Friday, October 17, 2008

Asset Management via the Fed is ... Popular This Week

The Fed's balance sheet has been motivating a few dramatic graphs.

First, it's a good thing that the Fed is extending its balance-sheet, during a time of crisis.

It's reasonable, however, to worry about too much of a good thing.

As it is, the Fed's new "discount window", called the TAF (or TSLF), is popular in the current week, to the tune of $114 billion.

By Fed district, the use of the get-a-treasury bond by pledging 'illiquid' collateral:

1. Table 1. TAF Lending Increase/(decrease) in week
(in $billions, w/w 08-Oct-18)

The FED's Pawn Shop: these are securities that the FED has accepted in its special program, on a collateralized, temporary basis, to help banks through hard times.

Total 114092
Boston 4500
New York 44585
Philadelphia 500
Cleveland 4535
Richmond 28638
Atlanta 8120
Chicago 2324
St. Louis -50
Minneapolis 5005
Kansas City -2100
Dallas 2000
San Francisco 16035

No doubt some will take this as proof of further asset deterioration among banks or as some kind of indicator of how unhealthy bank assets are. Begging more at the 'special window' may not be a short-term indication that asset quality is getting worse. It may just indicate that the work-out is speeding up. It may also be a true indicator of liquidity - these assets may be throwing off the expected cash flows, but the banks in question simply need to be able to get reasonable, non-market-price liquidity, in order to address what is happening on the liability side of their balance sheets.

In any case, the markets will naturally be sizing up the situation, through the tea leaves, and asking how sustainable the current situation is (so far, it looks like the Fed could hang in there as long as they want, even at these expanded levels, I'd *guess*).


It's not easy to decode the Fed's balance sheet in forty words or less.

In theory, the Fed's balance sheet is unbounded. In practice, it is constrained, in various ways. For one, by policy that guards untoward growth or contraction in the money supply. Second, there are preferred methods to do what they want to do, market methods that make it easier for them to operate (e.g. the open markets desk).

It's these method preferences / limits that keep the Fed and the U.S. Treasury linked (as well as the OCC, for that matter), and bring into play factors like the statutory debt limit and so forth. (I believe that is correct. There aren't too many people who know these inner workings without question. It makes intuitive sense, however, for there to be a link, because the traditional 'hyperinflation' is when the Central Bank starts to buy up the debt that the Government has issued, wholesale).

As I look at the sheet, there appear to be some signs that they are ... doing some of everything, including both sterilizing and expanding. There is little to suggest caution is to the wind. The MZM monetary aggregates ... are not "going vertical" (although they do not yet include this weeks robust activities). In the current environment, an exceptionally expansive money supply wouldn't matter anyway, even in the long run, as consumer inflation has flattened to zero in the recent month-to-month; virtually all willingness-to-lend surveys indicate that money velocity is at or near all time lows; and the traditional multipliers of money, banks, are expected to be failing / consolidating over the next twelve months.


What's more, the Fed still looks like it has enough "ordinary capacity" to handle even another $200b in its term lending, before it might be suggested that it could not fully, sometime down the road, undue all that it has done, if the "term" facilities had to be extended "forever" or even well into the economic recovery, when it comes. That's my read, but others who know these accounts better should offer an opinion. (Update: by putting into their quiver a new method, 'interest on reserves', the Fed appears set not to get 'constrained' by what I've called its heretofore 'ordinary' methods).

Unexplained, the drop is agencies held for foreign governments is worth inquiring about. Is it a permanent shift in investor preference or just a temporary blip.

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