Brad Setser

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Extraordinary times

by Brad Setser
September 26, 2008

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

And what have the rest of the world’s central banks done over this period?

There has been a lot of talk that central banks would abandon US assets because the perceived risk of holding dollars (and Treasuries) has gone up.

The custodial data though don’t provide much evidence to support this theory.

Over the last two weeks, the Fed’s custodial holdings have increased by over $40b, rising from $2394.7b to $2435.9b. Treasuries account for over $30b of the increase, but Agency holdings are rising as well. Chalk up one (minor) success for Paulson.

Right now, it seems like central banks are running into the safest US assets, not running away from the dollar. That of course could change. But it is hard to square a $20b weekly increase in the New York Fed’s custodial holdings with a story based on a fall in central bank demand for dollars. For that matter, it is hard to square the $425b increase in the New York Fed’s custodial holdings since last September with all the of the angst about the dollar’s status as a reserve currency.

If anything, the pace of growth in the Fed’s custodial holdings over the past two weeks strikes me as stronger than the likely pace of global reserve growth. That suggests to me that central banks are shifting funds out of the commercial banks (and money market funds) into Treasuries that can be held at the Fed’s custodial accounts. I would bet that central banks are shifting money to the BIS as well.

Remember, most central banks do not have a mandate to take credit losses. They can take currency losses — as currency risk is implicit in the notion of foreign exchange reserves. But having money in a bank that fails would be very hard for most to explain.

Note that all my data compares the data for the end of the reporting week, i.e the data for September 24 to the data for September 10.

UPDATE: I should have noted a fall in the Fed’s repos with the banks in my initial post. The changes in the Fed’s balance sheet are so large that I am not sure that I still know how to read the report, so please attach an error bar to the numbers above (apart from the numbers on the custodial holdings). I may have missed some additional credit extension, or some offsetting items. The basic story though is clearly true: the changes in the Fed’s “other loans” alone are enormous.


  • Posted by Flabbergasted in Palo Alto


    That was a totally senseless comment. The lifetime income of a tenured professor (more than 120000 hours of work) is less than one year’s bonus to one of the titans of industry that created this huge disaster. Everything is a matter of degree, my friend.


  • Posted by Rien Huizer

    London Banker,

    Good comments, but there may be more to it..

  • Posted by Rien Huizer

    3.1415. Cromwell’s supporters were nicknamed roundheads because of their rather pedestrian appearance. Your hiding behind the symbol of roundness does not excuse your unwarranted criticism of the AEA. Same heads like mine (someone who considers economics a pastime) enjoy reading AEA publications -on paper- and appreciate two things: (a) the ridiculously low price of the package (b) the distance from current affairs. Why on earth would a serious academic comment on this mixture of idiocy and vandalism that must pass for economic management in the US?

  • Posted by bsetser

    JKH — in addition to the $290b in credit extended to the financial system, i think the fed also increased its loans of securities to the broker dealers by $60b (this is reported next to the foreign custodial holdings), which would produce a net extension of $350b — plus whatever the ECB/ others did.

    Palo Alto — obviously, most people don’t worry about Ted spreads. And i accept that too many people have lived off debt rather than income for too long. the problem is that when this stops suddently, activity also stops suddenly — i.e. there is a recession. and the other problem is that those debts are the assets of the financial sector, and there currently does seem to be risk of cascading financial failure — hence all indications of distress in the credit market. and cascading financial failure means going from an economy with too much credit to one with far too little

  • Posted by jim

    The Fed can never be illiquid. They can create their own liquidity with their electronic printing press.

    They are free to create unlimited amounts of electronic dollars to buy unlimited amounts of treasuries or any other securities.

    This leads me to question why the federal government is creating this crisis to pass a bailout plan when it can be solved entirely with the Fed’s balance sheet without any legislation required.

    There is another game being played here. It’s not entirely clear what that is but we’ll find out shortly.

    I predict the bailout plan fails and the stock market crashes. This is what our government leaders want right now for some reason.

  • Posted by gillies

    the bailout could fail in its advertised objectives while succeeding in its ulterior objectives.

    they asked of nixon – “would you buy a used car from this guy ?”

    now ask of bush, bernanke, paulson – “would you make a loan to these guys to buy a used car they have already crashed ?”

    i see george bush not as a lame duck, but as the lame ugly duckling who turns out to be a black swan.

