The Congressional Budget Office today released a study titled The Budgetary Impact and Subsidy Costs of the Federal Reserve’s Actions During the Financial Crisis which outlines the actions by the Federal Reserve to address the recent financial crisis. The traditional and non-traditional operations undertaken by the Fed in an attempt to stabilize the financial system has led its balance sheet to increase more than two fold over the past two and a half years.
The composition of assets held by the Fed traditionally has consisted of U.S. Treasury Securities and ultra short (typically overnight) loans to commercial banks through its discount window. By lowering rates the Federal Reserve can attempt to provide liquidity by effectively making it cheaper to borrow. After Bear Stearns nearly had to file for bankruptcy and was ultimately taken over by JPMorgan in March 2008 the Federal Reserve allowed non commercial banks access to its discount window and institutions were allowed to borrow for up to 90 days. This liquidity however did not calm the markets for long and after Lehman Brothers filed for bankruptcy during September 2008 the Federal Reserve implemented new extraordinary programs to provide liquidity to both traditional and non-traditional banks. Programs for depository banks included the Term Auction Facilty, an increase repurchase agreements and central bank liquidity swaps. The programs for the non-banks consisted of providing short term loans through such programs as the Primary Dealer Credit Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility and the Term Asset-Backed Securities Loan Facility.
During 2008 the Federal Reserve also provided relief to the financial system through its purchases of assets held by AIG and Bear Sterns (part of the terms of JPMorgan purchase of Bear Stearns). With AIG being a counter party to many commercial and investment banks the direct injection of liquidity reassured the institutions that AIG would not fail. As a result many financial firms received 100% of the face value on many of the credit default swaps that AIG had on its books. The assets purchased by the Federal Reserve were then placed into three limited liability companies, Maiden Lane (Bear Sterns), Maiden Lane II (AIG) and Maiden Lane III (AIG) and are held on its balance sheet.
During 2008 the Federal Reserve also began to purchase U.S. Treasuries, Agency Debt and Mortgage Backed Securities. The Fed began buying what would amount to $300 billion in U.S. Treasuries during the second quarter of 2009. This was done in an attempt to lower borrowing costs and was last done in the 1960s. To provide support to mortgage lending and housing markets and to try and improve overall conditions in private credit markets, the Federal Reserve launched a program to purchase $1.25 trillion of agency mortgage backed securities (guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae) and about $175 billion of agency debt. Agency debt was first purchased post-Lehman and agency mortgage-backed debt purchases began January 2009. Both purchase programs are now nearly complete.
The liability side of the Federal Reserve’s balance sheet historically has consisted mostly of currency with very small amounts of excess bank reserves and treasury deposits. During the 3rd quarter of 2008 bank reserves and treasury deposits grew as a result of the programs mentioned during the discussion of the asset side of the balance sheet. Historically banks have deposited very little in the way of excess reserves with the Federal Reserve. Today excess reserves are at unprecedented levels.
The challenges faced by the Federal Reserve beginning in the summer of 2007 were first met with more traditional operations such as cutting the discount and federal funds rates. These actions were then followed by non-traditional operations to provide liquidity and confidence to a financial system that was under stress. This CBO study effectively outlines the impact of these extraordinary actions to stabilize financial markets and the institutions that comprise it.
(Also, see attachement at bottom of the post for a A Visual History of the Federal Reseve System) A Visual History of the Federal System