What's on the Fed's Balance Sheet?

One of my long weekend's readings was the Federal Reserve's latest balance sheets (May 20, 2009). (I'm probably semi-autistic and) I just like to absent-mindedly look at the numbers. So the following is just my leisurely observation and not a rigorous balance sheet analysis, which I will leave it to Representative Paul and his co-sponsors (his "Audit the Fed" bill, by the way, now has 179 co-sponsors.) Besides, my knowledge of financial accounting was almost all cleared from my cache as soon as the final exam at B-school was over...

The Fed's balance sheet is over $2 trillion. The following spreadsheet simply shows major line items in their consolidated balance sheet. (As such, they are not supposed to balance.) The Fed does seem to be between a rock and a hard place.

First, take a look at a Liability item, "Federal Reserve notes". That's our currency. According to the Fed's consolidated statements, Federal Reserve notes are backed by Treasury securities, federal agency debt (Fannie and Freddie), and mortgage-backed securities (guaranteed by Fannie and Freddie), which are accordingly on the Assets side. The latter two are held at face value.


I hope you are all comfortable with "face value" of the debts issued and/or guaranteed by Fannie Mae and Freddie Mac, because they are part of collateral held against Federal Reserve Notes. Even with the recent purchase of Treasuries by the Fed, Treasuries alone are not enough to cover the entire currency circulated. No wonder US dollar is declining.

Then, take a look at another Liability item, "Deposits from Depository institutions". That's the bank reserves, including huge excess reserves (actually almost all of it). Right now, the Fed is paying interest to the banks for keeping the reserves at the Fed. Sooner or later, once inflation hits, these reserves will be withdrawn and put to work to earn higher returns. The Fed will have to reduce the Asset side of the balance sheet to compensate for the decline in the liabilities. That means they have to sell either Treasuries, agency debts (that no one will want), or mortgage-backed securities (will anyone want those?). Treasuries may get a decent price still, but the other two won't get sold at face value. That will put further downward pressure on the US dollar.

Or how about those term auction stuff and other LLCs that they created (most of LLCs are managed by the New York Fed)? If they gets unwound, what will happen to the liabilities side? Which items will get unwound? And what are the consequences? We don't even know what's in these LLCs.

On top of all that, the Fed wants to issue its own debt.

What a mess.

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