  • Posted by Cedric Regula


    In da old days Uncle Machiavelli used ta say “If’n yous feeds dem, dey just make more babies.”

    Uncle Bruno tinks it’s really dumb to force consumption growth(and production in Asia) in a world dat seems to be running out of space, natural resources, energy, water and air. Wads da use in mak’en babies?

    He’s recommending dat da Family restrict loan activity to overnight loans at da pool hall. He also recommends these be secured wida wedding ring, or car in da parking lot, or sum such collateral.

    He tinks it’s time da goombahs be taught da value of money.

  • Posted by ReformerRay

    If the Treasury can sell all the notes it wants at less than 4%, why cannot the FRB balance sheet be replisnished by Treasury?

    The banking crisis in Japan in 1989 lingered for a decade because the banks with bad loans were not allowed to fail. The U.S. is not making that mistake. Spurred by short selling and the desire of investors to get their money out of a “threatened” bank (or investment firm), several once powerful financial institutions no longer exist. The market is doing its job, without any help from Bernanke and Paulson.

    Look on the bright side. Everything when up during the period 2003 – 2007. Everything has to come back to earth before a resurgence can begin. Thanks to the rapid cleansing, wall street may be able to recover its footing much quicker than most expect.

    Bernanke is doing just fine in his primary job – to provide liquidity to financial markets when liquidity dries up in the private sector. Thanks to his timely action, dollars are available all over the world from Central Banks to provide funds to support short-term lending. He is being proactive in a very positive way as regards short-term liquidity.

    Bernanke is doing a very bad job as a forecaster. He did not expect the decline to be as serious as it has become and he does not expect the recovery to be as rapid as it will be. He panicked.

    The idea that the markets could not sort out winner and losers is wrong. The idea that loses on Wall Street will freeze main street is false. The connection between the two streets is minor rather than major. Of course, credit is getting tight and the cost of loans is rising. Debt will not decrease until credit becomes expensive. Columbus Dispatch has a story today saying that small businessmen in Columbus are still able to get loans. Many local banks did not invest in sub-prime mortgages. That business is increasing in small local banks is a plus.

    I am not saying that everything is fine. Everything is terrible. A lot of investments are worth much less than their purchase price. This going to be the largest downturn in economic activity since the Great Depression. What I am saying is that a period of terrible is necessary. The recovery in the financial sector can be swift if Bernanke will get some sleep and keep his cool. What is important is that people like Bernanke and Paulson and Obama have a public sector investment plan passed the Congress and ready to go when the first signs of emerging growth appears. That is the time to spend public money.

    The House Republicans (with the help of John McCain) are my current heroes because they are stalling the unnecessary and useless bailout plan of Paulson. Scrap the plan and allow the stock market to follow its natural inclination (yes I own stock and I am not selling any of it because I have a long investment horizon).

    If the politicians want to do something constructive, they can scrap the bailout plan and pass the additional authority to regulate the financial markets requested by the Chairman of the U.S. Securities and Exchange Commission in his Testimony before the Senate Committee on Banking on Sept. 23, 2008.

    W. Raymond Mills
    1006 Oberlin Dr.
    Columbus, OH 43221
    Ph. 614-451-4075

  • Posted by ReformerRay

    Did I pass math this time?

  • Posted by ReformerRay

    Where is my original contribution?

  • Posted by ReformerRay

    Well, heck.

    I did tell about an alternative plan, based on termporarily “parking” toxic assets with a fedral agency, when the owner does not want to sell and does not want the decrease in asset value to show on their books.

    I don’t want to retype it. Imagine it for yourself.

  • Posted by indignant_prole

    Lots of amateurs here: I know plenty of forutne 100 companies that are deeply affected by the reluctance of banks to lend… especially in the project finance realm.

    Bernanke is smart: this isn’t inflationary: they’re trying to not increase the money supply, and that’s why they’re “selling” the junk to taxpayers. It is inflationary in that your dollar is buyng “less”…

  • Posted by jim

    Prole, You’re the amateur idiot here. The Fed has increased its balance sheet by 35% over the past 2 weeks. If you don’t think that’s inflationary, you’re truly a Moron.

  • Posted by JKH


    I guess I wouldn’t describe securities lending as a net extension of credit per se – other securities are swapped back as collateral. There is no net extension of cash, and the size of the Fed’s balance sheet doesn’t change.

