Ben S Bernanke: The Federal Reserve's balance sheet
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Federal Reserve Bank of Richmond 2009 Credit Markets
Symposium, Charlotte, North Carolina, 3 April 2009.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
In ordinary financial and economic times, my topic, "The Federal Reserve's Balance Sheet,"
might not be considered a "grabber." But these are far from ordinary times. To address the
current crisis, the Federal Reserve has taken a number of aggressive and creative policy
actions, many of which are reflected in the size and composition of the Fed's balance sheet.
So, I thought that a brief guided tour of our balance sheet might be an instructive way to
discuss the Fed's policy strategy and some related issues. As I will discuss, we no longer live
in a world in which central bank policies are confined to adjusting the short-term interest rate.
Instead, by using their balance sheets, the Federal Reserve and other central banks are
developing new tools to ease financial conditions and support economic growth.
Some principles for balance sheet policy
Before I get into the details of our balance sheet and how it reflects various Federal Reserve
initiatives, I would like to note some general considerations that have been important in
shaping our policy approach. As you know, financial markets and institutions both in the
United States and globally have been under extraordinary stress for more than a year and a
half. Relieving the disruptions in credit markets and restoring the flow of credit to households
and businesses are essential if we are to see, as I expect, the gradual resumption of
sustainable economic growth. To achieve this critical objective, the Federal Reserve has
worked closely and cooperatively with the Treasury and other agencies. Such collaboration is
not unusual. We have traditionally worked in close concert with other agencies in fostering
stable financial conditions, even as we have maintained independent responsibility for
making monetary policy.
Though we have been creative in deploying our balance sheet, using a multiplicity of new
programs (and coining a multiplicity of new acronyms, I might add), we have done so
prudently. As much as possible, we have sought to avoid both credit risk and credit allocation
in our lending and securities purchase programs. As I will discuss further today, the great
majority of our lending is extremely well secured. And our programs have been aimed at
improving financial and credit conditions broadly, with an eye toward restoring overall
economic growth, rather than toward supporting narrowly defined sectors or classes of
borrowers.
In pursuing our strategy, which I have called "credit easing," we have also taken care to
design our programs so that they can be unwound as markets and the economy revive. In
particular, these activities must not constrain the exercise of monetary policy as needed to
meet our congressional mandate to foster maximum sustainable employment and stable
prices.
We are also committed to working with the Administration and the Congress to develop a
new resolution regime that would allow the U.S. government to effectively address, at an
early stage, the potential failure of systemically critical nonbank financial institutions. As this
audience well knows, the lack of such a regime greatly hampered our flexibility in dealing
with the failure or near-failure of such institutions as Bear Stearns, Lehman Brothers, and
American International Group (AIG).
The principles I have just noted were recently formalized in a joint Federal Reserve-Treasury
statement.1 Those principles are: (1) that the Fed will cooperate closely with the Treasury
and other agencies in addressing the financial crisis; (2) that the Fed in its lending activities
should avoid taking credit risk or allocating credit to narrowly defined sectors or classes of
borrowers; (3) that the Fed's independent ability to manage monetary policy must not be
constrained by its programs to ease credit conditions; and (4) that there is a pressing need
for a new resolution regime for nonbanks that, among other things, will better define the
Fed's role in preventing the disorderly failure of systemically critical financial institutions. I
welcome the clarity that this public statement brings to the principles underlying our policy
strategy during this very difficult period.
The balance sheet as a tool of monetary policy
The severe disruption of credit markets that began late in the summer of 2007 and the
associated tightening in credit conditions and declines in asset prices have weighed heavily
on economic activity here and abroad. The Federal Reserve has responded by aggressively
easing short-term interest rates, beginning in September 2007. In October 2008, as the
financial crisis intensified, the Federal Reserve participated in an unprecedented coordinated
rate cut with other major central banks. At its December 2008 meeting, the Federal Open
Market Committee (FOMC) reduced its target for the federal funds rate close to its lower
bound, setting a target range between 0 and 1/4 percent. And, with inflation expected to
remain subdued for some time, the Committee has indicated that short-term interest rates
are likely to remain low for an extended period. With conventional monetary policy having
reached its limit, any further policy stimulus requires a different set of tools.
