Thursday, September 4, 2008

The Summer of 2008 at the Fed

Time to take a quick look at what the Federal Reserve has been doing this summer…just as a check. Operationally, the Fed has done business, as usual. During the summer months, people take money out of the banking system for vacations and such and so Currency in Circulation goes up seasonally. Also, there usually is an increase in funding transfers which puts pressure on financial institutions to supply and clear funds through the banking system so that, generally, bank reserves held at the Federal Reserve increase seasonally. Responding to these movements just falls into the operational responsibilities of the Federal Reserve System.

Overall, looking at the Federal Reserve’s H.4.1 release, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks”, we observe that Currency in Circulation increased by approximately $8.0 billion from the banking week ending June 25 to the banking week ending August 28. Also during this time period, the reserve balances of depository institutions at the Federal Reserve increased by about $8.5 billion. Thus, on a seasonal basis, there is an increase in the Monetary Base supplied to the public in the summer time.

These were the main changes on the operational side.

There were two changes in the actions of the Federal Reserve that related to the financial dislocations of earlier this year. One had to do with the lending of credit to primary dealers, which began operations on March 17, 2998. This category included credit extensions such as the arrangements involving JPMorgan Chase & Co. and The Bear Stearns Companies, Inc. In the first week this account existed, the balance shown was a $13.4 billion increase in Fed credit extended. The balance rose to a maximum amount of $38.1 billion in the banking week ended April 2, 2008 and then declined slowly after that. By June 26, 2008 this account dropped to zero as the resolution of the JPMorgan and Bear Stearns bailout reached its next stage.

The next stage of the JPMorgan and Bear Stearns arrangement with the Federal Reserve showed up in the formation of a limited liability company called “Maiden Lane LLC.” But let’s go to the actual statement of the Federal Reserve to define this company and how the funds advanced to it appear on the release showing the factors supplying and absorbing reserves to the banking system.

“The Board’s H.4.1 statistical release, “Factors Affecting Reserve Balances of Depository Institutions
and Condition Statement of Federal Reserve Banks,” has been modified to include information
related to Maiden Lane LLC, a limited liability company formed to facilitate the arrangements
associated with JPMorgan Chase & Co.’s acquisition of Bear Stearns Companies, Inc.

On June 26, 2008, the Federal Reserve Bank of New York (FRBNY) extended credit to Maiden
Lane LLC under the authority of section 13(3) of the Federal Reserve Act. This limited liability
company was formed to acquire certain assets of Bear Stearns and to manage those assets through
time to maximize repayment of the credit extended and to minimize disruption to financial markets.
Payments by Maiden Lane LLC from the proceeds of the net portfolio holdings will be made in the
following order: operating expenses of the LLC, principal due to the FRBNY, interest due to the
FRBNY, principal due to JPMorgan Chase & Co., and interest due to JPMorgan Chase & Co. Any
remaining funds will be paid to the FRBNY.

Consistent with generally accepted accounting principles, the assets and liabilities of Maiden Lane
LLC have been consolidated with the assets and liabilities of the FRBNY in the preparation of the
statements of condition shown.”

Thus, the statement put out for the week ending July 2, 2008 had a new account called “Net portfolio holdings of Maiden Lane LLC” and showed a balance of $29.8 billion. This account declined to $29.2 billion by August 27, 2008.

What offset this increase in factors supplying reserves to the banking system? Net repurchase agreements declined by $11 billion in July and then declined by roughly another $10 billion in August. That is much of the increase in reserves supplied to the banking system during this time was offset by the decline in repurchase agreements. The initial support for the Bear Stearns bailout was a temporary phenomenon and so it seemingly was supported by a temporary supply of funds. As the accounting for the bailout was resolved, the temporary supply of funds was replaced by a more permanent source of funds consistent with the bailout agreement.

It should also be noted that NO additional funds were supplied to the banking system through the Term Auction Facility (TAF) during this time period. Auctions were held during this period, but the TAF line item began the period under review at $150.0 billion and ended the period at this same amount.

So what is the bottom line on the summer activity of the Federal Reserve?

To summarize…first, the Fed took care of business by supplying seasonal reserve needs to the banking system. Second, the Fed resolved the accounting treatment of the commitments made in the March bailout of Bear Stearns. Overall, nothing exciting was going on…which in the case of the central bank is a very good thing!

In terms of more aggregative data…things seem to be moving on relatively smoothly. As mentioned in my last post of September 1 ( which dealt with banking failures and the working out of banking failures: the situation may not be a good one and recovery may not take place as soon as we would like it to, but if the adjustment is going smoothly then that is the best that we can hope for in the near term. We don’t want surprises!

The Monetary Base (monthly on a non-seasonally adjusted basis) has grown, year-over-year, roughly between about 1.5% and 2.5% in the past six months. The year-over-year growth of total reserves at depository institutions, again monthly on a non-seasonally adjusted basis, has fluctuated a little bit more jumping roughly between 0.5% and 3.5% during the past six months. At present, however, there seems to be no trends established in either of the measures which seems to indicate that adjustments are taking place without any major disruptions. This is good!

Money stock growth (as measured by the broader M2 measure) seems to me to be too high for my comfort level but the year-over-year growth rate has remained relatively stable throughout 2008. This growth rate has fluctuated in the 6.0% to 6.5% range except in February and March when the Fed was resolving the liquidity crisis and the Bear Stearns bailout. In April, the rate of growth dropped back into the stated range. The interesting thing is that the year-over-year growth rate of the M1 money stock measure has popped up in the last two months after staying around a zero rate of growth for the first six months of the year. Seems like “Other Checkable Deposits” at both commercial banks and at thrift institutions have jumped up more than seasonally. (These are primarily NOW accounts and ATS accounts.) But, this appears to be just a re-arrangement of how people are managing their money because the increase in the growth rate of the M1 measure has not translated itself into an increase in the growth rate of the M2 measure.

So, things seem to be calm right now on the banking and monetary front. We can only hope that it stays so.

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