The Fed's balance sheet, part 2: So, what's on it?
Since 2008, first because of the crash and great recession of 2008-09 and now because of the COVID-19 crisis, the assets on the Fed balance sheet have ballooned with the Fed’s aggressive purchases of assets to keep the economy afloat. The theory behind this is that the Fed’s purchases and other actions keep the economy stable until the market has a chance to recover on its own. Then, when the market recovers, the Fed should be able to sell off the ‘temporary’ assets on its balance sheet without tanking the markets. In practice, though, assets on the Fed’s balance sheet have not substantially contracted since it began ballooning in 2008. You can see that clearly in this chart:
Now let’s take a look at that chart again, this time broken down into the specific assets the Fed has on its balance sheet:
Here’s what the colors mean (check the source if you are curious about the specifics of each category):
Blue: Treasury securities
Red: Mortgage-backed securities (MBS)
Purple: This is a collection of assets like gold, foreign currency, etc. that can be ignored for purposes of this series.
Green: Discount window lending and repurchase agreements. These are ways the Fed helps banks get short-term liquidity.
Yellow: Emergency facilities the Fed established during the ‘08 recession and again during the COVID pandemic.
From this chart, we see that the largest share of the money the Fed is creating is going into buying Treasury securities and MBS. Let’s dig a bit deeper into what that all means.
MBS are rolled up packages of mortgages. These are the kind of securities that caused the 2008 recession when they got packed with subprime mortgages, and as we all learned, the securities were only as good as the mortgages they were based on. Not all MBS were ‘toxic’ in this way—it was mainly the ‘private label’ ones put together by investment banks like Bear Stearns and Lehman Brothers that failed. So since then, these securities are only issued by authorized institutions, and the Fed only buys MBS issued by Fannie Mae, Freddie Mac, or Ginnie Mae, which are all government-sponsored enterprises or government-owned corporations guaranteed against failure.
Since the COVID pandemic hit, the Fed has dramatically increased its purchases of MBS. In fact, the Fed trading desk is currently instructed to buy $40 billion of MBS a month. In 2008, the main reason to start buying these assets was to keep the housing market from totally collapsing and taking the economy down with it. And in the late autumn of 2012, the Fed even launched ‘QE3’ to raise housing prices by committing to purchasing $85 billion of MBS every month--this is probably why the housing markets finally recovered in 2014. But why is the Fed buying so much MBS now?
The answer is, basically, to keep new money flowing into the economy so that banks and people continue to have access to cheap credit. When the Fed creates money to buy MBS (or any other asset) off the market, it is essentially replacing an unspendable, illiquid asset (in this case, the MBS) with something spendable and liquid (money). The idea is that this money will then be lent out by banks to people and businesses, who will use it to produce and consume and keep our economy running.
Additionally, the Fed taking this action signals to everyone that the Fed is not going to let the housing or commercial property market collapse. This way, banks feel little risk in continuing to offer low-interest rate mortgage loans for property at a time that the pandemic is causing a lot of uncertainty about the economy. So the Fed is essentially keeping money flowing towards home and commercial property loans and telling banks ‘keep investing in homes and commercial properties — we’ve got your back.’
But who is the Fed buying these MBS from? Unfortunately, the Fed won’t publish MBS transaction data for 2020 for about another two years, but they do tell us who the approved banks they buy from are. These are the only banks that are allowed to sell MBS to the Fed and so they are the recipients of new money the Fed creates to buy MBS:
We also can get some idea of who the Fed is likely buying MBS from now based on transaction data that is available through 2018. Here, for example, is who the Fed bought $104 billion of MBS from in 2018 (values are in millions of dollars):
And in the chart below, you can see the net amount of MBS purchased and sold by the Fed to and from the 15 largest sellers between 2009 and 2018. Remember, this is all new money the Fed is creating and giving to these banks to buy the MBS!
(To see the full source data for this chart, click here).
