Federal Reserve balance sheet

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Contents

Federal Reserve resources

Resources at the Federal Reserve site about information on the various Federal Reserve liquidity and credit facilities and greater background on the Federal Reserve's balance sheet.

  • Crisis response provides information about the Federal Reserve's strategy since the beginning of the financial crisis.
  • Federal Reserve's balance sheet discusses the Board's weekly H.4.1 statistical release, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks," which contains the Federal Reserve's balance sheet and related information.
  • Federal Reserve System financial statements includes annual financial statements for the individual Reserve Banks, the Board of Governors, Maiden Lane LLC, Maiden Lane II LLC, Maiden Lane III LLC, and the Commercial Paper Funding Facility LLC.
  • Federal Reserve liabilities discusses the key liabilities on the Federal Reserve's balance sheet, including currency and reserve balances.
  • Recent balance sheet trends provides a graphical depiction of selected assets and liabilities of the Federal Reserve.
  • Open market operations discusses this traditional policy tool, including its evolution during the financial crisis.
  • Central bank liquidity swaps discusses the use of reciprocal currency arrangements with other central banks, in response to the global nature of the financial crisis.
  • Lending to depository institutions discusses the primary, secondary, and seasonal credit facilities as well as the Term Auction Facility.
  • Lending to primary dealers discusses the Primary Dealer Credit Facility and securities lending programs.
  • Other lending facilities presents information about the
    • Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility,
    • Commercial Paper Funding Facility,
    • Money Market Investor Funding Facility
    • Term Asset-Backed Securities Loan Facility
  • Support for specific institutions discusses the special lending arrangements with
  • Collateral and rate setting provides details on eligible collateral for a number of lending facilities and a summary of the terms and conditions of the Federal Reserve's lending facilities.
  • Risk management explains how the Federal Reserve manages the risk associated with various liquidity programs, and provides details on the rapid expansion of its balance sheet.
  • Longer-term issues discusses some of the challenges the Federal Reserve will likely face in the future as the financial crisis evolves.
  • Reports and related resources provide links to Federal Reserve reports to the Congress and related items.

Current Federal Reserve balance sheet

It is time for the weekly update of the only financial component that really matters: the composition of the Fed's $2.3 trillion (and rising) balance sheet.

  • Securities held outright: $2,047 billion, an increase of $1.8 billion from the week prior.
  • Total Treasury holdings increased from $786 billion to 788 billion, as the Fed bought another $1.7 billion in USTs as part of QE Lite.
  • MBS holdings were flat at $1.1 trillion.
  • Agency holdings were also flat at $157 billion.
  • Net borrowings: unchanged at $60 billion from the prior week.
  • Float, liquidity swaps, Maiden Lane and other assets: $185 billion, an increase of $1 billion.
  • FX liquidity swaps are at $64 million as the same bank that is experiencing a USD funding crisis continues to have no EURIBOR/LIBOR acces.
  • The "value" of Maiden Lane I declined just marginally from the highest since November 2008, and was at $15.97 billion.
  • Maiden Lane II was at $23 billion, while AIA Aurora was $25.7 billion.
  • The monetary base declined by $2 billion and was $1.993 trillion (even as M2 surged in the past week. More on this shortly)
  • Reserve balances with banks: $1.031 trillion, a decline of $3 billion from the prior week.
  • Foreign holdings of USTs and MBS at a new all time high of $3.22 trillion.

Central bank balance sheet comparisons

The balance sheet of a central bank provides detailed information about how it uses its monetary policy instruments. It is therefore also a useful guide for understanding how monetary policy is implemented. The changes in balance sheets that have occurred since the start of the fi nancial market turmoil show that central banks have used existing tools in innovative ways, as well as introduced new ones, in order to relieve liquidity shortages and ensure the smooth functioning of money markets, which is essential for the transmission of monetary policy. As central banks have stepped up their intermediation role in money markets and offered crucial support to other credit markets during the fi nancial turmoil, particularly after the bankruptcy of Lehman Brothers in September 2008, the size and complexity of their balance sheets have increased significantly.

This article describes and compares the evolution of the balance sheets of the Eurosystem, the Federal Reserve and the Bank of Japan.1

As there are differences in the monetary policy implementation frameworks and accounting standards of these central banks, the comparison is not based on their detailed financial statements but on simplifi ed versions thereof (hereinafter referred to as “simplified balance sheets”).

