Category Archives: Fed Balance Sheet

Why the Fed Is So Wound Up

There is endless talk about the Fed exiting from the QE-induced asset bubble on its balance sheet. We will show what the Fed can and cannot do to unwind its balance sheet. First some background data from its balance sheet in terms of assets and liabilities. The balance sheet is a wonderful tool for understanding what can happen, what can’t happen, and the corner the Fed has painted itself into.

Flash Point: Fed Math

Bloomberg has printed a summary of today’s FOMC meeting: Fed Expands Asset Buying, Links Rates to Joblessness, Prices. We will preempt the usual misinterpretations of a summary of the now and future position of the Fed’s balance sheet.

Flash Point: Welcome to Hotel California

Bernanke expressed confidence in his Jackson Hole speech,  Monetary Policy since the Onset of the Crisis, that the Fed can “exit smoothly” when it wants to:

The FOMC has spent considerable effort planning and testing our exit strategy and will act decisively to execute it at the appropriate time.

In The Dilemma of the Impatient Trader, traders wishing to acquire or divest large positions quickly pay a premium for their impatience equal to the spread between average purchase and average sell prices minus the market bid/ask spread. Any exit strategy by the Fed must include the divestiture of their large securities position. This would begin if and when the economy were heating up and needled to be slowed. It might also become necessary if inflation takes off driving interest rates up. These would not necessarily be mutually exclusive scenarios.

From a balance sheet perspective, the cause of the exit is unimportant. What happens is the Fed sells securities to primary dealers (PDs) who pay for them from their excess reserves on deposit. These reserves were created by the Fed’s initial purchases of securities from the PDs. But the PDs are patient traders and the Fed is an impatient trader. The cost to the Fed, as its assets approach zero through sales, is the premium they paid on acquisition plus the premium they pay on sales. This means the PDs have a net balance left equal to this total premium. This is the money given to the PDs for their assistance in implementing Fed policy.

To balance assets and liabilities in true accounting fashion, the Fed’s capital position goes negative and the Fed becomes insolvent. Before this happens, however, by recent arrangement with the Treasury, the Treasury will backstop (bailout) the Fed.

The monetary base is considered the base of the money supply in the economy and is known as money with zero maturity. It is roughly the sum of the reserves on deposit with the Fed plus currency in circulation. Many have argues that if the excess reserves, currently standing at  about $1.5 trillion, enter the economy, large scale inflation will result. The caveat has been that the Fed could unwind its balance sheet. But as we have argued, it can’t entirely. The trading premium incurred will remain as a liability after assets are gone. It will also remain as part of the monetary base and the Fed cannot do anything remotely orthodox to fix this. The result: built in inflation.

So welcome to Hotel California where any central bank can check in but it can’t check out.

Update 20120917

It is always gratifying to get confirmation of our thinking from people much smarter and informed than we are. Today we got this eletter from Bob Eisenbeis, Chief Monetary Economist of Cumberland Advisors: We’ll Know It When We See It! These people understand the Fed, Fed operation and policies, and debt and bond markets as well as anyone and better than most. Bob wrote:

Certainly, the materials provided imply a long period of sustained asset acquisitions and a further substantial increase in the Fed’s balance sheet. This expansion will only exacerbate the Fed’s exit problem, and to the extent that it experiences capital losses on asset sales, those losses will accrue to the taxpayer through reduced remittances to the Treasury, and increase the deficit.

The “capital losses” are what we described as “premium paid” in The Dilemma of the Impatient Trader.

What Is the US Treasury Up To?

In our weekly look at the Fed’s balance sheet, Tracking the Fed Balance Sheet, we noticed what we thought was anomalous behavior in the Treasury and the depository institutions’ reserve accounts. We believe we can show something is going on although the details of the implied transactions remain to be discovered. In short, the Treasury is borrowing money on a daily basis from the reserves that depository institutions have on deposit with the Fed. Our argument follows.

What’s Going On Here?

