Thursday, October 22, 2009

Borrowings from Fed Down, Reserves Way Up what gives?

The Federal Reserve chairman Ben Bernanke, when he outlined his so-called "exit strategy" back in July, said that the bank reserves at the Fed would naturally decrease as the various loan programs winded down. (If you want to review his strategy, here's my post from July.)

Well, the Fed's various loan programs have been winding down. At their peak, the total borrowings by depository institutions (=banks) exceeded $400 billion. They have been flat about $100 billion since April this year. Have the bank reserves come down?

Answer: Not at all.

I created the graph using St. Louis Fed's FRED. The red line is the bank reserves. The blue line is the total borrowings by the banks from the Fed. As you can see, the bank reserves recently spiked to a new high to $1 trillion. In the latest Federal Reserve Statistical Release H.4.1 Factors Affecting Reserve Balances (10/22/09), the bank reserves are recorded at: $1,034,078 million, up $52,459 million from last week.

$1 trillion minus $100 billion equals $900 billion. How has this $900 billion in the bank reserves been earned? What securities could the banks have given to the Fed in exchange for the credit to their reserves, outside those lending programs that are winding down?

Scanning the Fed's Statistical Release, my eyes stopped at these line items:

Federal agency debt securities (2) 137,866 + 3,320
Mortgage-backed securities (4) 766,543 + 63,970
The first column is the total, the second column is the change from last week. If you add the two numbers in the first column, you get: $904,409 million. Rounding it up, $904 billion.

Oh what a coincidence.

Is it possible that, as the lending programs wind down and the banks takes the collateral back, the banks are selling them back to the Fed as part of the Fed's permanent open market operations (POMO)? So now it's not a loan any more, the sale has been made. The banks have sold the agency bonds and agency-backed MBS that hardly anyone in the world wants to the Federal Reserve, and in exchange they got their bank reserves credited. Probably at the face value, good as cash.

I may be missing some important things and I could be totally wrong and it is just a coincidence, but if this is what has happened, then all the Fed has done is to shift temporary assets (loan collateral) to permanent assets backed by the government.

At least, we now know that Bernanke's "exit strategy" No.1 didn't work. According to Zero Hedge, the New York Fed experimented on another of his strategy to use reverse repo with the primary dealers and the experiment reportedly ended in disaster.

The only way to effectively shrink the balance sheet would be to sell long-term securities in the open market. Treasuries, agency bonds and MBS, which account for $1.678 trillion of the Fed's $2.230 trillion balance sheet.

Why was Mr. Bernanke so eager to be reappointed to be the Fed chairman, given this practically impossible task?

Unless the Fed's interest is not to save the system or the economy, but save its credibility... (One Fed board member said as much, remember?)

Or, unless someone has decided that the proverbial "bad bank" is to be the Federal Reserve, never to fail...


Anonymous said...

I think you have the answer. "the fed is the bad bank"

Glad you have the posting fixed. Altho using disqus is helpful and allows posters to tweet their posts and can increase your blog visitors.

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