Between June 2007 and December 2008, the total assets of the Eurosystem and the Federal Reserve grew considerably, by 90% and 160% respectively, as a result of the measures introduced in response to the financial turmoil.

With the improvement in money market conditions in the first half of 2009, the total assets of the Eurosystem declined by about 20% and those of the Federal Reserve by 10%.

However, high demand for the Eurosystem’s first one-year refinancing operation, conducted on 24 June 2009, triggered an increase once again in the size of the Eurosystem’s balance sheet, almost to its peak level. By contrast, the Bank of Japan’s balance sheet was relatively large in 2007 owing to the signifi cant increase in outstanding banknotes in the late 1990s, which meant that the level of banknotes in circulation remained above its long-term trend. The Bank of Japan’s balance sheet therefore grew by only 25% between June 2007 and March 2009, when it peaked as a result of the financial turmoil.

Several factors have contributed to the considerable expansion and increased complexity of the balance sheets of these three central banks during the fi nancial turmoil. Prior to September 2008, the Eurosystem and the Federal Reserve increased the number of refinancing operations, especially at term maturities, and introduced foreign currency liquidity-providing operations.

At the same time, the Bank of Japan relied on instruments that were developed during the financial crisis in Japan in the 1990s and therefore already contained unconventional elements, such as longer maturities and a wider range of eligible collateral. Subsequently, during the more intense phase of the financial turmoil, when interest rates came close to zero, all three central banks focused increasingly on the transmission of monetary policy to the real sector of the economy. As a result, it became essential to support major credit markets through outright asset purchases or special lending facilities.

Section 2 introduces the concept of simplified balance sheets and Section 3 reviews the developments in the balance sheets of the three central banks in more detail.

Conducting monetary policy at very low short-term interest rates

May 2004

Ben Bernanke and Vincent Reinhart (who until 2007 was Director of the Division of Monetary Affairs for the Board of Governors of the Federal Reserve System) publish “Conducting Monetary Policy at Very Low Short-Term Interest Rates” in The American Economic Review. How, they ask, can a central bank effectively move beyond conventional policy measures when short term rates are at or approaching zero? Bernanke and Reinhart suggest three strategies:

Convince market participants rates will stay low for a period beyond current expectations Change the composition of the central bank’s balance sheet (credit easing) Increase the size of the central bank’s balance sheet to a level exceeding what is necessary to achieve zero short term rates (quantitative easing) Strategy #2 is radically aggressive insofar as it contemplates altering the composition of a central bank’s assets- which, in non-crisis conditions, consists entirely of Treasuries of various maturities- to include other, perhaps even riskier assets. For instance:

As an important participant in the Treasury market, the Federal Reserve might be able to influence term premiums, and thus overall yields, by shifting the composition of its holdings, say, from shorter-to longer- dated maturities. In simple terms, if the liquidity or risk characteristics of securities differ, so that investors do not treat all securities as perfect substitutes, then changes in the relative demands by a large purchaser have the potential to alter relative security prices. The same logic might lead the central bank consider purchasing assets other than government securities, such as corporate bonds or stocks or foreign government bonds. (The Federal Reserve is currently authorized to purchase some foreign government bonds but not most private-sector assets, such as corporate bonds or stocks.)1

October 31, 2008

In the context of rapidly deteriorating market conditions, Jan Hatzius, Chief US Economist for none other than Goldman Sachs publishes “Getting to the End of the Rate Cut Road” in US Economics Analyst. With overnight Fed Funds at 1%, Hatzius argues the time for more aggressive monetary policy may be at hand. Specifically:

…Fed officials could start to purchase risky asset[s] such as corporate bonds and even equities. At present, such an aggressive approach is legally quite problematic, as the Federal Reserve must not take on a material amount of default risk. Thus, the purchase of risky assets would probably require an explicit stamp of Congressional approval. Should the economic and financial environment continue to deteriorate, however, it would be foolish to rule out such a more radical approach.2

November 14, 2008

Hatzius publishes “Marco Policy in a Liquidity Trap” in US Economics Analyst, advocating still more radical policy measures. In his words:

The most radical step would be debt- or even money- financed purchases of risky assets such as nonconforming mortgages, corporate bonds, or equities… Policy makers could focus specifically on the mortgage market, buying up mortgages or entire mortgage-backed securities in size, restructuring the terms on a loan-by-loan basis, and then holding the loans to maturity. Alternatively, they could target risky assets more generally- private-label mortgages as well as corporate bonds, equities, and potentially a whole host of more exotic securities. Especially, if such a program were financed by money creation, it would be considerably more radical than anything seen previously. Hence, the hurdle for adoption is high one, and the political scrutiny in Congress would likely be intense. Nevertheless, we believe it could become a serious possibility should the economic and financial slump deepen in 2009.3

