As I discussed briefly yesterday, Treasury has announced plans to revitalize its Supplementary Financing Program (SFP), which will effectively mop up $200 billion in excess reserves over the next two months. Even though this is a Treasury action, it strikes me as an important step (with many yet to come) in the Fed’s exit strategy.
The boost in the SFP has created some confusion among observers, however, because of the limited information that Treasury and the Fed have provided about the rationale for the move. Indeed, as one reader pointed out to me, Ben Bernanke makes no mention of the SFP in his prepared testimony today. (Anyone know if he was asked about it in Q&A?)
Over at Econbrowser, Jim Hamilton provides an excellent summary of the SFP and the possible implications of its rebirth. He concluding thoughts:
Still, one is led to wonder whether there might be a connection between today’s announcement about the SFP and last week’s announcement of an increase in the Fed’s discount rate. Numerous Fed officials encouraged us to interpret the latter as a routine and technical management tool. Are the discount hike and SFP renewal separate and purely technical developments, or is something more involved?
If you are interested in these issues, I encourage you to read his entire post.
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As Confucius Lao Tzu once said, a journey of a thousand miles begins with a single step. The Fed faces just such a journey today: returning monetary policy to normal as the economy heals. And in case you didn’t notice, the Fed has already taken three steps down the road.
Step 1 was the termination of various special credit facilities (e.g., the Term Auction Facility) that were created to provide liquidity during the crisis.
Step 2 was last week’s sort-of-surprise announcement that the Fed was increasing the discount rate from 0.5% to 0.75%.
Step 3 is today’s announcement that Treasury is reviving the Supplementary Financing Program (SFP). Over the next two months, Treasury will issue $200 billion in bills for the SFP and then place the proceeds in its account at the Fed. The SFP will thus mop up $200 billion of liquidity that Fed asset purchases have injected into the monetary system.
Treasury began the SFP in September 2008 when the Fed needed help sterilizing the monetary impact of the programs it created to provide liquidity to the financial sector. The program peaked at more than $500 billion in late 2008, and then began to decline as sterilization ceased to be a Fed concern and as the federal debt limit began to loom. With the recent increase of the debt limit, Treasury again has room for the SFP, hence today’s announcement.
Update: Thanks to Brooks for pointing to Lao Tzu as the source of the famous quote; many sites attribute it to Confucius, but those claiming Lao Tzu seem more credible. If you start Googling or Binging this topic, you can also explore such amusing issues as: How do you spell Lao Tzu? Didn’t he really say “a journey of a thousand miles begins beneath one’s feet”? And “wait a minute, the ancient Chinese didn’t use miles, did they?”
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The Federal Reserve system is doing its part to cut the budget deficit (at least for now). Treasury will receive $46.1 billion of profits from the Federal Reserve profits for fiscal 2009. That’s about a third higher than the amount remitted for 2008.
According to the Fed’s news release this morning, the following items drove profits:
$46.1 billion in earnings on securities acquired through open market operations (U.S. Treasury securities, government-sponsored enterprise (GSE) debt securities, and federal agency and GSE mortgage-backed securities) [Profits on traditional open market operations plus the new credit easing operations]
$5.5 billion in net earnings from consolidated limited liability companies (LLCs), which were created in response to the financial crisis [Profits on the Maiden Lane partnerships etc.]
$2.9 billion in earnings on loans extended to depository institutions, primary dealers, and others [Profits on the new loan facilities]
[$2.6 billion in] net earnings from currency swap arrangements, which have been established with 14 central banks, and investments denominated in foreign currencies
Additional net earnings of $1.5 billion were derived primarily from fees of $0.7 billion for the provision of priced services to depository institutions
Those $58.6 in gross earnings were slightly offset by the following expenses:
[$3.4 billion for] operating expenses of the twelve Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents
[$2.2 billion in] interest paid to depository institutions on reserve balances [As noted previously, the Fed's still-new ability to pay interest on reserves is a big deal for monetary policy; this is the cost side]
[$0.9 billion in] Board expenditures, including the cost of new currency
The resulting $52.1 billion in new profits were then distributed as follows: $46.1 billion to the Treasury, $1.4 billion as dividends to member banks, and $4.6 billion retained to “equate surplus with paid-in capital.”
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The Business News Network of Canada interviewed me yesterday about TARP and Fed Chairman Bernanke’s “Person of the Year” award from Time Magazine.
