Monday, April 6, 2009

Fed Balance Sheet Stuff

Fed Chairman Ben Bernanke gave a helpful overview of the Fed's balance sheet in a speech he delivered today at the Richmond Fed's Credit Market Symposium, mostly lauding and justifying the Fed's actions and their positive effects. Bernanke seemed to go out of his way to keep his comments relatively simple, continuing the dialogue he struck with the general public in his recent appearance on 60 Minutes.

Bernanke made mention, for example, of a new section on the Fed's Web site, called Credit and Liquidity Programs and the Balance Sheet, a section that consolidates information on the various Fed programs. It appears to be a useful section, although avid Fed watchers are sure to continue to visit the New York Fed's Web site for operational details regarding the Fed programs.

Bernanke's underlying goal in his speech ostensibly was to not only describe in simple terms the factors and motivations behind the use of the Fed's balance sheet, but also to allay concerns regarding how it is currently being used. Bernanke described almost line by line the main parts of the balance sheet. For example, Bernanke noted that about 45% of the Fed's assets consist of short-term liquidity provided to financial institutions (loans are assets in the world of banking).

Bernanke described the loans as "fully secured" and having been made to "sound institutions," with maturities of no greater than 90 days. These short-term loans represent a key part of the Fed's exit strategy.

Other parts of the Fed's exit strategy (Bernanke listed four measures), include reverse repurchase operations, soaking up money through the Treasury's Supplemental Financing Program (the Treasury could sell bills to the public, draining money from the system), and increasing interest rates on reserves (by raising the interest rate the Fed pays on bank reserves, banks would be apt to hold reserves rather than lend them).

Each of these could in fact be done quickly, but there remain big question marks over the Fed's ability to do so in a timely manner. It is akin to walking a dog with a long leash, and with the leash getting longer and longer, it is getting trickier to know when to maneuver and keep the dog (the economy and inflation) in line.

Bernanke notes some risk in its purchase of mortgage-backed securities, noting the purchases entail interest-rate risks. Bernanke said they could be offset by the Fed's own low cost of money and the generally upward sloping yield curve.

Bernanke continued to display deep angst toward AIG, saying that the emergency lending to AIG and for the acquisition of Bear Stearns "have been extremely uncomfortable for the Fed to undertake."

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