Federal Open Market Committee (FOMC)
Reading the following reminds me that the Treasury does not go to the Federal Reserve to sell its bonds. It puts the bonds on the market for anyone to buy and the Fed, through its Federal Open Market Committee (FOMC) decides whether they want to buy any or not.
Committee that sets interest rate and credit policies for the Federal Reserve System, the United States’ central bank. The FOMC has 12 members. Seven are the members of the Federal Reserve Board, appointed by the president of the United States. The other five are presidents of the 12 regional Federal Reserve banks. Of the five, four are picked on a rotating basis; the other is the president of the Federal Reserve Bank of New York, who is a permanent member. The Committee decides whether to increase or decrease interest rates through open-market operations of buying or selling government securities. The Committee’s decisions are closely watched and interpreted by economists and stock and bond market analysts, who try to predict whether the Fed is seeking to tighten credit to reduce inflation or to loosen credit to stimulate the economy.
Read more: http://www.answers.com/topic/federal-open-market-committee#ixzz1NToN2A5s
The following from Investopedia reminds me that a big part of QE1 and QE2 has been the Federal Reserve buying not just U.S. bonds but buying bad debt the banks were holding, such as mortgage bonds. Such activity is outside the traditional scope of Federal Reserve open market actions, and may not be legal – although nobody cares about legality anymore.
Quantitative Easing
A government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
U.S. Excess Reserves – a Primer
… The surge in excess reserves is a byproduct of a surge in the Fed’s balance sheet … . When the Fed decides to boost the volume of assets it holds, via expansion of an existing facility (e.g., making more loans in the discount window), creation of a new one (from the Term Auction Facility created in late 2007 to those created in the wake of the Lehman bankruptcy to support the commercial paper market), or direct purchases of assets (Treasury securities, agency debt, or agency MBS), its liabilities must go up by a similar amount.
The Fed’s two main liabilities are currency (Federal Reserve Notes) and bank reserves, which together constitute the monetary base. … A decision by the Fed to expand its assets typically results in a parallel increase in the monetary base.
Mechanically, this usually occurs by the Fed’s crediting a bank’s reserve account if that bank is the recipient of a loan (from the TAF, for example) or the seller of securities to the Fed. … In cases where the Fed’s counterparty is not a bank (another financial institution selling securities to the Fed, for example) the transaction will increase bank reserves as the seller deposits the proceeds at the bank where it does business. Conceivably, though, the Fed’s purchase of securities could result in an increase in currency instead (I suppose if the counterparty is not a bank and does not deposit their proceeds).
The reason behind the latest increase in excess reserves, from about $850bn in mid September to more than $1trn currently, is a bit different. In late September the US Treasury Department announced that it would allow balances in its Supplemental Financing Program (SFP) to run down from $200bn to $15bn to provide more flexibility to finance ongoing operations as it approaches the statutory debt limit. The SFP had been introduced a year earlier as a device to permit the Fed to shield the monetary base from its balance-sheet expansion; to do so the Treasury sold special cash management bills, effectively draining reserves in the process and holding the proceeds on deposit at the Fed. As the Treasury more recently paid down most of the remaining $200bn in bills that had financed this program, reserves were put back into the banking system. …
(Excess reserves) currently earn only ¼%. …
(Focusing) on the banking system as a whole, … the extension of a loan by one bank will usually just transfer reserves to other banks. The borrower uses proceeds from the loan to pay workers, suppliers, etc., who in turn deposit the money in their accounts at various banks (possibly including the bank that made the original loan). As this occurs, reserves simply move from one bank to another. Although some can “leak out” of the banking system as cash, this leakage tends not to be significant. …
In theory, banks could keep lending (one might say re-lending) out excess reserves until this expansion of their balance sheets converted all the excess reserves into required reserves – a process well known to students of money and banking as the “money multiplier.” In this framework, excess reserves still reflect unexploited lending opportunities. … The money multiplier implied by (fractional reserve) requirements is huge (perhaps one reason people worry about inflation). (But) long before bank lending reached the money multiplier limit, capital requirements are apt to limit lending, especially at a time when the consequences of too much leverage are so fresh in bankers’ minds. …
As for the long term, excess reserves do have the potential to create inflation if left in the system for too long. This is where the Fed’s exit strategy comes into play. …
(One strategy is to reduce) excess reserves … via a restructuring of the liability side of the Fed’s balance sheet … (in this) probable order of implementation:
1. Increase interest rates … . (The Fed can) lift their target for the federal funds rate and the interest rate on excess reserves (IOER) in tandem with one another, most likely by first reestablishing a small spread with the funds rate over the IOER. (No drainage of excess reserves there.) …
The theory is that at higher levels of interest rates banks will have an incentive to arbitrage any tendency for the funds rate to drop below the IOER – why lend to another bank at a lower rate when you can lend to the Fed (hold excess reserves) without risk at this rate? …
2. Conduct large-scale reverse repurchase agreements … which would draw reserves out of the banking system as the Fed sold securities out of its massive portfolio with agreements to repurchase those securities at a later date. Reverse repos have been used before to fine-tune the volume of reserves in the system, but on a much smaller scale and for much shorter periods than would now be needed if they concluded that excess reserves should be withdrawn from the system in greater quantity. …
3. Offer banks time deposits. The idea would be to “lock up” excess reserves, much as a commercial bank locks up deposits in a certificate of deposit, by offering higher rates on longer maturities. While Fed officials have mentioned this possibility off and on, it has not gotten as much attention as the reverse repos. …
4. Sell assets. When this idea first surfaced in the spring, Fed officials were quick to downplay it as an option, noting that such a move would have significant implications for market interest rates and stressing that they were a “buy and hold” institution. (The New York Fed has reportedly backed these words up with actions by hiring portfolio managers for its burgeoning portfolio of MBS.) More recently, however, it has been mentioned as an option, though it appears to be a last resort.
Many observers assume that asset sales would incur losses for the Fed as well as create problems of sending market signals. … We offer two quick observations. First, the Fed has a fairly thick cushion of earnings power. In the fiscal year that just ended, the Fed remitted $34bn in profits to the Treasury. With an expanded balance sheet, this cushion is apt to grow (!? They bought crap!). Second, and perhaps more importantly, the Fed does own a significant amount of securities on which losses would not be an issue. At a minimum, those maturing within the next year can be redeemed at par as they come due. In this regard, the Fed’s Treasury holdings include almost $100bn due within a year, with another $23bn of such paper in its agency portfolio.
Fed and Treasury officials could also reactivate the SFP once the debt limit has been lifted. In short, the Fed has a number of options to manage a high volume of excess reserves. At this point, however, we see no reason why they should be in hurry to do so.
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(Want more?)
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