Here’s a link to the video of the interview. Going in, I was focused on the following talking points:
- Within current budget rules, the Congress can indeed use unspent TARP money to “pay for” new spending initiatives. However, it needs to cut TARP authority by $2 for every $1 it wants to spend.
- Those “savings” are mythical, however. Treasury Secretary Geithner recently predicted that TARP would use at most $550 billion of its $699 billion in authority. Trimming TARP’s authority by a moderate amount (e.g., $50 billion) will thus generate no actual budget savings. Only deep cuts would begin to generate some savings.
- The financial system is not fully healed, and the United States still lacks a coherent system for dealing with large, failing financial institutions. For that reason, I support Geithner’s extension of TARP as an insurance policy. However, I do not support the TARP extension if its main effect it to allow Congress to use TARP “cuts” to generate mythical budget “savings” or to encourage creative uses of TARP money.
- Usain Bolt had a remarkable year, but Chairman Bernanke is still the right choice as Person of the Year. And he’s the right choice for Fed Chairman.
- But his work is only half done. If he can figure out an exit strategy that keeps the economy growing, avoids new asset bubbles, and sidesteps inflation, then maybe he will be Person of the Year again next year.
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A few weeks ago, Fed Chairman Ben Bernanke appeared before the Senate Banking Committee for his confirmation hearing. Following the normal ritual, Committee members made their statements and peppered Bernanke with questions about every economic topic under the sun. That much is well-known (and was closely followed on CNBC).
What’s less well-known is that Bernanke went back to his office to discover an enormous stack of homework, including a 70-question take-home exam from Senator Jim Bunning.
Senator Bunning’s questions cover a lot of territory: Fed policy, fiscal policy, AIG, the dollar, etc. Chairman Bernanke’s answers are worth a read, when you have time for a 34-page, single-spaced document.
Here’s one important excerpt, reiterating the Fed’s view that Lehman could not have been saved with then-existing authorities:
54. What was your rationale for letting Lehman fail?
Concerted government attempts to find a buyer for Lehman Brothers or to develop an industry solution proved unsuccessful. Moreover, providers of both secured and unsecured credit to the company were rapidly pulling away from the company and the company needed funding well above the amount that could be provided on a secured basis. As you know, the Federal Reserve cannot make an unsecured loan. Because the ability to provide capital to the institution had not yet been authorized under the Emergency Economic Stabilization Act, the firm’s failure was, unfortunately, unavoidable. The Lehman situation is a clear example of why the government needs the ability to wind down a large, interconnected firm in an orderly way that both mitigates the costs on society as whole and imposes losses on the shareholders and creditors of the failing firm.
P.S. Calculated Risk also posts some good excerpts.
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Posted in Macroeconomics, tagged Federal Reserve on November 10, 2009 |
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Back in July, I expressed concern that Congress might undermine a key pillar of U.S. economic policy: the independence of the Federal Reserve.
Why is that so important? Because independent central banks do a better job of controlling inflation. Inflation may not be an immediate threat to the U.S. economy, but as that day approaches, the Federal Reserve needs to be able to pull back on monetary stimulus without political interference.
Of course, the remarkable scale of Fed actions over the past 18 months requires close review. Both practically and politically, Congress needs to exercise careful oversight over a now-multi-trillion arm of the Federal government.
The political challenge is finding a way to provide such oversight, while defending the Fed’ independence. In today’s Wall Street Journal, Anil Kashyap and Rick Mishkin suggest one way to strike that balance:
- Oppose the House bill (sponsored by Rep. Ron Paul) that would give the Government Accountability Office (an arm of Congress) broad auditing powers over Fed actions, including monetary policy.
- Endorse a pending amendment (sponsored by Rep. Mel Watt) that would give the GAO specific authority to audit the various lending programs created under the 13(3) provision regarding “unusual and exigent circumstances.” As Anil and Rick describe it:
This audit would involve oversight of the operational integrity of these facilities’ accounting, internal controls, and protection against losses. It would also disclose the borrowers from these facilities one year after the facilities are closed. The audit would produce new, important information that is not otherwise available and would play to the strengths of the GAO. And the amendment would exempt the Fed’s normal monetary policy actions from the audit.