    That said, it’s certainly “liquefying” the system apart from the Fed with improved credit quality, which is more to your point, I think. Indirectly the dealers borrowing treasuries have an easier time using them to finance through repo. That said, they’d be backing into their bank credit lines anyway if they couldn’t finance their own collateral on repo.

  • Posted by Nicole Tedesco

    I have been witnessing first hand that capital still exists (indigenous to the United States) for investment, and that these investors want to invest in things worth investing! What I am also witnessing is that these investors want to be a little more directly involved in their investments. Instead of relying on the levels of informational indirection that the current financial system induces, they want a little more of the transparency and control that proximity can afford. The downside for them is that their portfolios are slightly more exposed to specific investments and their risks are a little less spread.

    My current hypothesis is that we are witnessing an evolution (albeit a painful one) in the financial industry more than we are witnessing a breakdown of wealth and wealth creation. (Though the latter is occuring to some extent, the financial system evolution may be having the greater impact across the board.) This is an evolution of information and control–perhaps individual investors are feeling more enabled due to individual education, the empowerment of information technologies and the ability to manage larger social/investor networks. In other words, individual investors may be starting to do for themselves what specialists have been doing for them for a long time.

    It seems that as long as we can avoid damaging inflation, investor wealth will remain intact and investment will continue. The new problem for the potential debtor (whether you need investment capital or a mortgage) is that you need to improve your education, master information technologies and leverage a large social/investment network in order to get what you need. Capital match-making has not and will not go away, it just became harder for the individual investor and debtor. This, I believe, is a long term trend not just for the United States but for the entire world; the United States has been the first to feel its impact because of its culture, structure and place in the world.

  • Posted by bsetser

    jkh — good points, as usual. liquifying the system is a nice image.

    Jim. Please be civil. Technically, you actually are wrong — so long as the fed sterilizes the increase in its balance sheet, the expansion doesn’t need to lead to a monetary expansion. and in this case, the sterilization was done through the sale of t-bills to raise cash for the fed, cash that the fed then lent out. the net result isn’t necessarily any new money creation. in a lot of ways this is analogous to china’s sterilization of the rapid growth of its fx assets, though the mechanism used for sterilization differs.

  • Posted by Fullcarry

    I am not sure I understand the notion that the FED’s balance sheet is limited. The FED can always increase its balance sheet by monetizing more debt. Where is the limit?

    In fact, in the face of the AIG cash infusion the FED’s balance sheet has in fact expanded:

    Of course, the treasury started issuing T-bills last week to help drain the excess liquidity the FED’s AIG assistance had generated. But the fact remains the FED can always increase its balance if it chooses.

    If my reasoning is faulty I would appreciate a response. Thanks.

  • Posted by ReformerRay

    The FRB press release fo Sept. 26 (yesterday) talks about “temporary recroprical currency arrangements (swaps)” with other Central Banks amounting to 290 billion dollars, to be used by the central banks to provide liquidity to short-term U.S. dollar funding markets.

    I assume “recroprical” means the U.S. received other nations currency equal in value to $290 billion. If that is the case, this infusion of money would not necessarily show up on the balance sheet of the FRB, would it?

    My impression is that these guys have all kinds of tricks and resources and that they can supply whatever liquidity the short-term dollar market needs.

    If the private banks withdraw from this market, the Central Banks can and apparently have, stepped in. So where is the liquidity crisis?

  • Posted by Nicole Tedesco

    I could be wrong. See here [] for commentary on lag–my observations can easily be a result of the fact that I have just not yet been exposed to lagging effects of the current crisis.

    Other possibilities: Are we seeing cutting edge indicators of the very long term drop of the very concept of “cash” itself? (Assume distant future in which, because of advances in technologies, the cost of manufacturing anything converges to zero.) Are we witnessing the effects of the weakening of the concept of “nation”? Something is telling me what we have been witnessing over the last couple of decades is something unlike anything we have witnessed in the past. Can’t quite put my finger on it though…

  • Posted by artichoke

    There are two ways of increasing money available to banks:

    1. Bernanke prints it.
    2. Treasury gives it, taxes the taxpayers for it.

    The two are equivalent, except that in the second case the burden is put squarely on the taxpayers. In the first, we “share the wealth” with those who hold USD, e.g. China.