When the Fed structured QE1, it resulted in the acquisition of approximately $1.2 trillion in Mortgage-Backed Securities (MBS) for the Fed’s balance sheet. (see WSHOMCB)

In this graph we see the rollover and decline of the total holdings beginning in 2010 after QE1 ended and as securities matured. However, in early 2011, the decline slowed and ceased at the end of the year. Since then, we have begun to see new purchases of MBSs. We wonder what strategy or policy the Fed is pursing here.

QE WTF

MarketWatch reported today that the Fed said to weigh new form of bond buying. The proposed Fed operation is in fact so bizarre, appearing to be some deviant twist of Operation Twist, that we think what has become twisted are the personal parts of Fed officials caused by the contortions they are going through to influence the economy and markets. Indeed, the novel twist involved is labeled as a form of sterilization. You, dear reader can surmise where the twist is applied. We explain below.

Note: All the sources we researched go back to an original story in the Wall Street Journal. We have searched the sites of the FRB and FRBNY and can find no news releases, speeches, articles or anything that discusses this alleged program proposal. The most recent minutes of the FOMC dated January 24-25, 2012, simply authorize the Fed to continue operations and programs already announced and in place. No new programs were discovered.

Tracking the Ownership of US Debt

As of Dec. 2012, we are no longer updating this data monthly. The links provided give the reader access to the base data. In the year we have been tracking it, US debt has shown a steady increase without exceptional events. We have seen no change in the Chinese component that is cause for comment or alarm.

Tracking the Fed Balance Sheet

The aspects of the Fed’s balance sheet that we track weekly (see The Fed’s Balance Sheet) are shown here in a snapshot view and below in some detail. The snapshot is a visual indication of the week-over-week (wow) and year-over-year (yoy) changes in dollar value shown in Table 8 of the H.4.1 statistical release. We also can track activity through the weekly New York Fed System Open Market Account Holdings.

Aug 7, 2014 (Millions) WOW
Change
YOY
Change
Total assets (size of balance sheet WALCL)  + 3,474 + 824,752
Gold certificate account (WGCAL)  0  0
U.S. Treasury securities (WSHOSNB)  + 2,280  + 832,196
Federal agency debt securities (GSE) (WSHOFDSL)  0 – 24,394
Mortgage-backed securities (MBS) (WSHOMCB)  0  + 427,399
Central bank liquidity swaps (see WACBS)  0  – 1,404
Federal Reserve notes, net of F.R. Bank holdings (WCURCIR)  + 2,493 + 87,549
Other deposits held by depository institutions (WRESBAL)
 + 3,608  + 628,424
U.S. Treasury, General Account (WLTGAL) – 799  + 6,645
Other (deposits) (WLDOL)  – 3,265  – 17,227

This is the first update since May. We are not actively tracking it any more.

Although the balance sheet is still growing the rate of growth is decreasing due to the “Taper”. When QE purchases are finished in Sept. or Oct. it will be interesting to watch the balance sheet to see whether the Fed allows it to shrink by normal maturation of assets or whether the Fed rolls maturing assets over.

The Gold Holdings of the US

There is much discussion about whether the US actually has the gold that is on its books or whether it has been loaned out. We won’t wade into conspiracy theories. An audit would satisfy some, but others would spin new conspiracies around any audit. Instead we work with the information available.

The Fed’s Balance Sheet

Introduction

A balance sheet is an accounting document showing all the assets and liabilities owned by an entity. It is extremely useful for showing how an entity is doing financially at a particular point in time. It is normally part of the regular financial reporting of a business or institution. The Fed’s balance sheet is an important document to watch because it gives a high-level summary of the Fed’s operations on a weekly basis. It is published as FEDERAL RESERVE statistical release H.4.1, each Thursday, generally at 4:30 p.m. Publication may be shifted to the next business day when the regular publication date falls on a federal holiday.

In this post, we will explain how to find both current and past data. We will analyze the content of a sample balance sheet and we will provide links to other posts which track items of interest in the balance sheet on a weekly basis. Currently there is much discussion in the media and among analysts and pundits on central bank activities, balance sheets, money printing, asset purchases and related items. A lot of it is poorly informed or misinformed. It is our intention to give you, dear reader, accurate and informed information on what the US Federal Reserve (Fed) is doing, explained in simple but comprehensive terms.

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