Who Needs $1.4 Trillion in Excess Reserves?

On August 27, 2010, Fed Chairman Ben Bernanke gave the world the first news about QE2. (See my post, “Bernanke in the Hole”, http://seekingalpha.com/article/222704-bernanke-in-the-hole.)

His explanation left something to be desired.

I had just made the comment:

"The Federal Reserve has two basic problems right now. First, those running the Fed don’t know what they are doing. Second, they are doing a terrible job explaining this to the world.

Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.

We have experienced the end of the Fed’s exit strategy, the effort undertaken by the Fed to reduce the size of the Fed’s balance sheet. The exit strategy was designed to reduce the massive amounts of reserves pumped into the financial system by the Fed so that a period of hyper-inflation would not result. That exit strategy saw the Fed’s balance sheet grow by $331 billion over the twelve-month period the “exit” strategy was in place. Excess reserves held by the banking system rose by 38% during the same time period. (Details here.)"

Guess what?

Things really haven’t improved.

Guess what again?

The Fed is now going to hold a press conference on a regular basis, four times each year after selected meetings of the Fed’s Open Market Committee, the committee that sets monetary policy for the nation.

The purpose of these press conferences? To explain monetary policy to the nation and to make things “more clear” about what the Federal Reserve is trying to do.

This, to me, would be really funny if the Fed did not have such a crucial role to play in our lives.

Why don’t we just let Alvin and the Chipmunks sing four times a year after meetings of the Fed’s Open Market Committee?

Why does the banking system need $1.4 trillion in excess reserves?

In August 2010, the banking system averaged a little more than $1.0 trillion in excess reserves.
So, excess reserves have gone up about $400 billion.

Since August 25, 2010, two days before Bernanke’s Jackson Hole speech, the Fed has added a net of $520 billion of Treasury securities to its Treasury securities portfolio. The Fed’s portfolios of Federal Agency issues and Mortgage-backed securities has declined by $183 billion.

Thus, the Fed has added a “net” of $337 billion to its “total” securities holdings since just before the speech. This compares with the proposed “net” increase in Treasury purchases of $600
billion.

Overall, “Reserve balances with Federal Reserve Banks”, a proxy for excess reserves in the commercial banking system, has increased by $358 billion over this time period to $1.4 trillion.

So, operationally, the Federal Reserve has done exactly what it said it would do.

By the end of June, therefore, excess reserves in the banking system should be between $1.6 and $1.7 trillion.

And, bank loans? Usually when the Fed puts reserves into the banking system, bank loans increase.

Loan and leases at commercial banks in the United States has declined by roughly $130 billion during from the time from August to the early March.

Although Commercial and Industrial (business) loans have increased slightly (about $18 billion), Real Estate loans have dropped precipitously by almost $95 billion. Consumer loans have also decreased by a little more than $65 billion.

In the real estate area, the big drop has been in commercial real estate loans which fell by almost $75 billion. Revolving home equity loans declined by another $20 billion with residential loans remaining roughly constant on bank balance sheets.

Again, one can ask the question, why does the banking system need $1.4 trillion (going to $1.7 trillion?) in excess reserves?

In explaining the reasoning for “throwing so much spaghetti against the wall” we are told that the Fed is acting in this way to spur on economic growth.

Are four more press conferences per year going to throw any more light on the rationale for these Fed actions than we already have?

Let me just reiterate something I said in the early blog post: “Never have I seen such confusion in such an important institution. Never have I seen such inadequate leadership.”

My take on the story? See my March 24 post, “Banking and Real Estate Loans: the Problems are Still There” (http://seekingalpha.com/article/259867-banking-and-real-estate-the-problems-are-still-there). I believe that the banking statistics presented above capture a part of this story. I am not sure it justifies a banking system with $1.7 trillion of excess reserves. But, then, maybe those banks smaller than the 25 biggest banks in the country are more insolvent than I believe they are. But, the Fed isn’t telling us this and four more press conferences a year is not going to shine, in my mind, any more light on the issue.