Wikinvest Wire

Deconstructing the Fed's balance sheet

Monday, December 22, 2008

Jim Hamilton at Econbrowser dissects the balance sheet of the Federal Reserve, explaining in excruciating detail why you shouldn't be alarmed at the chart you see below.
IMAGE Here's the part that should make you feel better.

That is, the part where Fed Chairman Ben Bernanke transforms from the $800 billion man back in September to the $2.3 trillion man (and counting) in December without creating any new money.

Beginning in September, the Fed decided it couldn't afford to sell off any more of its Treasuries, but wanted to lend more and still have no effect on the money supply. To do so it needed to find a way to funnel the reserves created by the new loans it would make into categories on the liabilities side that would not result in more cash held by the public. The first such device was to reach an agreement with the Treasury for the Treasury to simply hold on to a huge volume of Federal Reserve deposits, some $484.6 billion as of last week. The way this worked is that two operations were implemented simultaneously. First, the Fed created a lot of new deposits, for example, $318.8 billion from the Commercial Paper Lending Facility alone. Second, the Treasury borrowed an additional half trillion from the public, forcing somebody in the public to send a check to the Treasury. In the aggregate, the reserves created by the Fed through the CPLF end up just being parked in the Treasury's account with the Fed, with no creation of money.
The second measure that the Fed employed to allow this ballooning of its assets was to start paying banks an interest rate on reserves that is exactly equal to its target for the fed funds rate itself, essentially eliminating any incentive for the banks to lend fed funds and encouraging banks instead to simply let excess reserves accumulate. Last week, banks were sitting on about $800 billion in excess reserves with the Fed, doing absolutely nothing with them. The Fed was in effect lending those funds in place of the banks.
It's good to know that the Treasury Department can just go out and borrow a half trillion dollars for the Fed if and when it wants to.

It helps that the rest of the world remains scared to death of just about any asset other than U.S. Treasuries and is more than happy to keep buying the stuff.

Reading through the rest of this piece, you get the feeling that the Fed really knows what they're doing and they have things well under control, up until the point where you read:
Ben Bernanke has made a gamble with something approaching $2 trillion. If the gamble wins, taxpayers owe nothing. If the gamble loses, taxpayers are committed to borrow a sum equal to any losses and start making interest payments on it.
Ultimately, things don't sound nearly as good at the end as they did in the beginning.


Mathlete said...

I think many have been too glib in their assessment of Fed printing and focus on one side of the balance sheet.

What the Fed is doing is high stakes, but "as of yet" they have not made inflationary moves. They've made a big water filled bubble in Treasuries. If things go well, they'll drain the water. If it pops, we get an inflation flood. The latter scenario is probably a good bet, but will it fail totally or partially?

I think the Fed is yesterday's news though. They made their bet, we know it, we can discount it. The real action will be at the Federal and State level of government because we have moved on to a debt crisis. The Fed can drain their toxic swamp if there's a supply of Treasuries. If the market gets filled up on roads, entitlements and military borrowing, however, there won't be anything for the Fed.

KG said...

How are the AIG assets, for example, possibly ever going to be worth what the Fed paid for them???? At some point they have to just print up the money, don't they?

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