Appendix I. Fed Balance Sheet and Earnings Before and During the Great Depression
Appendix II Federal Capital Policy from U.S. Code
Adrian, Tobias, and Hyun Song Shin, 2008a, “Financial Intermediary Leverage and Value-at-Risk” Federal Reserve Bank of New York Staff Reports # 338, Revised August 2008.
Adrian, Tobias, and Hyun Song Shin, 2008b, “Liquidity and Leverage” Federal Reserve Bank of New York Staff Reports # 328, May 2008, revised January 2009.
Bagehot, Walter, 1873, Lombard Street: A Description of the Money Market (London: H. S. King & Co). Fourteenth edition May 1915.
Bernanke, Ben S., 2009, “Federal Reserve Policies to Ease Credit and Their Implications for the Fed’s Balance Sheet”, National Press Club Luncheon, Washington, D.C. February.
Broaddus, J. Alfred Jr., and Marvin Goodfriend, 1996, “Foreign Exchange Operations and the Federal Reserve,” Federal Reserve Bank of Richmond Economic Quarterly, Volume 82, No. 1 (Winter).
Business Week Online, 2003, “Is the Bank of Japan Barreling toward a Bailout?”(February 3). http://www.businessweek.com/magazine/content/03_05/b3818169.htm
Cargill, Thomas F., 2005, “Is the Bank of Japan’s Financial Structure an Obstacle to Policy,” IMF Staff Papers, volume 52 number 2 (Washington: International Monetary Fund).
Chailloux, Alexandre, Simon Gray, Ulrich Klueh, Seiichi Shimizu, and Peter Stella, 2008, “Central Bank Response to the 2007-08 Financial Market Turbulance: Experiences and Lessons Drawn”, IMF Working Paper 08/210 (Washington: International Monetary Fund).
Chailloux, Alexandre, Simon Gray, and Rebecca McCaughrin (2008) “Central Bank Collateral Frameworks: Principles and Policies.” IMF Working Paper 08/222 (Washington: International Monetary Fund).
Cukierman, Alex, 2008, “Central bank independence and monetary policymaking institutions—Past, present and future” European Journal of Political Economy, December.
Enoch, Charles, May Khamis, and Peter Stella, 1997, “Transparency and Ambiguity in Central Bank Safety Net Operations”, IMF Working Paper 97/138 (Washington: International Monetary Fund).
Federal Reserve Banks, 2009, Combined Financial Statements, 2007–2008. http://www.newyorkfed.org/aboutthefed/annual/annual08/MaidenLanefinstmt2009.pdf
Friedman, Benjamin. The Future of Monetary Policy: The Central Bank as an Army With Only a Signal Corps NBER Working Paper 7420, November 1999.
Goodfriend, Marvin, 1994, “Why We Need an ‘Accord’ for Federal Reserve Credit Policy: A Note,” Journal of Money, Credit and Banking, Vol. 26, No. 3, pp. 572–80.
Keister, Todd, Antoine Martin, and James McAndrews, 2008, “Divorcing Money from Monetary Policy” Federal Reserve Bank of New York Economic Policy Review September. www.newyorkfed.org/research/epr/08v14n2/0809keis.pdf.
MacKenzie, George A. (Sandy), and Peter Stella, 1996, “Quasi-Fiscal Operations of Public Financial Institutions,” IMF Occasional Paper No. 142 (Washington: International Monetary Fund).
Restrepo, Jorge, Salomó, Luis and Rodrigo Valdés, 2009, “Macroeconomía, Política Monetaria y Patrimonio del Banco Central de Chile”, Economia Chilena, Volumen 12, Numero 1, Abril.
Sims, Christopher A., 2003a, “Fiscal Aspects of Central Bank Independence,” (mimeo; Princeton, New Jersey: Princeton University) (February 15).
Stella, Peter, 2005, “Central Bank Financial Strength, Transparency, and Policy Credibility,” IMF Staff Papers, volume 52 number 2 (Washington: International Monetary Fund).
Stella, Peter, 2008, “Central Bank Financial Strength, Policy Constraints and Inflation,” IMF Working Paper 08/49 (Washington: International Monetary Fund).
Stella, Peter and Ake Lonnberg, 2008, “Issues in Central Bank Finance and Independence”, IMF Working Paper 08/37 (Washington: International Monetary Fund).
U.S. General Accounting Office, 2002, Federal Reserve System: The Surplus Account (Washington). Available via Internet: www.gao.gov/cgi-bin/getrpt?GAO-02-939
U.S. General Accounting Office, 1996, Federal Reserve System: Current and Future Challenges Require Systemwide Attention (Washington).
The author would like to thank Jerome Vandenbussche, Zsofia Arvai, Alain Ize, Charles Kramer, Herve Ferhani, Stephen Meyer, Kotaro Ishi, Luis Jacome, Alexandre Chailloux, Christian Mulder, and participants in an MCM seminar for helpful suggestions and Breda Robertson for editorial assistance. The author is responsible for any remaining errors.
The Future of Monetary Policy: The Central Bank as an Army With Only a Signal Corps NBER Working Paper 7420, November 1999.
The fact that approximately half of FR notes are estimated to circulate abroad is actually immaterial to the argument but is certainly supportive of the notion that they do not factor into U.S. monetary policy.
See FRBNY (2006).
“Policy Assets” are defined as liquidity providing repos plus loans to depository institutions, other loans, central bank liquidity swaps and investments held by consolidated variable interest entities. All but the first two categories were absent from the FRB balance sheet prior to 2007.
The low and declining level of reserves demonstrates the absence of any motivation to direct credit by the Federal Reserve. In many central banks, during the 1960s and 1970s, high reserve or liquidity requirements were used to fund direct lending to “priority” sectors.
Borio and Nelson (2008); and Chailloux, Gray, Klueh, Shimizu and Stella (2008) discuss how other central banks altered their liquidity management frameworks in response to the initial phases of the crisis.
U.S. depository institutions also have access to liquidity through the discount window against a broader range of collateral although this was not commonly used until the current crisis.
At the end of 2008 the figure was 86 percent of GDP.
The reader may wonder why this balance sheet, earlier “rejected” is now being discussed. How the demand for U.S. banknotes might behave in a global financial/economic crisis is relevant to the discussion in Section III.
The 2006 and 2008 balance sheets were audited by PricewaterhouseCoopers LLP and Deloitte and Touche LLP, respectively.
To a certain extent, this “new” role in commercial credit brings the Fed back to its roots: “…to influence the market a Reserve Bank must always be in the market, and in this sense Reserve Banks will be active banking concerns when once they have found their true position under the new banking conditions.” First Annual Report of the Federal Reserve Board for the period ending December 31, 1914 (p. 18).
Here liquidity refers to the ability of the monetary authority to use the instrument in reserve draining operations. In some countries, a legislative act would be required to allow the central bank to sell or pledge gold. In those cases gold could not be considered a liquid asset. Central banks often acquire illiquid assets such as nonperforming loans in conjunction with bank rescue operations.
The Fed can also withdraw liquidity by not rolling over its portfolio as it matures. This drains liquidity by requiring the Treasury to transfer to the Fed bank reserves acquired, e.g., by issuing t-bills into the market. The fall in outright holdings of Treasuries in 2007 was the first such fall since 1989 (see FRBNY(2007)).
This compares with a “usual” target of $5 billion for Treasury’s Fed balance in 2007. See FRBNY (2008).
The U.K. Treasury has cooperated closely with the Bank of England during various phases of the crisis. Sims (2003a) points out potential consequences for the European Central Bank in the absence of treasury financial support.
See “The Role of the Federal Reserve in Preserving Financial and Monetary Stability—Joint Statement by the Department of the Treasury and the Federal Reserve (March 23, 2009).
This change was implemented with the reserve maintenance period starting (Thursday) October 9, 2008. See http://www.newyorkfed.org/banking/circulars/11998.html. There was also discussion at the time of allowing the Fed to issue its own securities.
The Fed has recently been providing more detail on the composition of its balance sheet. See Bernanke (2009). Maiden Lane I relates to the Bear Stearns operation, while II and III pertain to AIG.
The TALF is designed to support the issuance of asset-backed securities collateralized by auto loans, student loans, credit card loans and loans guaranteed by the U.S. Small Business Administration. See FRB press release November 25, 2008.
The Fed provides a website describing its programs: http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm
See Stella (1997), (2005), and (2008) for country examples and further argumentation. Sims (2003b) discusses how central bank balance sheet difficulties can make it impossible to attain an inflation target.
Federal Reserve Act, Section 2.4, “Liabilities of Shareholders of Reserve Banks.”
For example, in 1934, the FRB of Chicago refused to purchase securities held by FRBNY to assist the latter with a shortage of gold holdings. See Meltzer (2003) page 387, footnote 136.
In its 2008 Annual Accounts, the ECB suggested that National Central Banks set aside provisions amounting to 5.7 billion Euro (amounting to 1.5 percent of total ECB assets) owing to possible losses from defaulted loans to Lehman Brothers Bankhaus AG, three subsidiaries of Icelandic banks, and Indover NL, a Dutch bank.
