JPMorgan Chase Bank, New York
Economic Research
Global Data Watch
Economic Research note
Current Federal Reserve balance sheet
Liabilities and owners' equity
• The Fed has attempted to address current financial
strains through unconventional means
58 Capital accounts
• By changing the composition, not size, of its balance
sheet, the Fed is hoping to target liquidity problems
Estimated Federal Reserve balance sheet as of April
$ billion
• Balance sheet space to deal with liquidity is limited;
Liabilities and owners' equity
at some point such actions expand the balance sheet
In his first speech as a Fed governor, Ben Bernanke re- marked: “My suggested framework for Fed policy regard- ing asset-market instability can be summarized by the ad- age, Use the right tool for the job.” At the time, Bernanke was referring to two sets of tools. For the job of achieving 58 Capital accounts
good macroeconomic outcomes, the tool is the federal funds rate. For the job of ensuring financial stability and Assets on Fed balance sheet
liquid markets, the tool is the discount window as well as the Fed’s other regulatory and supervisory powers. As the credit crunch has proceeded, the Fed has had to invent avariety of new tools to deal with the latter responsibility.
Total assets
Fed accounting
The Fed is a bank. Like any bank, the Fed has a balance Treasuries held outright
sheet, with assets on the left side and liabilities and equity on the right. There the similarities end. The liabilities of theFed are unique and essentially form the monetary base, a quantity which, as the name implies, is the building block Assets on Fed balance sheet
for all broader concepts of money. These liabilities—the monetary base—take essentially two forms: currency andreserve balances of depository institutions.
Equity in the Fed, though it does exist, is trivially small andis a relatively unchanging quantity.1 Therefore, for the bal- ance sheet to balance, increases in the Fed’s liabilities must be a result of increases in the Fed’s assets; for the monetarybase to expand, the Fed must acquire assets. It is these as- sets on the Fed’s balance sheet that have been the object ofthe Fed’s recent actions.
SOMA—consist entirely of Treasuries and constitute the Before last December, there were three important catego- vast bulk of the Fed’s balance sheet. Securities held under ries of Fed assets: securities held outright, securities held repo include Treasuries, GSE agency debt, and agency under repurchase (repo) agreement, and direct loans to MBS. Discount window lending is small in normal times.
banks through the discount window. The outright holdingsof securities—called the System Open Market Account or With this in mind, Bernanke’s distinction among policytools—and the Fed’s actions taken as the credit crisis has 1. Ownership in the monopoly supplier of the nation’s currency would seem to be a great investment; however, retained earnings are minimal as the Fed returns most of the inter- proceeded—can be seen in the context of the effect on the est earned on its stock of Treasury securities back to the Treasury Department.
JPMorgan Chase Bank, New York
Economic Research
US: the Fed reaches deeper into its toolbox • Monetary policy. Fed actions to support macroeconomic
Recent Fed liquidity initiatives
goals should be viewed as an expansion or contraction of Term repos
the Fed’s balance sheet. By changing the size of the money supply, i.e., the Fed’s liabilities, the Fed is able to affect the overnight price for money—the federal funds rate.
Liquidity and financial stability. Actions taken by the
Fed to promote liquid and functioning markets have af- fected the composition of the Fed’s balance sheet, not itssize. By taking out-of-favor assets onto its balance sheet,in return for Fed liabilities, the Fed creates liquidity for the Fed balance, but leave the size of the balance sheet rela- the institution that held those assets.
tively unchanged by selling or lending more Treasuries tothe public. By reducing the supply of the relatively illiquid With respect to the second policy goal, the Fed has altered asset and increasing the supply of the currently more de- the composition of its balance sheet several times during the sired asset, the Fed is using the composition of its balance credit crisis in order to affect liquidity conditions. One no- sheet to foster liquidity where it is needed.
table example has been the Term Auction Facility (TAF).
The TAF has lent funds to banks against a broad range of Limits to a distinction
collateral that the borrowing institution has pledged to theFed. To offset the increase in the balance sheet resulting As the credit crisis has unfolded, FOMC members have from the TAF, the Fed has had to reduce holding of other repeatedly made reference to separating their monetary assets—in this case Treasuries in the SOMA.
policy (or macro-prudential) responsibilities from the fi-nancial and liquidity (or micro-prudential) responsibilities.
In a similar fashion, the Fed has announced that it will ef- Arguably, this has always been a distinction without a dif- fectively “sterilize” the liquidity provided through the ference: failure in one realm will invariably bleed over and TSLF and the expansion of term repos. The TSLF (or Term Securities Lending Facility) expands the Fed’s existing se-curities lending arrangement. Under the new facility, the 20 However, as the Fed continues to devote its balance sheet primary dealers will be allowed to exchange mortgages to attending to its micro-prudential responsibilities, there (both GSE agency mortgages and private label RMBS) for may come a time when the distinction between responsi- Treasuries that the Fed holds in the SOMA. In principle, bilities will reach its limits. After the Fed completes the the broker dealers should be able to fund these Treasuries expansion of the TAF, the rollout of the STLF, and the in- more easily than they can fund mortgages. This should al- crease of term repos there will be a much smaller SOMA; if low broker dealers who have trouble securing liquidity to the overall size of the balance sheet were held constant more readily fund their portfolio. The acquisition of mort- (probably a valid working assumption given its recent slow gages through the TSLF does not have to be offset by a re- growth), Treasuries in the SOMA not lent out would duction in balance sheet elsewhere because it automatically amount to just under $400 billion, down from $700 billion reduces the amount of Treasuries in the SOMA.
currently. If the Fed were to expand the TAF again, ormove to directly purchase agency mortgages, this number In contrast, the increase in term repos is being offset by a lowering of the SOMA. On March 7, the Fed announced anintention to undertake $100 billion in 28-day term repos.
While not imminent, it is not inconceivable that at some This has two effects: first, it provides more term funding to point such liquidity actions will use up the remaining the banking system; second, it does so by (potentially) tak- SOMA balance sheet. At that point, the Fed would have to ing on board more mortgage collateral. Unlike the outright confront the fact that a further reconfiguration of its bal- security holding, securities held under repo include GSE ance sheet would have monetary policy implications as it agency debt and MBS. Already, the Fed has begun to re- would expand the balance sheet and lower the funds rate.
duce SOMA holdings to accommodate the increase in term In that environment, the distinction between monetary repos. What the TAF, TSLF, and term repos all have in policy and actions to promote financial stability would no common is that they potentially bring more mortgages onto


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