The Federal Reserve has been a global leader in developing such tools. In particular, to
further improve the functioning of credit markets and provide additional support to the
economy, the Fed has established and expanded a number of liquidity programs and
recently initiated a large-scale program of asset purchases. These actions have had
significant effects on both the size and composition of the Federal Reserve's balance sheet.
Notably, the balance sheet has more than doubled, from roughly $870 billion before the crisis
to roughly $2 trillion now. In the remainder of my remarks, I will walk you through the major
components of the Fed's balance sheet, which is a convenient way to discuss the range of
policy tools the Fed is employing and some of the issues we are confronting in our policy
decisions.
An excellent source of information on our balance sheet, by the way, is a new section of the
Board's website, entitled Credit and Liquidity Programs and the Balance Sheet.2 This section
brings together much diverse information about the Fed's balance sheet, including some only
recently made available, as well as detailed explanations and analyses. Serious Fed
watchers should add this link to their online favorites list.
Let me begin with the asset side of our balance sheet. For decades, the Federal Reserve's
assets consisted almost exclusively of Treasury securities. Since late 2007, however, our
holdings of Treasury securities have declined, while our holdings of other financial assets
have expanded dramatically. It is useful to group the Federal Reserve's assets into three
broad categories: (1) short-term credit extended to support the liquidity of financial firms such
as depository institutions, broker-dealers, and money market mutual funds; (2) assets related
to programs focused on broader credit conditions; and (3) holdings of high-quality securities,
notably Treasury securities, agency debt, and agency-backed mortgage-backed securities
(MBS).3 As I will discuss later, the Federal Reserve also has provided support directly to
specific institutions in cases when a disorderly failure would have threatened the financial
system.
Liquidity programs for financial firms
The first of these categories of assets - short-term liquidity provided to financial institutions -
totals almost $860 billion and today represents nearly 45 percent of the assets on our
balance sheet. These loans are made to sound institutions, are fully secured, and are for
maturities no greater than 90 days, usually less. Thus, they are very safe. The main
components of this category are lending to commercial banks and primary dealers, as well
as currency swaps with other central banks to support interconnected global dollar funding
markets.4
From its beginning, the Federal Reserve, through its discount window, has provided credit to
depository institutions to meet unexpected liquidity needs, usually in the form of overnight
loans. The provision of short-term liquidity is, of course, a long-standing function of central
banks. In August 2007, conditions in short-term bank funding markets deteriorated abruptly,
and bank funding needs intensified sharply. In response to these developments, the Federal
Reserve reduced the spread of the primary credit rate - the rate at which most institutions
borrow at the discount window - relative to the target federal funds rate, and also made it
easier for banks to borrow at term. However, as in some past episodes of financial distress,
banks were reluctant to rely on discount window credit to address their funding needs. The
banks' concern was that their recourse to the discount window, if it became known, might
lead market participants to infer weakness - the so-called stigma problem. The perceived
stigma of borrowing at the discount window threatened to prevent the Federal Reserve from
getting much-needed liquidity into the system.
To address this issue, in late 2007, the Federal Reserve established the Term Auction
Facility (TAF), which, as the name implies, provides fixed quantities of term credit to
depository institutions through an auction mechanism. The introduction of this facility seems
largely to have solved the stigma problem, partly because the sizable number of borrowers
provides anonymity, and possibly also because the three-day period between the auction
and auction settlement suggests that the facility's users are not relying on it for acute funding
needs on a particular day. As of April 1, 2009, we had roughly $525 billion of discount
window credit outstanding, of which about $470 billion had been distributed through auctions
and the remainder through conventional discount window loans.
Like depository institutions in the United States, foreign banks with large dollar funding
positions were also experiencing powerful liquidity pressures. This unmet demand for dollars
was spilling over into U.S. markets, including the federal funds market. To address this issue,
the Federal Reserve has cooperated with foreign central banks in establishing what are
known as reciprocal currency arrangements, or liquidity swap lines. In these arrangements,
the Federal Reserve provides dollars to foreign central banks which they, in turn, lend to
banks in their jurisdictions. Credit risk is minimal in these arrangements, as the foreign
central bank is responsible for repayment, rather than the institutions that ultimately receive
the funds; in addition, the Fed receives foreign currency from its central bank partner of equal
value to the dollars lent. Liquidity provided through such arrangements peaked ahead of
year-end 2008 but has since declined as pressures in short-term funding markets have
eased; the outstanding amount currently stands at about $310 billion.