    The massive resistance to printing, for the past year from Bernanke, has been to put all the burden on the taxpayer, sterilizing at his expense. The Paulson plan is more of the same, except in the form of gifts to banks rather than loans.

    The taxpayer has suffered as his pocket has been picked.

    Now Bernanke has no choice and indeed he is printing. He should keep printing, he is doing the right thing.

    And Congress should do nothing in a rush. I’m not opposed to helping the banks increase capital, in exchange for common or preferred equity at current market prices. This should be considered. But the current proposals are bad and too rushed, this is no way to do business. It’s Bernanke’s job to handle things in the mean time, and the market can have confidence that he is providing liquidity to those solvent banks that need it.

  • Posted by Austrian Banker


    The second alternative is *not* correct. The treasury BORROWS the money from the MARKET, postponing the pay off until such time revenues make up for it (ie. taxation).

    That very money, which is right now sitting around and providing some oil in the real economy.

    When the state entices this money to leave money market funds etc, then $700 billion are effectively wiped out from the good economy and handed to the bad economy (the bankers).

    That is the sucking sound of an economy going to permasleep.

  • Posted by Judy Yeo

    aww, missed the londonbanker and rebeleconomist crossfire with the other commentators…


    some academics spend a lifetime waiting to be proven right, guessing that roubini has just struck the economic version of the vegas one arm bandit… not much point being right if you don’t get the jackpot 😉


    saw some of your comments – the accounting, I wisely leave to the experts, after all, they are paid for that. as opposed to me.

    safe to say- some of those assets are more likely to be “liabilities” though classified as assets- what is of concern is how they will account for (the unlikely, at least according to industry experts) decrease in value of the purchased crap, sorry, distressed assets? Amortization?

  • Posted by ReformerRay

    “this is a real crisis”. Based solely on some numbers. Amount of money lent out by Central Banks, IMF AND FRB.

    Comparing apples to oranges. If the money is lent overnight, the Fed has it back the next day to lend it again.

    Need to compare the total amount of lending that is not recovered within a short period of time (as in the IMF lending). Could be a very small number.

    The websites of FRB and the European Central Bank give the story of the increase in overnight lending throughout the world. Central banks have stepped in to provide liquidity where the private banks have withdrawn. Any reason why the Central Banks cannot continue to do what they have been doing for the past week?

    I think we have been suckered by Bernanke crying wolf (entire system will collapse) when there is no wolf at the door. My hope is that no bill will be passed tomorrow and the next day so as to show that the economy is not about to collapse.

    Alas, the desire of Congress to go home will override good sense.

    My consolation is that any bill that is passed can be revisited later.

  • Posted by Dave G

    Can anybody say with any assurance that $700 billion of cash – not loans – is readily available for the government to use? The banks do not have the money, redemption of money market funds will simply lead to more demands on the system for liquidity. Sovereign wealth funds ? – they already own the existing bonds, why would they want more?

    I don’t get exactly where is the source of these funds, assuming this plan is not a fig leaf for monetizing $700B of new debt.

    Any ideas?

  • Posted by RebelEconomist


    Regarding the effect of the reciprocal swap arrangement on the Fed H.4.1 report, take a look at my blog posting:
    including the comments.

    I think that the swap itself does not appear on the H.4.1 report, which is, after all, entitled “factors affecting reserve balances”, rather than being the Fed’s complete balance sheet.

  • Posted by RebelEconomist

    Dave G,

    The banks will have the money after the TARP buys their crud. In theory, the banks could spend the proceeds on more crud in an attempt to earn a higher return, but I think that the US authorities would take a dim view of such behaviour!

  • Posted by Edwardo

    Someone wrote:

    “The Fed can always print money on a grand scale. But if it does this, the international funding that the US needs will stop. Thus, the Fed is limited in a very real way. And it is burning through its current balance sheet at a terribly fast pace. As Brad Setser says… […]”

    Whatever the Fed’s balance sheet may show today, absconding with untold billions via a massive disinformation campaign/putsch will not remotely resolve the problem. Why? Because the problem exists at the heart of the global fiat based money system that relies on growth that is no longer possible in a world of finite resources.

    I submit that what we are witnessing now is a secular change of epic size. Peak debt, the death of which we are currently witnessing came about as a way to make something from nothing. It is no accident that the reach for outsized yield that is at the heart of the advent of all the lethal financial instruments of mass destruction came about after this nation was stripped of its industrial base.

