Friday, December 5, 2008

How does the Federal Reserve spend so much?

The Federal Reserve Banks earned $6.9 billion in 1977. How are the Federal Reserve Banks able to “earn” this amount of income? One popular misconception is that the Federal Reserve Banks earn income by investing member bank reserves. In fact, earnings of the Federal Reserve Banks are not the result of the volume of member bank reserves, but that bank reserves and earnings of the Federal Reserve Banks are both by-products of the way a central bank operates. [1]

Assume that there were no legal restrictions that required banks to hold deposits at Federal Reserve Banks.  Would the ability of the Federal Reserve Banks to generate their own earnings be affected? The answer is no.  To implement its monetary policy objectives, the Federal Reserve would still buy and sell Government securities.  Its holdings of Government securities would still represent the primary source of the “base” under bank deposits.  The Federal Reserve would pay for the securities just as it does now, with a check written on itself.  Commercial banks would then be “paid.” [2]

In 2005 the Federal Reserve System had holdings of $753,748,000,000, in 2006 it had $787,872,000,000 and in 2008 it had holdings of $816,115,000,000.[3]

As of September 2008 the holdings of the Federal Reserve System was $476,600,000,000. [4

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000), e.g.$100/0.10=$1,000. 

Federal Reserve lending crisis lending:
 (TAF) Term Auction Credit (allocated) $900,000
Discount Window Lending $139,256
Banks (other loans primary credit) $92,645
Investment Banks $46,611
(other loans Primary dealer and other broker-dealer credit)
Loans to buy ABCP (other loans Asset-backed $661,923
commercial paper money market mutual fund liquidity facility)
AIG (allocated minus Treasury 40B) $112,500
Bear Stearns (initial loan to JPMorgan) $295,000
(TSLF) Term Securities Lending Facility $225,000
Swap Lines (other federal reserve assets) $601,963
debt issued by government-sponsored mortgage $100,000
financers Fannie Mae (FNM, Fortune 500) and $100,000
Freddie Mac (FRE, Fortune 500).
mortgage-backed securities purchase $500,000
(these amount are in millions of dollars)

Total amount guaranteed by the Federal Reserve is $6,549,398,000,000.
[5][6]

When Reserve requirements are considered the potential from the banking system is $4,766,000,000,000 yet the Federal Reserve has committed spending of about $6.5 trillion.  

Hmmm, what system are they working with now to justify their spending spree?  Earlier in the week Bernanke said that the Fed may buy treasuries to aid economy. [7]  I guess they will just write a check written on themselves to buy them!

1 comment:

Junior said...

Bernanke's got a birthday coming up; maybe he'll have a couple new GM cars in his garage for the occasion?

Love your blog... it's nice to see such succinct information. Very well done!