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Wednesday, October 8, 2008

Treasury Supplements and Maiden Lanes

This blog post from EconoBrowser is very interesting. It traces the recent moves by the Federal Reserve by analyzing changes in it's balance sheet. What's interesting is the recent additions to the balance sheet on the asset side under various acronyms pertaining to recent "credit facilities" (cash loans to banks against their crappy assets) as well as their investment in Bear Stearns under the name "Maiden Lane".

The author asks, how could the Fed "buy" all this stuff without a corresponding increase in "currency in circulation" or in "reserves"? The Fed created a line item in their balance sheet called "Treasury Supplement" following an obscure press release quoted in the post. The upshot is that the Treasury is effectively placing cash with the Fed obtained in a "supplemental" auction of T-Bills with which the Fed turns around and loans this cash against "private assets", i.e., the crappy debt discussed above. This allows the Fed to explode its balance sheet without having to "create" money immediately. I imagine that if the markets stabilize they will quietly unwind this and if it doesn't they will "monetize" it by creating money to cover losses.

Basically, this is yet another example of how through complicated mechanisms, the Federal Reserve and the Treasury operate to redistribute risk and losses (through inflation) to the people who least deserve it: American taxpayers who pay their bills.


SN said...

It's not just the $29 billion for Maiden Lane. The same has been done for the bulk of the short-term money being lent to banks.

Check this Fed release. Near the top, note the "Securities Held Outright/U.S.Treasury" has dropped by $303 billion over the last year. Near the bottom see the +266 billion for the "U.S. Treasury supplementary", which reprsents a sale by the treasury rather than the FED (amounts to the same thing, when one nets out government actors).

The Fed and the treasury have each sold about $300 billion worth of government securities in the last year, taking money out of the banking system. Then, they have used thast money to give banks various types of short-term loans, against an increasingly diverse range of securities.

Considered as a net transaction, the holders of the government securities have provided the cash for the short term lending to the banking system. Indeed, with people panicking, there has been good demand for such government securities.

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