The Fed and the Banking System

At the close of the banking week ending Wednesday, September 3, 2008, Federal Reserve Bank credit amounted to $887.3 billion or roughly $0.9 trillion, while at the close of the banking week ending Wednesday, October 22, Federal Reserve Bank credit totaled $1,803.3 billion or about $1.8 trillion. In seven weeks, the increase in Federal Reserve Bank credit rose 103.2%! These figures are from the Federal Reserve release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.

Reserve balances with Federal Reserve Banks on an average daily balance rose from $10.9 billion in the earlier week to $301.3 billion in the week ending Wednesday, October 22. The balances were down to $220.8 billion at the close of business on Wednesday, October 22.

In terms of total bank reserves, a figure that also includes vault cash used to satisfy reserve requirements, the increase has been massive. Total bank reserves (on a non-seasonally adjusted basis), averaged $44.2 billion during the two weeks ending September 10, 2008. For the two weeks ending September 24, total bank reserves averaged $111.3 billion! And, for the two weeks ending October 22, total bank reserves averaged $327.6 billion! This is a 641.2% rise in a little more than a month.

The Monetary Base also shows substantial increases. (The Monetary Base consists of all things that are bank reserves or could become bank reserves, like the currency component of the money stock.) In the two weeks ending September 10, 2008, the Monetary Base averaged $849.9 billion. This figure rose to $915.1 billion in the two weeks ending September 24 and then climbed to $1,148.6 billion or about 1.15 trillion in the two weeks ending October 22. This is a rise of 35.2% from the earlier date. This rate is lower than the others are because much of the monetary base is made up of currency in circulation, which does not change as much over time.

The Federal Reserve’s plan is to liquefy world financial markets as much as possible. The Fed is pushing out the liquidity and it seems as if they are finally getting some type of a response.

Money stock growth finally seems to be increasing. The M1 measure of the money stock is showing a rise of 13.0% from the 13 weeks ending July 14 to the 13 weeks ending October 13. The primary growth is coming in both the currency component and the demand deposit component of the money stock. As of yet this movement has not translated itself into the M2 measure of the money stock.

These numbers are no guarantee that the Fed’s efforts are gaining some success, but it does present a little bit of hope, and in today’s financial markets, we are looking for all the hope we can find!

Comments

[Mase:]

To put things into perspective...it took the Fed about 94 years to increase Federal Reserve Bank Credit to $900 billion. It took the Fed another seven (7) weeks to double this total!

2008 Oct 24 08:15 AM

[NeilEzell:]

I'm not the dumbest duck on the pond. Honestly though I can't understand exactly what all this means. Can someone futher explain it???

2008 Oct 24 08:31 AM

[rdr4:]

It means you can rig a fixed game, you can justify everything without understanding anything, and that government statistics are largely unrelated to events in the real world.

2008 Oct 24 08:41 AM

[John Lounsbury:]

NeilEzell - - -

The banks have created "funny money" over the past several years, in the form of poorly secured debt instruments, derivatives and credit default swaps. I have seen several estimates of the notional value, but an average of these estimates would be in the vicinity of $60 trillion. For a while this "funny money" was exchanged as "real money". Then, over a year ago, the "funny money" started to become suspect and it stopped being exchangeable for "real money".

As the value of their "funny money" assets declined the banks (especially the unregulated investment banks, but including some of the commercial banks) found that their assets no longer covered their liabilities. In order to remain solvent, banks had to raise equity (in real money). At first they got the needed equity from private sources and sovereign wealth funds. Soon this dried up and the lenders of last resort, national central banks (the Fed in the U.S.) had to step in to rescue their own financial institutions.

The Fed has had to have the U.S. Treasury crank up the printing presses and create more "real money", about $1 trillion according to John Mason's article. In addition, the treasury has issued more debt, the amount of which I do not have an estimate at the moment.

Thus, some of the "funny money" has disappeared (been written off as an asset "loss") and some has been replaced by "real money" (newly minted currency and increased treasury debt). The write-offs will probably end up being several times larger than the amount of new "real money" created. The larger the write-offs/new-money ratio the more pain for the financial institutions. Some argue that this pain should be as great as possible without bringing down the entire financial system.

So why isn't all this new "real money" creating inflationary pressure? Why are hard assets deflating? Isn't inflation produced when more "real money" is created? There is inflation only when money in circulation increases. Almost all of the new money is going into a black hole to replace "funny money". It is retiring bad debt and deleveraging the financial system. In otherwords, the new money is not going to be spent; it is replacing :funny money" that HAS ALREADY BEEN SPENT.
The "funny money" was spent to buy overpriced houses, inflated commodities, bonds and stocks. The values of the assets purchased has experienced dramatic declines so some of the "funny money" has disappeared (write-downs). The value of the rest of the "funny money" spent resides in the remaining value of the houses, commodities, bonds and stocks. To the extent that the amount of "funny money" exceeds the current value of assets purchased, there must be further write-offs and/or "real money" created to balance the books.

Until we finish replacing "funny money" already spent, creation of new "real money" will not go into circulation and there will be little inflationary pressure.

2008 Oct 24 09:57 AM

[Kevin Lamson:]

For anyone who doesn't understand what the Federal Reserve has done let me try to simplify it. The Large Banks and Investment Banks were all insolvent. (Liabilities exceeded assets) Rather then going simply going bankrupt the Federal Reserve decided to loan these insolvent Banks twice as much money as they had already loaned to them. They claimed that this was needed to fix the "credit squeeze" so banks would start loaning money to other banks. In other words the insolvent banks were not lending money to other banks. So the Federal Reserve agreed to flood these insolvent institutions with more money. They have now loaned more than twice as much money to Large Banks, and former Investment Banks than they owed seven (7) weeks ago. But many of these banks are simply hoarding these new funds, and still not lending to other banks.

Why not loan money to Americans who are upside down on their home loans. Why not loan them twice as much as they already owe. This would certianly spike the economy!

This whole "bailout" is nothing more than a ruse to cover up the fact that the Federal Reserve and our entire banking system is for all intents and purposes bankrupt. Unfortunately the cost of this ruse will be laid upon the American taxpayer. Wall Street bankers will continue to mismanage their banks as long as they continue to get paid millions in salaries and wages and are not taken to task for bankrupting these institutions. America wake up!

2008 Oct 24 11:16 AM

[OldLimey:]

Thanks to the author, and to jloundsbury59 and Kevin Lamson for helpful comments.

2008 Oct 24 01:10 PM