    The global Great Depression, which will be the greatest experienced by mankind post enlightenment, is underway and the U.S., particularly Wall Street, is the epicenter of the initial quake. This bailout, as obscene as it is, one perpetrated by rubes and criminals and abetted by cowering fools has as much chance of arresting the onset of the well underway U.S. economic contraction as a one legged pygmy does of bringing down a rogue elephant with a bent thumbtack.

  • Posted by artichoke

    Austrian Banker, you’re right.

    If this passes, I think I will move to China. Seriously.

  • Posted by Howard Richman


    Thank you for your welcome back comment and for sharing with me your posting about my writing. Too bad you didn’t mention our book when you were criticizing it. Trading Away Our Future is readily available (see ).

    Some day, you will have to reread Adam Smith to find out what he is really saying about mercantilism. He is saying that mercantilism hurts the world economy as a whole. To him, mercantilism was the concept that accumulating gold should be the goal of economic policy. He was advocating, instead, that the wealth of a nation is its production, not its stock of gold.

    You should also look at what Hume actually argued. He said that an inflow of gold drives up prices in the surplus country and drives prices down in the deficit country which tends to correct the trade imbalance.

    Hume was correct about the mercantilism of his day, but did not anticipate modern mercantilism. In fact, if the goal of the gold mercantilists were to build their industry (not their gold hoards), they could have practiced the same system that the modern mercantilists practice today by using the gold obtained from trade to buy assets in the trade deficit country.

    It’s also too bad you haven’t yet checked Peking University Heng-Fu Zou’s 1997 mathematical treatment of mercantilism, “Dynamic Analysis of the Vineer Model of Mercantilism” (Journal of International Money and Finance). So you would have realized that your consumption argument was a short-term argument. Indeed, Chinese mercantilism enhances present US consumption, and reduces present Chinese consumption. But Zou demonstrated mathematically that the modern form of mercantilism results in long-term gain in consumption for the practicing country, even though in the short run it has less consumption.

    The huge factor that you missed entirely in your analysis is the effect of mercantilism upon investment opportunities in the practicing country and the victim country. By holding its exchange rate approximately 40% below where it should be, China makes its products 40% less expensive to American consumers and American products 40% more expensive to Chinese consumers. As a result China gets investment while the United States does not, making Chinese products even less expensive to American consumers, compared to American products.

    Seeing as the current US investment slump is causing our economy to go into economic stagnation with the definite possibility of an economic talespin, you really should look into the factors that are causing it.

    Howard Richman

  • Posted by Twofish

    The problem isn’t the banks.

    If the banks go into survival mode they will (and in fact are) pulling money out of the commercial paper market. If the commercial paper market dies, then you will start seen a huge number of companies starting to fall from the skies.

    Companies have gotten into the habit of borrowing short term to fund long term expenses. If you can get money at 1-2% with a 30-day loan, you aren’t going to borrow money at 6-7% with a 30-year bond. The theory is that as one loan expires you can borrow more money and rollover the short term loan. This all works….

    Until you run into a situation in which no one is willing to loan money at any price. At which point companies suddenly go broke. And then the credit-default swap bomb goes off, because when a company goes under, then all of a sudden billions of dollars of payments are triggered….

    Right now banks are not lending and the *only* thing that is keeping the short term credit markets from collapse are massive purchases by central banks. They are going to run out of money in about a week or two. If you can’t get the credit markets to start lending, then you are going to see massive corporate bankruptcies and defaults when they are unable to rollover their short term financing. The world economy is going to shut down.

    We are in the financial equivalent of the “Cuban missile crisis” where one wrong move and the whole financial system blows up. No one right now is thinking more than one or two months ahead because if we don’t get through the next few days, it doesn’t matter.

    The financial system is in the process of crashing and the reason for bailout package is to make sure that there is this huge $700 billion pile of feathers to absorb the impact of what is about to happen. Everything you’ve seen, that’s just a prelude. It’s going to get a lot worse.

    The good news is that something is going to get done, and we’re probably going to make it through all of this…. I’m a little surprised and amazed that we’ve gotten to this point in one piece.

    So I’m an optimist. 🙂 🙂 🙂

  • Posted by emoboy

    Hey, My pictures of my new emo hairstyle