In addition, following the sharp deterioration in market conditions in March 2008, the Federal
Reserve used its emergency lending authority to provide primary dealers access to central
bank credit. Primary dealers can obtain short-term collateralized loans from the Fed through
the Primary Dealer Credit Facility, or PDCF. The PDCF, which is closely analogous to the
discount window for commercial banks, currently has about $20 billion in borrowings
outstanding. Another program for primary dealers, called the Term Securities Lending
Facility, lends Treasury securities to dealers, taking investment-grade securities as collateral.
The primary dealers then use the more-liquid Treasury securities to obtain private-sector
funding. Extensions of credit under this program, which currently total about $85 billion, do
not appear as distinct assets on the Fed's balance sheet, because the Federal Reserve
continues to own the Treasury securities that it lends.
As I mentioned, the provision of liquidity on a collateralized basis to sound financial
institutions is a traditional central bank function. This so-called lender-of-last-resort activity is
particularly useful during a financial crisis, as it reduces the need for fire sales of assets and
reassures financial institutions and their counterparties that those institutions will have
access to liquidity as needed. To be sure, the provision of liquidity alone cannot address
solvency problems or erase the large losses that financial institutions have suffered during
this crisis. Yet both our internal analysis and market reports suggest that the Fed's ample
supply of liquidity, along with liquidity provided by other major central banks, has significantly
reduced funding pressures for financial institutions, helped to reduce rates in bank funding
markets, and increased overall financial stability. For example, despite ongoing financial
stresses, funding pressures around year-end 2008 and the most recent quarter-end appear
to have moderated significantly.
Before leaving this category of assets, I should mention briefly the Fed's actions to ensure
liquidity to another category of financial institution, money market mutual funds. In
September, a prominent money market mutual fund "broke the buck" - that is, was unable to
maintain a net asset value of $1 per share. This event led to a run on the other funds, which
saw very sharp withdrawals. These withdrawals in turn threatened the stability of the
commercial paper market, which depends heavily on money market mutual funds as
investors. Following the long-standing principle that the central bank should lend into a panic,
the Federal Reserve established two programs to backstop money market mutual funds and
to help those funds avoid fire sales of their assets to meet withdrawals. Together with an
insurance program offered by the Treasury, the Fed's programs helped end the run; the
sharp withdrawals from the funds have been replaced by moderate inflows. Although credit
extended to support money funds was high during the intense phase of the crisis in the fall,
borrowings have since declined substantially, to about $6 billion.
Direct lending to borrowers and investors
A second set of programs initiated by the Federal Reserve - including the Commercial Paper
Funding Facility (CPFF) and the Term Asset-Backed Securities Loan Facility (TALF) - aims
to improve the functioning of key credit markets by lending directly to market participants,
including ultimate borrowers and major investors. The lending associated with these facilities
is currently about $255 billion, corresponding to roughly one-eighth of the assets on the Fed's
balance sheet. The sizes of these programs, notably the TALF, are expected to grow in the
months ahead.
The commercial paper market is a key source of the short-term credit that American
businesses use to meet payrolls and finance inventories. Following the intensification of the
financial crisis in the fall, commercial paper rates spiked, even for the highest-quality firms.
Moreover, most firms were unable to borrow for periods longer than a few days, exposing
both firms and lenders to significant rollover risk. By serving as a backstop for commercial
paper issuers, the CPFF was intended to address rollover risk and to improve the functioning
of this market. Under this facility, the Fed stands ready to lend to the highest-rated financial
and nonfinancial commercial paper issuers for a term of three months. As additional
protection against loss, and to make the facility the last rather than the first resort, the CPFF
charges borrowers upfront fees in addition to interest. Borrowing from this facility peaked at
about $350 billion and has since declined to about $250 billion as more firms have been able
to issue commercial paper to private lenders or have found alternative sources of finance.