Similar to its ramp up of purchasing MBS, the Fed has also aggressively ramped up purchasing Treasury securities, announcing that it wants to purchase $80 billion in Treasury securities a month. (Note that this is almost as much as the Fed committed to purchase in MBS through QE3 back in 2012.) These include Treasury bills, bonds, and any other security that the US Treasury issues. And while the Fed often coordinates buying these Treasury securities with the US Treasury, which is tantamount to simply printing new money for the Treasury, the Fed does not buy Treasury securities directly from the Treasury but, instead, from pre-approved banks, just like with MBS. These are the Fed’s ‘Primary Dealers’ that are approved to do Treasury security transactions with the Fed:
As with MBS purchases, the primary goal of purchasing so many Treasury securities is for the Fed to pump more money into the economy to make sure cheap credit remains available while the future of the economy remains uncertain because of the pandemic. But the Fed is also purchasing large amounts of Treasury securities so that the Treasury can confidently issue debt to fund, among other programs, the CARES Act that Congress passed last March. Though the Fed isn’t directly purchasing from the Treasury, the Fed is, in effect, ensuring a market for the Treasury’s securities.
So is it working?
Are these purchases doing what they are meant to do? On the one hand, yes. For the Fed, the goal was to keep low-interest credit available to consumers and businesses, keep the MBS and Treasury markets well supported, and make money available to the Federal government for its relief efforts. And in those goals, it has succeeded.
But if we take a step back and think about this holistically, it’s hard not to feel like there’s a big missed opportunity here. If we can just create trillions of dollars ‘from nothing,’ why wouldn’t we invest that into manufacturing electric cars, producing solar panels, retrofitting buildings to render them energy-efficient, investing in 5G, 6G, and AI, and all the other productive industries we know America needs to build the sustainable economy of tomorrow and provide millions of people with high wage employment in doing so?
Right now, the money the Fed gives to big banks (the ones listed above as ‘Approved Counterparties’ or ‘Primary Dealers’) does not have to go to anything in particular. The Fed leaves it up to these banks to deploy this capital into the economy, assuming they will know best what businesses to invest in and consumers to give loans to. But in reality, it is often more profitable in our economy for banks to use this money to gamble on Wall Street instead of making long-term investments into Main Street businesses. And we also see how, because the Fed essentially guarantees the mortgage-backed securities markets by buying so much of their product, home and commercial mortgages are some of the cheapest and easiest kinds of loans to get in America. Imagine if the Fed made it just as easy to get loans for starting a business building bioreactors for vaccines or to upgrade the machines in your furniture factory? At New Consensus, we have a proposal for how the Fed could direct the new money it creates towards exactly that, and we will dive further into that proposal in a future blog post.
To be clear, this isn’t to say that the Fed shouldn’t be buying MBS and Treasury securities right now. Monetizing these is the easiest way in our system, as it currently operates, for the Fed to make sure low-interest credit remains available to consumers and business. And that’s necessary when a pandemic causes the economy to go into recession. But Treasury securities and MBS are not issued to finance new goods and services production. They are, instead, issued to finance government operations and purchases of already-existing real estate. And while financing government debt could result in productive investments (as we propose here), real estate is not, on its own, “productive.” So Fed purchases of MBS and Treasury securities are more like ‘treading water’ than ‘moving forward.’ And while treading water is better than drowning, it would be even better if we were getting ahead. And we get ahead by producing.
What we are witnessing in real time right now is how trillions of dollars can be created from nothing and put into mostly non-productive activities in our economy with no corresponding rise in inflation. If that is possible--that is, if we can create so much new money without causing inflation even when we are not producing more goods with the money--then it ought to be clear that we absolutely have the power to create trillions of more dollars without inflation to finance more productive activity (which increases the supply of goods and so naturally curbs inflation).
To some extent, those now in charge at the Fed probably agree with what we are saying here. Many of the new emergency facilities the Fed established last spring (the yellow part of the chart above) were started in order to route money directly to smaller and medium-sized Main Street businesses, not just Wall Street banks, during the pandemic. But these are, as the charts above show, dwarfed in size by the Fed’s MBS and Treasury security purchases. So while they’re a step in the right direction, we will have to go much further if we want to restore America’s status as the world’s premier producer, and with that the great American middle class.
In our next posts, we will dive into some of the Fed’s newer lending facilities just mentioned in order to look at what these programs are, where the new money has flowed, and how we might make them both bigger and better.