A fascinating recent paper by Juan Montecino and Gerald Epstein at the Institute for New Economic Thinking looks at who has been the real beneficiary of the Federal Reserve's money printing mania since 2008.
As we are all aware, the Federal Reserve has massively impacted the American economy through its LSAP or Large Scale Asset Purchases program aka Quantitative Easing. This long-term program began when the Fed announced QE 1 on November 25, 2008 once it became apparent that their traditional tool of lowering interest rates was no longer effective because interest rates were already at the zero lower boundary. At that time, the Fed stated that it would buy up to $500 billion in agency mortgage-backed securities (MBS) and $100 billion in government sponsored enterprise (GSE) debt, starting on December 16, 2009. This amount was increased on March 18, 2009 when the FOMC announced that it would buy an additional $750 billion in agency MBS bringing the total to $1.25 trillion, another $100 trillion in GSE debt bringing the total to $200 billion and $300 billion in longer-term Treasury securities. This was further increased on November 3, 2010 when the Fed announced that it would purchase $600 billion in longer-dated Treasury securities at a pace of about $75 billion per month. The Federal Reserve further expanded its Large Scale Asset Purchase program on September 13, 2012 when it announced that it would continue to purchase up to $40 billion worth of agency MBS and $45 billion worth of longer-dated Treasuries on a monthly basis as previously announced until the economy experienced "maximum employment and price stability".
Here is what has happened to the Federal Reserve's balance sheet since 2008:
Here is the current composition of the Fed's balance sheet:
The Fed now owns $4.231 trillion worth of securities, including $2.460 trillion worth of U.S. Treasuries and $1.734 trillion worth of mortgage-backed securities.
Now that we have that background, let's look at the paper by Montecino and Epstein. The Federal Reserve had to purchase all of these assets from someone, and, in the case of the Fed's now ample inventory of mortgage-backed securities, the paper was sold to the Fed by what are known as the "treatment banks" or "counterparty banks". The paper answers the key question:
"What was the impact of QE on the profitability of the banks involved in selling the assets to the Federal Reserve?"
In other words, was the Fed attempting to kickstart the economy or play to their main constituency, America's banking sector?
The authors looked at transactions-level data on LSAP purchases along with the income and balance sheet data from 826 bank holding company regulatory filings over the period from Q1 2008 to Q4 2009 (i.e. QE 1) which allows them to identify the effect of the Federal Reserve's MBS purchases on bank profitability. Fortunately, under the Dodd-Frank Act, the Fed is required to publish data on each transaction carried out during the conduct of any program that impacts monetary policy within two years of the transaction. Each transaction shows the name of the counterparty (bank), the type of security, the amount bought or sold and the price paid.
Here is a table showing the data for each counterparty (in $ billions) for the time period as noted above:
One of the problems that the authors ran into was the ownership structures of some of the foreign banks since the ownership of those brokers or dealers was less clear because the foreign-owned holding company may have been sold off or restructured. That said, of the original 16 counterparties in the table above, there were six matches that enabled the authors to complete their analysis.
After completing a rather complex analysis that is well beyond the capabilities of mere mortals, the authors found that profits for the banks that were counterparties to Federal Reserve's Mortgage-Backed Securities were significantly and statistically higher than for those banks that did not participate. These increased profits likely occurred because of price increases on MBS as demand rose because of the Fed's purchases. As well, the banks with large holdings of MBS relative to their total assets prior to QE (what are known as the the "exposure banks") also experienced significant increases in profitability.
Here are some details of their conclusions starting with the impact of QE 1 on LSAP counterparty banks (i.e. the banks that sold MBS to the Federal Reserve):
1.) The profitability of banks that were LSAP counterparties improved by 0.35 of a percentage point relative to their non-counterparty peers and when compared to non-LSAP periods. To help you put this into context, this is roughly proportional to the median return on assets among the sample banks which tells us that the effects were significant.
Here is what happened to the impact of QE 1 on the non-counterparty banks (i.e. exposure banks) which held MBS in their asset pool:
1.) Larger banks with an MBS share that is roughly 24 percent of assets (i.e. banks with MBS holdings that are in the 95th percentile) in 2008 experienced an increase in the return on assets as large as 0.14 percentage points.
2.) Smaller banks or banks with an MBS share that is roughly 7 percent of total assets (i.e. banks with MBS holdings that are at the median) saw their return on assets increase by only 0.04 percentage points.
Here is a quote from the authors:
"Although our results suggest that MBS purchases increased bank profits, we find only mixed evidence that these were associated with increased lending. Our findings are thus consistent with the hypothesis that the Federal Reserve undertook these policies, at least in part, to increase the profitability of their main constituency: the large banks."
While the Federal Reserve's actions since 2008 may have prevented the economy from collapsing completely, it has had other consequences. At the same time as these actions have pushed up the prices of bonds and Treasuries and pushing down yields, it has been quite successful at severely reducing interest earned on more traditional fixed income investments for millions of American households. Simultaneously, this analysis shows us that the Federal Reserve's long-term monetary policy experiment has been successful at one additional thing - redistributing wealth to the banking sector, particularly those that either sold mortgage-backed securities to the Fed or held them as a significant part of their assets. With the Fed's holdings of MBS now in excess of $1.73 trillion, the banking sector has benefitted even more than this analysis shows.