November 21, 2008

Hatzius publishes “What’s Needed to Stop the Rot?” in US Economics Analyst reiterating his call for unconventional policy action even while noting that it currently sits on shaky legal ground. That is:

…the Congress should consider providing explicit authority to either agency [Treasury or Fed] to buy a broader range of risky assets, including corporate debt and even equities. Although many politicians have difficulty swallowing this on philosophical grounds, this week’s market action should convince them that the risks of inaction are serious. However, such a more radical step is unlikely until sometime in 2009.4

March 13, 2009

Chaos reigns globally. Respected academics and high ranking politicians call for bank nationalization. CNBC reports of “secret” meetings at Goldman Sachs amid fears Geithner cannot get the job done. US equity indices are down more from their highs than the corresponding period in The Great Depression. Pension funds, 401k plans, endowments, insurance companies, etc., are fully exposed, taking heretofore unimagined losses. With nearly everyone in the country exposed to equities in one way or another, the unthinkable begins to seem increasingly plausible. Insurance companies cannot pay claims; pension funds cannot meet their obligations; universities suspend session; Mr. and Mrs. Smith, told just months earlier an unprecedented $700 billion bank bailout was designed to save them and their neighbors on Main St., stand to lose everything. The Fed, having thrown just about everything in its arsenal at the crisis, appears to be losing control. In the most desperate of times, Hatzius call for the most desperate of measures:

…Fed officials might need to expand their balance sheet by as much as $10 trillion to make policy appropriately accommodative (pg. 2)…To be sure, “quantitative easing”- an increase in base money beyond what is needed to keep the funds rate at zero- by itself may not be sufficient on its own because Treasury bills become perfect substitutes for base money once short-term interest rates have fallen to zero. But the Fed can engage in “credit easing” by purchasing assets whose yields are still positive, including longer-term Treasuries, commercial paper, mortgages, corporate bonds, and perhaps even equities.5

Five days later, the Fed shocks the world (though not, it seems, Goldman Sachs) with its most aggressive policy action yet, expanding both the size and composition of its balance sheet via increased purchases of mortgaged-back securities, agency debt, and long-dated Treasuries. Spreads immediately tighten; Bonds- both IG and HY- scream higher; equities stage one of the most explosive rallies in history; the debate shifts from bank nationalization to record bank profits and excessive pay; financial collapse, along with the terrifying social, political, and economic consequences associated with it, is averted. The war, we are confidently told, is over.

Mission accomplished.

Questions, however, still remain:

  • Forget the "Paulson Bazooka," if Lehman’s collapse was a financial Pearl Harbor, was the Fed’s policy response on March 18, 2009 the financial equivalent of Fat Man and Little Boy? (The direct purchase of equities?)
  • In the face of the unthinkable, did the Fed exceed its policy statement by directly buying assets not contemplated therein?
  • Did Bernanke, encouraged by Goldman’s Hatzius, heed his own advice and monetize the equity markets?
  • At best, the evidence offered here is circumstantial. This is not, to be sure, conclusive proof the Fed bought equities- nor is it intended to be. All I have endeavored to do is raise a rational doubt, one that could easily be done away with if Bernanke answered (finally) under oath direct questions as to the Fed's purchase of equities at any point during his tenure as Chairman. Perhaps Alan Grayson might put his worries about foreign currency swaps to the side, and ask Chairman Bernanke about equities.

(The author would like to acknowledge the generous help of Zero Hedge's Marla Singer in the production of this article).

  1. The American Economic Review, Vol. 94, No. 2., p. 86. (Emphasis ours).
  2. "US Economics Analyst," Vol 08, Number 44, Goldman Sachs, October 31, 2008, p. 6.
  3. "Macro Policy in a Liquidity Trap," US Economics Analyst Issue 8 Number 46, Goldman Sachs, p.6 (Emphasis ours)
  4. "What's Needed to Stop the Rot?" US Economics Analyst, Issue 08, Number 47, Goldman Sachs, p. 3.
  5. "The Specter of Deflation," US Economic Analysis, Issue 09, Number 10, Goldman Sachs, March 13, 2009, pg.3. (Emphasis ours)
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