Brad Setser

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Give the Fed a bit of credit …

by Brad Setser
October 2, 2008

For holding things together. Barely. Bad as things are, they could be worse. Really.

By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system.

The Fed’s latest balance sheet data shows: $80b of repos; $150b of term auction credit, $410b in other loans, $30b in portfolio investment with “Maiden Lane” (the Bear Stearns vehicle), $320b in “other assets,” and $260b in securities lent to dealers.

Do the math. It is a huge number. Or look at my CFR colleague Paul Swartz’s updated chart. I wouldn’t believe these numbers could possibly be true if I hadn’t been watching the data for a while. Frankly the TARP is now starting to look small relative to the Fed’s balance sheet.

The $1.25 trillion total likely includes the swap lines that have allowed other central banks to provide dollar liquidity to their financial institutions.** (This sentence has been edited after my initial post: see the note below, it is important)

I have long thought that sovereign funds, which provided equity capital to support banks’ existing management in the early stages of this crisis, have gotten too much credit for helping to stabilize the financial system and the Fed and other central banks have gotten too little, in part because there isn’t as obvious a set of beneficiaries.

The latest data release should settle the question; absent enormous liquidity support from the Fed, a much broader set of financial institutions — including some that received equity investments from sovereign wealth funds — would have failed.

What are sovereign investors from the emerging world doing? We don’t know much about what sovereign wealth funds are doing — and in any case, the set of sovereign funds and big state firms from the emerging world is sufficiently diverse that it makes little sense to try to paint a single picture. But we do know a little bit about what the world’s central banks are doing from the New York Fed’s custodial data.

That data suggests an overwhelming flight away from any kind of risk. Or at least any kind of risk other than the currency risk that they have to take. Central banks are petrified of losing money. This is one reason why I have long thought that sovereign investors could be destablizing; they aren’t necessarily leveraged — but they are very loss-adverse.

From August 27 to October 1, the world’s central banks added $72.6b to their custodial holdings of Treasuries, and $0.9b to their custodial holdings of Agencies. Annualized, that works out to a $872b annual growth for Treasuries — a sum well in excess of the US current account deficit.

Between July 30 and October 1, they added $118.5b to their Treasury holdings (a $710b annual pace) while reducing their Agency holdings by $12.5b.

The enormous growth in central bank custodial holdings of Treasuries has helped to support the dollar — and that is stabilizing. The United States credit crisis has not turned into a currency crisis. But the flight out of risk has destablized other key markets, and that hasn’t been stabilizing. I suspect that central banks and sovereign funds are pulling out of money market funds, for example. The growth in the Fed’s custodial holdings in September almost certainly exceeded the growth in central banks’ reserves (we will have data on this next week) — a fact that suggests that central banks have sold other, slightly more risky assets and used the proceeds to buy Treasuries.

The basic story that emerges from the Fed’s balance sheet over the past few months is simple: the emerging world’s central banks have fled from any asset with a hint of credit risk, and while the Fed (and other G-10 central banks) have been lending ever large sums to the financial system. In the process they have taken on a lot more credit risk — and offset the broad flight away from risk by private investors and emerging market central banks alike.

Absent the Fed’s liquidity support, things would be worse. Much worse.

** I initially wrote that the $1.25 trillion in liquidity support to private financial institutions that shows up on the Fed’s balance sheet data likely did not capture the swap lines with foreign central banks, and thus understates the Fed’s true activity. The comments have led me to revise this view — as it seems that “other federal reserve assets” captures the fed’s foreign assets, including the collateral posted against swap lines that have been used, and thus $1.25 trillion likely represents the global total for dollar credit extended by all central banks to all financial institutions globally. JKH was the first to suggest this, and Murph’s comments lent support to JKH’s point. I hope to get full clarity on this on Friday; if anyone knows, please email me at bsetser at cfr dot org or just contribute to the comments. It is important.

UPDATE: I have confirmed that the foreign exchange posted as collateral in dollar swap line appears in “other federal reserve assets.”

UPDATE 2: I initially wrote “the credit crisis has turned into a currency crisis” (after describing how central bank dollar purchases had been stabilizing); I meant to write “the credit crisis has NOT turned into a currency crisis.” The post has been updated.


  • Posted by free lunch


    Re: underinformed suckers

    Couple of SWF banking investments had repricing clauses hardly the action of the underinformed suckers

    Can you name any private US underinformed insane suckers who made contemporaneous or prior investments? I see quite a few.

    Some of the SWFs have arguably lower costs of capital than US private investors and a currency hedge in US investments

    SWFs may have strategic reasons for investments

    “The trouble is that no one knows what their own exposure is. How much money do *you* stand to lose if nothing is done? You probably don’t know.”

    “No. Most of the offenders have been driven out of business, and their CEO’s and senior management have been kicked out. They may have gotten golden parachutes, but they were still kicked out of the plane.”

    How do you then know who the offenders are? Have you been on the Pestowire?

  • Posted by ReformerRay

    Will someone please teach me how to add?

    Twofish had an excellent answer to my call for the Fed to enforce transparency. But I could not continue the discussion because I flunk math. Help!

  • Posted by ReformerRay

    I added the numbers before typing – math OK. I add the numbers after typing – math bad. Is that the secret?

  • Posted by ReformerRay

    Twofish says the Fed cannot enforce transparency because each individual firm does not know its own level of exposure to toxic loans.

    I am a naive observer. My reply is the common sense view that each firm varies in the degree to which it is ignorant of its own exposure to bad loans and in the degree to which loans payable constitute total assets.

    The fact that some firms are willing to buy parts of other firms or in some cases whole firms indicate that ignorace of bad loan exposure is not universal.

    The only way out of this mess is to have each firm provide information about the good stuff on its books. Ignore the bad stuff. Would that mean that few firms would have good stuff to report?

  • Posted by ReformerRay

    Twofish postulates a chain of loans – from firm A to firm B to Firm C etc. It seems reasonable that a domino effect is possible.
    But in no case, does any one bad loan becoming unpayable knock over any one domino. I claim there has to be some way that the least vulnerable firms can separte themselves from the rest of the pack. I also believe that it is the responsibility of the Fed to enforce this sorting.

    I have no idea how to do the sorting but it must be done. To continue with the idea that no firm can be trusted to repay a loan means that the credit system cannot be reformed.

  • Posted by ReformerRay

    What information is available about short terms loans that are arranged off the exchange? I would expect money Market funds to arrange to make loans to firms that they trust. