How does being on the hook for close to $5 trillion in loans backed by bad assets sound? Well, that’s the deal the Federal Reserve has struck on behalf of the American people.
A bit more than two years ago, the total amount of assets held by the Fed was about $850 billion. It’s more than doubled since. As of April 2, the amount of the Fed’s holdings stood at over $2 trillion and is likely to keep growing. According to the Subsidyscope team’s conservative estimate, the Fed’s holdings could exceed $5 trillion within a year.
The assets reflected on the Fed’s balance sheet are mostly securities — essentially loans that banks sell to the Fed for cash. Traditionally, after a short period of time – up to about 14 days — the banks will turn around and buy their securities back with interest. But this simple formula the Fed uses to keep banks liquid and maintain a relatively modest amount of assets on its books has disappeared. The place where these transactions were documented still lives on the Fed’s balance sheet; it’s a line item called “repurchase agreements.” Repurchase agreements haven’t been taking place since earlier this year. So if the Fed has stopped doing business with banks the way it always has, what is it doing and why have its assets grown so tremendously?
Simply put, it’s changed its focus and expanded its operations. Once upon a time, the Fed’s sole purpose was to set and maintain the Federal Funds Rate, which determines the rate at which banks lend to one another. It has a trickle-down effect in that the more money a bank can make in trading and selling its assets to other banks the more it’s willing to lend to people who need home loans and credit cards.
As the economy was plundered by countless mortgage loans gone bad (now known as toxic assets, or legacy loans) banks stopped lending to one another. As a result, more and more banks needed to go to the Fed’s discount window – a place they could get fully collateralized emergency loans.
The Fed is hardly lending through it’s original discount window anymore and it’s hasn’t touched the Federal Funds Rate since December of last year. Why? First, the Fed, according to its own Web site, has changed its monetary policy and begun purchasing securities outright, such as mortgage-backed securities, and making below-market rate loans to private investors through the Term Asset-Backed Lending Facility (TALF) so they can buy bad assets on their own. The Fed has also created a new lending window called the Term Auction Facility (TAF) through which banks that are in trouble, or not, can borrow money at discounted rates as long as they can fully collateralize the loans.
The TAF muddies the water when it comes to figuring out which banks might be in trouble. It used to be that banks that borrowed from the discount window were in need of help. With TAF, no distinction is made between banks that are in trouble and those that aren’t. Any bank can borrow at discounted rates if it can front the collateral. Not a ringing victory for transparency.
In a lawsuit it filed against the Fed last fall, Bloomberg News not only wants to know who the Fed is buying assets from, but what assets the Fed is buying. Bloomberg also wants to know how much money is being lent versus the face value of what is being purchased. The news service’s stated goal is to find out if taxpayers are getting the most for their money.
In all, the Fed has created 11 programs aimed at growing its balance sheet. Its intentions appear good: Keep credit flowing and, return the nation to prosperity. Some fear the Fed’s new tactics are coming perilously to close to nationalizing the nations banking system. Others believe this is the best way to restore our economy. I think that before anyone passes judgment, it helps to know exactly what the Fed is doing. I hope we’ve made that a little clearer this week.