Thursday, September 13, 2012

The Federal Reserve's Balance Sheet - Entering Uncharted Territory

Now that QE3 is reality, it's time to take a look at the Fed's assets.  Every time the Federal Reserve enters the so-called "free market" to prod the United States economy back to life, they impact their own stock of assets, commonly known as their balance sheet.  In this posting, I'll be taking a look at some details about the asset side of the Federal Reserve's balance sheet.

The Fed's balance sheet has ballooned since the implementation of QE1, QE2 and "The Twist" from $869 billion on August 8th, 2007 to $2.824 trillion on September 5th, 2012, a rise of 225 percent, as shown on this graph:

Here is a graph showing the assets held by the Federal Reserve:

Assets held by the Fed have changed substantially over the past five years.  The darker green line shows growth in the securities held by the Fed; these include Treasuries, agency mortgage-backed securities and agency securities purchased under the FOMC's quantitative easing programs.  These securities form the vast majority of the Fed's assets, comprising $2.580 trillion or 91.4 percent of the total.

Here is a maturity breakdown of the Fed's assets and liabilities:

United States Treasuries total $1.649 trillion of the total, with nearly 48 percent maturing in a five to ten year time frame. By purchasing longer-term Treasuries, the Fed is pushing Treasury prices up (by increasing demand) and pushing yields down further along the curve.
Notice the blue line in the graph above?  This line shows the liquidity facilities offered during the Great Recession.  These facilities peaked at $1.519 trillion in December 2008 when they made up 67.5 percent of the Fed's balance sheet.  In case you've forgotten, these emergency liquidity funds were used to give banks a source of short-term liquidity, to back up issuers of commercial paper and to provide liquidity to financial institutions including Bear Stearns and AIG, preventing what would otherwise have been a calamitous failure of the banking system and the credit markets.  Here is a graph showing a detailed breakdown of the liquidity facilities offered by Mr. Bernanke et al to their pals and past/future employers in the financial and insurance sector with the orange line showing the total, and the other lines showing various facilities supplied:

As you'll note, these liquidity facilities have wound down and are now at a relatively negligible level, however, they did reach very, very uncomfortable levels during late 2008 - early 2009 as I noted in the previous paragraph.

Here is a look at the support that the Fed gave to various institutions including AIG (green), Maiden Lane (blue), Maiden Lane II (khaki) and Maiden Lane III (dark blue):

The green line shows the support for AIG which was used to prevent its disorderly failure.  This peaked at a whopping $90.323 billion in October 2008 and, at that time, was 77 percent of all liquidity supplied by the Fed.  This single action by the Fed was the largest "bailout" of the crisis and prevented the collapse of AIG.

Whether America knows it or not, all Americans are connected to the Federal Reserve's balance sheet.  This interconnectedness and the unprecedented changes in how the Fed is managing its balance sheet should concern every American.  If Part 2 of the recession that never really ended comes to the forefront requiring 2008-type intervention by the Fed, bloating of its already overweight balance sheet could reach even more uncomfortable levels.  Another concern revolves around an increase in interest rates; should Treasury investors around the world become concerned about the ability of the U.S. government to control their debt, prices could be pushed down and yields pushed up.  This would have a strong negative impact on the value of the Fed's assets.  A third round of market-distorting asset purchases by the Fed will likely magnify the problem down the road, particularly if/when rates rise on a severely bloated balance sheet.  Unfortunately, economics is not a science and the response of the economy and the bond market to actions taken by central bankers are far from predictable.

1 comment:

  1. Every day I watch the markets. Of course, to the chagrin of my gf. Nonetheless, I asked: "How much can the U.S. economy withstand such as QE, debt-to-GDP ratio, or food prices? I ask because when oil was $25 per barrel and gas less than $1.50 per gallon we never thought just 12 years ago that oil would breach $100 let alone $140 and gas sell for almost $5 per gallon. We laughed with, Those are prices at least four generations away. But yet, here we are in less than one generation seeing massive distortions in prices wrecking havoc on quality of life worse than tsunamis, hurricanes, and earthquakes because at least in the latter Government does lend a small hand after the fact. As for the former, they are the hand that is unleashing the next crisis: complete and utter destruction of the U.S. dollar.