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Posted in Economy, Finance, Politics, Regulation, Uncategorized, tagged Banks, Economics, Fannie Mae, FDIC, Federal Reserve, Finance, Freddie Mac, J.P. Morgan, Lehman, Pimco, Politics, Regulation, TARP on September 13, 2009 |
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A front page story in today’s Washington Post (“In Shift, Wall Street Goes to Washington“) documents the Capital’s rising importance in the financial world:
J.P. Morgan Chase for the first time convened its board in Washington this summer, calling the directors to a meeting at the downtown Hay-Adams hotel, then dispatching them to Capitol Hill for meet-and-greets.
Last month, a firm run by the billionaire investor Wilbur Ross hired the head of Washington’s top mortgage regulator to pick through the wreckage of the housing bust looking for bargains.
And the world’s largest bond fund, Pimco, which has traditionally assessed the risk of any new investment according to five financial criteria, recently added one more: the impact of any change in federal policy.
“In the old days, Washington was refereeing from the sideline,” said Mohamed A. el-Erian, chief executive officer of Pimco. “In the new world we’re going toward, not only is Washington refereeing from the field, but it is also in some respects a player as well. . . . And that changes the dynamics significantly.”
The Ross example doesn’t tell us much — the financial world has always recruited government officials. The J.P. Morgan and Pimco examples, however, highlight how much the playing field has changed over the past two years. Washington is not just a more aggressive regulator. Given the stresses on the system, it has become a serial intervener — stepping in to prop up specific firms or credit channels that appear too important to fail. And it is now a major investor, with a burgeoning portfolio of investments in financial firms, auto companies, and mortgage backed securities.
As we commemorate the first anniversary of the fall of Lehman, it appears that the worst of the financial and economic crisis is behind us. And the policy conversation should increasingly focus on exit strategies. Not just the narrow question of how the Federal Reserve eventually unwinds the extraordinary expansion of its programs. But also how the Treasury eventually unwinds it TARP investments. How the FDIC walks back from offering guarantees on bank debt. How the government restructures Fannie Mae and Freddie Mac.
And, perhaps most importantly, how policymakers recalibrate their relationship with financial markets. To paraphrase Mohamed A. el-Arian: can Washington return to being a referee on the sidelines or will it continue to be a player?
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David Wessel of the Wall Street Journal reports that President Obama will re-appoint Ben Bernanke as Chairman of the Federal Reserve.
P.S. Don’t let this good news distract you from the much-less-good economic news on Tuesday: CBO and OMB are releasing new budget projections that will show trillions upon trillions of coming deficits.
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The Business News Network in Canada interviewed me last week about the gigantic amount of excess reserves being held by U.S. banks.
Here’s a link to the video of the interview. (We had a small technical glitch at the start, but then got rolling.)
Going into the interview, I was focused on the following talking points:
- Total bank reserves have skyrocketed over the past year, from roughly $50 billion to roughly $850 billion.
- When we studied economics in school, we were usually taught that a big increase in reserves would eventually translate into big inflation.
- However, that’s not true today, for two reasons: (1) short-term interest rates are effectively zero, and (2) the Fed can now pay interest on reserves. Those facts weaken / break the traditional link between reserves and inflationary pressures.
- Some have wondered whether the excess reserves mean that banks are hoarding, rather than lending.
- That’s not true either. Instead, the high level of reserves simply reflects the fact that the Fed has been a busy beaver, expanding its balance sheet by making loans and buying securities (i.e., credit easing). Banks might be hoarding or they might not; excess reserves don’t shed any light on the question.
- Viewers who are interested in these issues should check out a recent paper from the New York Federal Reserve, which does a great job of explaining each of these issues.
I didn’t manage to get all of that into the interview, of course, but I tried to hit some of the high points.
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That’s the question posed by a recent staff report from Todd Keister and James McAndrews at the New York Federal Reserve.
Their answer? Because the Federal Reserve has been really, really busy.
Keister and McAndrews begin their analysis by documenting the remarkable increase in excess reserves since the fall of Lehman:
Since September 2008, the quantity of reserves in the U.S. banking system has grown dramatically, as shown in Figure 1. Prior to the onset of the financial crisis, required reserves were about $40 billion and excess reserves were roughly $1.5 billion. Excess reserves spiked to around $9 billion in August 2007, but then quickly returned to pre-crisis levels and remained there until the middle of September 2008. Following the collapse of Lehman Brothers, however, total reserves began to grow rapidly, climbing above $900 billion by January 2009. As the figure shows, almost all of the increase was in excess reserves. While required reserves rose from $44 billion to $60 billion over this period, this change was dwarfed by the large and unprecedented rise in excess reserves.
Some observers have expressed two concerns about the spike in excess reserves:
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