Monday, February 7, 2011

Federal Reserve QE2 Watch: Part 3

At the close of business on February 2, 2011, the Federal Reserve System recorded a total of $1.1 trillion of U. S, Treasury securities on its balance sheet. To be more exact, the number was $1,138,166 million.

Thirteen weeks ago, the Fed held just $842,008 million in Treasury securities. Thus, the Fed’s holdings of these securities have gone up by almost $300,000 million or $300 billion or $0.3 trillion over this time. QE2 seems to be in full swing?

Thus, in the last three months, the Federal Reserve has surpassed the holdings of U. S. Treasury securities of China, a little less than $900 billion, and of Japan, a little less than the China.
At January 31, 2011, the Total Public Debt of the United States Government was $14.13 trillion.

Thus, the Federal Reserve System currently holds a little over 8 percent of its government’s debt!

The QE2 program of the Fed stated that the Federal Reserve would buy $600 billion of United States Treasury securities over a six month period and would buy an additional $300 billion in these securities to offset the amount of Federal Agency securities and Mortgage-backed securities that resided on the Fed’s balance sheet and were maturing during this time period.

As stated above, the Federal Reserve added $296 billion of U. S. Treasury securities to its balance sheet. During this time period the Fed lost $91 billion in Federal Agency securities and Mortgage-backed securities reducing the net addition of $205 trillion to its overall portfolio of securities as a part of QE2.

Over the last four week period, the Fed acquired $107 billion in U. S. Treasury securities, but had a runoff of $30 billion in these other securities so that the “net” new purchases added up to $77 billion.

But, this was not all going on that affected the amount of reserves in the banking system. One very big “happening” was that the settlement of the AIG bailout as the Fed’s involvement in this effor. “The Board's statistical release, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks," reflects the closing of the American International Group, Inc. (AIG) recapitalization plan, which occurred on January 14, 2011. The recapitalization plan was designed to restructure and facilitate repayment of the financial support provided to AIG by the U.S. Department of the Treasury (Treasury) and the Federal Reserve. Upon closing of the recapitalization plan, the cash proceeds from certain asset dispositions, specifically the initial public offering of AIA Group Limited (AIA) and the sale of American Life Insurance Company (ALICO), were used first to repay in full the credit extended to AIG by the FRBNY under the revolving credit facility (AIG loan), including accrued interest and fees, and then to redeem a portion of the FRBNY's preferred interests in ALICO Holdings LLC taken earlier by the FRBNY in satisfaction of a portion of the AIG loan. The remaining FRBNY preferred interests in ALICO Holdings LLC and AIA Aurora LLC, valued at approximately $20 billion, were purchased by AIG through a draw on the Treasury's Series F preferred stock commitment and then transferred by AIG to the Treasury as consideration for the draw on the available Series F funds.”

Basically, this adjustment, along with some other minor runoffs of other “financial emergency” management accounts, removed about $35 billion from the banking system over the past 13-week period and about $22 billion in the past 4-week period. Assuming the Fed offset this reduction in bank reserve with the open-market purchase of Treasury securities, this drops the “net” QE2 injections of reserves into the banking system to $170 billion over the last quarter and $55 billion over the last four weeks.

As always, there are the ordinary operating transactions the Federal Reserve must account for because these transactions, like movements in currency in circulation and movements of Treasury Tax and Loan monies, impact bank reserves. The Federal Reserve usually offsets these items so as to smooth bank adjustments in the regular course of business.

Over the past 13-week period, the Fed had approximately a net of $72 billion in operating transactions to offset. Over the past 4-week period, this total was approximately $7 billion.

Removing these amounts from the Fed purchases of Treasury securities, we find that the Fed bought $98 billion in securities that added to bank reserves over the past 13 weeks, and bought $48 billion over the past 4 weeks. In effect, these numbers reflect the “net” impact of securities purchased to increase bank reserves over this period of time.

Thus, one cannot say that over the last 13-week period the Fed bought almost $300 billion in U. S. Treasury securities as a part of the QE2 program because of all the other things going on during this time.

The Fed did buy over $90 billion in Treasury securities to offset the amount of securities that were running off in the rest of the portfolio, part of the $300 billion the Fed said it was going to do, but this cannot truthfully be considered a part of the $600 billion of new purchases it was supposed to undertake. And, one can make the case that the full amount of the almost $200 billion in purchases was not a part of QE2.

The real question concerns the effects this increase had on the banks and the economic system. Because of timing differences the following data don’t exactly foot. For example, reserve balances held at the Fed increased by $98 billion over this time period. The information we currently have from other sources indicate that the monetary base, which consists of bank reserves and coin and currency held outside of commercial banks, rose by almost $95 billion at the same time. So, we are roughly in the same ball park. One should also note at this time that all these data are non-seasonally adjusted!

Of the $95 billion, roughly $80 billion in the increase came in bank reserves and $15 billion came in currency held outside of banks. Of the $80 billion increase in bank reserves, about $12 billion of this was due to the increase of required reserves of commercial banks. Note that individuals and businesses are still moving their funds from money market accounts and small time and savings accounts, to demand deposits and other checkable deposits, and away from thrift institutions to commercial banks. (We will have more to say on this later this week.) The demand and checkable counts have higher reserve requirements than do the accounts that the funds have been moved from. This still remains the major reason why required reserves have increased over the past several years as well as currently.

So, $68 billion of the increase in total reserves went into excess reserves. Bank loans continued to decline in January (I will address this next Monday) so it appears as if commercial banks are still taking the excess reserves and putting them into “cash” rather than lending them. (Again there is a difference between the behavior of the big banks versus that of the smaller banks.)

The conclusion one can draw from this is that the Fed has been executing QE2, but has not been as aggressive as some people have thought when looking at just the aggregate dollar amount in the Fed’s portfolio of Treasury securities. The Fed still has other things going on that must be taken care of and this modifies any interpretation one can give to the aggregate figures. In terms of the banks: the banks still appear to be putting the “new” reserves the Fed is injecting into the banking system into excess reserves. So far, QE2 does not seem to be producing any substantial results in the banking system.

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