Conditions in the market have improved markedly since the introduction of this program, with
spreads declining sharply and with more funding available at longer maturities. Market
participants tell us that the CPFF contributed to these improvements.
Most recently, the Federal Reserve launched the TALF, which is aimed at restoring
securitization markets, now virtually shut down. The closing of securitization markets, until
recently an important source of credit for the economy, has added considerably to the stress
in credit markets and financial institutions generally. Under the TALF, eligible investors may
borrow to finance their holdings of the AAA-rated tranches of selected asset-backed
securities. The program is currently focused on securities backed by newly and recently
originated auto loans, credit card loans, student loans, and loans guaranteed by the Small
Business Administration. The first TALF subscription attracted about $8 billion in total
assetbacked securities deals and used about $4.7 billion in Federal Reserve financing. Over time,
the list of securities eligible for the TALF is expected to expand to include additional
securities, such as commercial mortgages, as well as securities that are not newly issued.
Relative to the Fed's short-term lending to financial institutions, the CPFF and the TALF are
rather unconventional programs for a central bank to undertake. I see them as justified by the
extraordinary circumstances in which we find ourselves and by the need for central bank
lending practices to reflect the evolution of financial markets; after all, a few decades ago
securitization markets barely existed. Notably, other central banks around the world have
shown increasing interest in similar programs as they address the credit strains in their own
countries. These programs also meet the criteria I stated at the beginning of my remarks
regarding credit risk and credit allocation. Credit risk is very low in both programs; in
particular, the TALF program requires that loans be overcollateralized and is further
protected by capital provided by the Treasury. Both programs are directed at broad markets
whose dysfunction impedes the flow of numerous types of credit to ultimate borrowers;
consequently, I do not see these programs as engaging in credit allocation - the favoring of a
particular sector or a narrow class of borrowers over others.
Purchases of high-quality assets
The third major category of assets on the Fed's balance sheet is holdings of high-quality
securities, notably Treasury securities, agency debt, and agency-backed MBS. These
holdings currently total about $780 billion, or about three-eighths of Federal Reserve assets.
Of this $780 billion, holdings of Treasury securities currently make up about $490 billion.
Some of these Treasury securities are lent out through the Term Securities Lending Facility
that I mentioned earlier. Obviously, these holdings are very safe from a credit perspective.
Longer-term securities do pose some interest-rate risk; however, because the Federal
Reserve finances its purchases with short-term liabilities, on average and over time, that risk
is mitigated by the normal upward slope of the yield curve.
The Fed's holdings of high-quality securities are set to grow considerably as the FOMC, in an
attempt to improve conditions in private credit markets, has announced large-scale
openmarket purchases of these securities. Specifically, the Federal Reserve will purchase
cumulative amounts of up to $1.25 trillion of agency MBS and up to $200 billion of agency
debt by the end of the year, and up to $300 billion of longer-term Treasury securities over the
next six months. The principal goal of these programs is to lower the cost and improve the
availability of credit for households and businesses. As best we can tell, so far the programs
are having the intended effect. For example, 30-year fixed mortgage rates, which responded
very little to our cuts in the target for the federal funds rate, have declined 1 percentage point
to 1-1/2 percentage points since our first MBS purchase program was announced in
November. Over time, lower mortgage rates should help to improve conditions in the housing
market, whose persistent weakness has had a major impact on economic and financial
conditions more broadly, and will improve the financial condition of some households by
facilitating refinancing. In addition, open-market purchases should benefit credit markets by
adding liquidity and balance sheet capacity to the system.
