simon m potter : implementation of open market operations in a time of transition remarks by mr simon m potter, executive vice president of the markets group of the federal reserve bank of new york, before the japan center for economic research, tokyo, 25 september 2014. * * * i would like to thank deborah leonard and matthew raskin for their excellent assistance in the preparation of these remarks and colleagues in the federal reserve system for numerous insightful comments and suggestions. thank you, takeuchi - san. it is a pleasure to reconnect with you here in tokyo and an honor to have the opportunity to speak before this distinguished audience. central banks responded aggressively to the financial crisis that began in 2007 and the slow recovery that ’ s followed, and have taken unprecedented steps in providing monetary policy accommodation in pursuit of their macroeconomic policy objectives. in doing so, many have had to adapt in unconventional ways the frameworks and tools they use to implement their policy decisions. my remarks today will focus on the role played by the open market trading desk ( the desk ) at the federal reserve bank of new york in the implementation of monetary policy in the u. s., and on the evolution of our operational tools in recent years. i will then discuss the implications of these changes for the federal reserve ’ s balance sheet and for the eventual “ normalization ” of monetary policy when the federal open market committee ( fomc ) believes it is appropriate to remove the extraordinary levels of monetary policy accommodation that it has provided. finally, i will discuss some of the considerations that must be taken into account in normalizing monetary policy. as always, these are my views and do not necessarily reflect those of the new york fed or the federal reserve system. the desk ’ s role in implementing monetary policy the federal reserve ( the fed ) has a somewhat more complex organizational and governance structure than most other central banks around the world, so before discussing recent developments in the implementation of monetary policy, i ’ d like to take a moment to describe roles and responsibilities within the federal reserve system and where the desk fits in. the statutory basis for u. s. monetary policy is found in the federal reserve act, which was enacted just over 100 years ago. modern language around monetary policy objectives was added in 1977, when the board of governors of the federal reserve system and the federal open market committee were charged by congress with maintaining “ long run growth of the monetary and credit aggregates … so as to promote effectively the goals of maximum employment, stable prices

##ity guarantee program, and here too there has been progress in a number of dimensions. most notably, perhaps, is that in the wake of the release of the results of the recent stress test, the largest u. s. bank holding companies have shown an increased ability to raise capital and issue debt without government support. the major securities firms have deleveraged and have built up significant liquidity buffers. although conditions in interbank funding markets and capital markets more broadly have shown signs of improvement, securitization markets are still significantly impaired. this is particularly true of the asset - backed securities markets, in which much of household and business credit is intermediated between borrowers and investors. what has transpired in the asset - backed securities market over the past two years has been dramatic. prior to august 2007, as much as 60 % of private credit creation in the u. s. was not held on the books of depository institutions but was instead distributed onwards through the abs markets into the so - called “ shadow banking system. ” through the use of abs, banks were able to package consumer loans, credit card receivables, student loans, residential and commercial mortgages, as well as other types of loans into securities that were then sold to investors. however, since august 2007, the abs market collapsed in a series of stages – first subprime mortgages, then alt - a mortgages and non - agency residential mortgage backed securities, and finally consumer abs and commercial mortgage backed securities or cmbs. the collapse spanned every area outside of the agency mortgage - backed securities market, which is supported by the government - sponsored enterprises, fannie mae and freddie mac. the final stage of collapse of the abs markets occurred following the failure of lehman brothers last fall, when the yields on outstanding abs issues soared and new originations virtually disappeared. this increase in yields did not solely reflect an increase in credit risk ; it also reflected a genuine loss of confidence and an accompanying increase in risk aversion. yield spreads on even the very safest abs obligations soared hundreds of basis points. this can be seen in the fact that aaa - rated student loan tranches, with underlying loans 97 % guaranteed by the federal government, climbed to yield levels as much as 400 basis points over libor. with the spike in yields, the economic incentives to issue evaporated – issuance was just too costly and there was no active market. after averaging around $ 50 billion per quarter of new originations