Posted by: Brad_M at October 29, 2008 05:03 PM
"The excess reserve increase is matched by a 1:1 M1 increase in its creation."
Increases in reserves do not increase the M1 money supply. Reserves are not money in circulation.
Posted by: Brian at October 30, 2008 01:49 PM
Rebel - good point. I am actually leaning toward thinking it might just manifest in higher interest rates, moreso than dollar swings. But, since this is all a great big experiment, I guess we will find out evenutally!
Posted by: Keith at October 31, 2008 05:42 AM
Financial commentators often mention the ability of the Fed to print money out of thin air. Is money printing occurring at present? How do we know it when we see it?
The recent, quantum increase in the asset side of the Fed's balance sheet seems to have been produced by borrowing from Treasury rather than outright money printing.
What would outright money printing look like in the H.4.1?
Thank you for any clarification. I have a keen desire to understand this matter.
Posted by: Bob at November 4, 2008 09:56 PM
Let us face it --- only inflation would result in a soft landing to this housing market crisis. The current US housing price index (using 1991 as base) is 210. However if we use an average 3.5% compound inflation from 1991, the housing price index should be 180 to be on par with 1991, ie no more or less expensive than 1991.
We can either 1)let housing market to drop another 20%, 2) let 3.5% inflation to run for another 5 years so that repayment ability can catch up, or 3) let inflation runs higher so that the catch up can be completed earlier.
Unfortunate the inflated CDS market already pointed to 3) as the answer. It is just Bernanke does not want to face the reality.
Posted by: Lee Siu Hoi at November 10, 2008 07:06 PM
Seems to me the $64 question is this: Can the Fed and Treasury pump enough dollars into the economy to prevent deflation? And if they do, isn't this akin to trying to fix a wrist watch with a sledge hammer? ie, might they end up with inflation far beyond their intent?
If they fail, and we do have an extended period of deflation, how will consumers, and the US government itself service all this debt with "deflating dollars"? Consumers can't service the debt in today's dollars.
Posted by: John Baughman at November 20, 2008 06:06 AM
Allen Charles Report
"Using the same authority that governments have to use or create FIAT CURRENCY the legislatures and Central Banks need to authorize the creation of ACCOUNT CREDIT in an amount equal to all the listed debts in the world...[blah blah]"
Wouldn't it just be easier to locate and blow up all the central accounting systems in the world, like they did in 'Fight Club'? No massive treaties, etc. required. Just let me know before you do it so I can buy as much property on credit as I can.
Posted by: Mark in SF at November 25, 2008 06:59 PM