Support for specific institutions
In addition to those programs I have just discussed, the Federal Reserve has provided
financing directly to specific systemically important institutions. With the full support of the
Treasury, we used emergency lending powers to facilitate the acquisition of Bear Stearns by
JPMorgan Chase & Co. and also to prevent default by AIG. These extensions of credit are
very different than the other liquidity programs discussed previously and were put in place to
avoid major disruptions in financial markets. From a credit perspective, these support
facilities carry more risk than traditional central bank liquidity support, but we nevertheless
expect to be fully repaid. Credit extended under these programs has varied but recently has
accounted for only about 5 percent of our balance sheet. That said, these operations have
been extremely uncomfortable for the Federal Reserve to undertake and were carried out
only because no reasonable alternative was available. As noted in the joint Federal
ReserveTreasury statement I mentioned earlier, we are working with the Administration and the
Congress to develop a formal resolution regime for systemically critical nonbank financial
institutions, analogous to one already in place for banks. Such a regime should spell out as
precisely as possible the role that the Congress expects the Federal Reserve to play in such
resolutions.
Liabilities
Having reviewed the Federal Reserve's main asset accounts, let me now touch briefly on the
liability side of the balance sheet. Historically, the largest component of the Federal
Reserve's liabilities has historically been Federal Reserve notes - that is, U.S. paper
currency. Currency has expanded over time in line with nominal spending in the United
States and demands for U.S. currency abroad. By some estimates, a bit over one-half of
U.S. currency is held outside the country.
Other key liabilities of the Federal Reserve include the deposit accounts of the U.S.
government and depository institutions. The U.S. government maintains a "checking
account" with the Federal Reserve - the so-called Treasury general account - from which
most federal payments are made. More recently, the Treasury has established a special
account at the Federal Reserve as part of its Supplementary Financing Program (SFP).
Under this program, the Treasury issues special Treasury bills and places the proceeds in
the Treasury supplementary financing account at the Federal Reserve. The net effect of
these operations is to drain reserve balances from depository institutions.
Depository institutions also maintain accounts at the Federal Reserve, of course, and over
recent months, as the size of the Federal Reserve's balance sheet has expanded, the
balances held in these accounts have increased substantially. The large volume of reserve
balances outstanding must be monitored carefully, as - if not carefully managed - they could
complicate the Fed's task of raising short-term interest rates when the economy begins to
recover or if inflation expectations were to begin to move higher. We have a number of tools
we can use to reduce bank reserves or increase short-term interest rates when that becomes
necessary. First, many of our lending programs extend credit primarily on a short-term basis
and thus could be wound down relatively quickly. In addition, since the lending rates in these
programs are typically set above the rates that prevail in normal market conditions, borrower
demand for these facilities should wane as conditions improve. Second, the Federal Reserve
can conduct reverse repurchase agreements against its long-term securities holdings to
drain bank reserves or, if necessary, it could choose to sell some of its securities. Of course,
for any given level of the federal funds rate, an unwinding of lending facilities or a sale of
securities would constitute a de facto tightening of policy, and so would have to be carefully
considered in that light by the FOMC. Third, some reserves can be soaked up by the
Treasury's Supplementary Financing Program. Fourth, in October of last year, the Federal
Reserve received long-sought authority to pay interest on the reserve balances of depository
institutions. Raising the interest rate paid on reserves will encourage depository institutions to
hold reserves with the Fed, rather than lending them into the federal funds market at a rate
below the rate paid on reserves.5 Thus, the interest rate paid on reserves will tend to set a
floor on the federal funds rate.
The FOMC will continue to closely monitor the level and projected expansion of bank
reserves to ensure that - as noted in the joint Federal Reserve-Treasury statement - the
Fed's efforts to improve the workings of credit markets do not interfere with the independent
conduct of monetary policy in the pursuit of its dual mandate of ensuring maximum
employment and price stability. As was also noted in the joint statement, to provide additional
assurance on this score, the Federal Reserve and the Treasury have agreed to seek
legislation to provide additional tools for managing bank reserves.
Conclusion
These are extraordinarily challenging times for our financial system and our economy. I am
confident that we can meet these challenges, not least because I have great confidence in
the underlying strengths of the American economy. For its part, the Federal Reserve will
make responsible use of all its tools to stabilize financial markets and institutions, to promote
the extension of credit to creditworthy borrowers, and to help build a foundation for economic
recovery. Over the longer term, we also look forward to working with our counterparts at
other supervisory and regulatory agencies in the United States and around the world to
address the structural issues - some of which have been discussed in this conference - that
have led to this crisis so as to minimize the risk of ever facing such a situation again.