Risk Assets are calculated by subtracting securities held outright, central bank swaps, gold, SDRs, and coin from total assets and adding the interdistrict settlement account.
FRBNY Consolidated Financial Statements note 6, page 25.
This is indisputable for the Bank of England, European Central Bank, Reserve Bank of Australia, and Swiss National Bank. One might argue that the payments capacity of the emerging market central banks is less assured. At present, FRB swaps with them represent a small fraction of their entire liquid reserves. It would be difficult to anticipate a default in that situation.
As of April 15, 2009 (the latest data available) banks borrowing from the discount window and TAF had pledged collateral net of haircuts valued at $1.226 trillion against loans of $503 billion. See the website: www.federalrserve.gov/monetarypolicy/bst_ratesetting/
See the audited accounts of Maiden Lane LLC for the period March 14 though December 31, 2008. Note 5.b, page 16 discusses the performance of the commercial and residential loan portfolio. http://www.newyorkfed.org/aboutthefed/annual/annual08/MaidenLanefinstmt2009.pdf.
A 20 percent default rate means here that loans equivalent to 20 percent of the total Fed portfolio go into default, i.e., the borrower(s) fails to pay on time and in full according to the original terms.
A ratings transition matrix provides the historical frequency that ratings change from one category to another. For example, the frequency that a AA rating transitions to a AAA or A rating at the next rating review. Historically, transitions from investment grade to default (C or D) within 3 months are very rare.
Owing to relatively low PDCF exposure and rounding margin, this does not change the hypothesized loss.
Owing to relatively low AMLF exposure and rounding margin, this does not change the hypothesized loss.
See FRB Combined Financial Statements, Note 3, page 10-11 and Note 11, page 40. As of April 20, 2009 the accounting treating of the Bank of America support had not yet been determined.
The original title was “franchise tax,” abolished by Congress in 1933. See Meltzer (2003) page 599.
The FRB expanded their liabilities at very low marginal cost in 2008. Compared with 2007, banknotes rose by $61 billion; government deposits—which bear no interest—by $349 billion; and bank deposits—currently paying interest at 25 basis points, by $839 billion.
The net loss to the Fed from the Maiden Lane SPVs in 2008 amounted to $3.4 billion as the 3 SPVs registered $1.9 billion in net interest income while $4.4 billion in losses were absorbed by JPMorgan and AIG.
In 1997, cost of currency amounted to 1.5 percent of consolidated FRB current income. In some countries this can be a material cost for the central bank. Some sub-Saharan central banks experience negative seignorage owing to the high cost of procuring banknotes relative to their nominal denominations in local currency as well as high costs to maintain quality currency in adverse climactic conditions.
The possible political economy consequences of this scenario are discussed below.
It is assumed that the 2010 effective rate of return on the TAF/Primary credit and swap portfolios is only 50 bps. This is equivalent to a 300 bps return reduced by the 250 bps loss assumed in Table 9. In 2011 it is assumed the effective rate of return rises to 300 bps.
In scenario 1, deposits fall by $265 billion in 2009. In scenario 3 this same reduction is used to finance the SPV purchase ($115 billion), general expenditure ($50 billion) and insure against TALF losses ($100 billion).
For a discussion of Gresham’s law of collateral and central bank collateral policy more broadly, see Chailloux, Gray and McCaughrin (2008).
Stella (2008) provides some quantification of this trend by measuring the decline in the proportion of “other items net” reported by 150 central banks and monetary authorities during 1992-2005.
Many central banks with significant foreign exchange holdings which are not hedged against currency fluctuations make adjustments to their accounts to avoid paying unrealized foreign exchange gains to government as this is seen an economically equivalent to unrequited money creation.
At the request of Congress, reviews were conducted by GAO (1996) and GAO (2002).
See Cukierman (2008) for further discussion of the development of the idea of central bank independence.
The FOMC consists of all 7 Board members, the President of the FRBNY and 4 Reserve Bank presidents alternating among the remaining 11 FRBs.
See Enoch, Khamis and Stella (1997) for a discussion of the difference in ex-ante and ex-post transparency.
Friedman and Schwartz (1963), among others, have thoroughly examined the Fed’s role in the Great Depression.
Figure 24 also includes “industrial loans” but the volume of these loans was zero before 1934 and not significant enough thereafter to influence the total enough to make it visible in the Figure.
The official price of gold was changed from $20.67 per ounce to $35 per ounce in January 1934. In 1934 U.S. citizens were prohibited from buying, selling or holding gold.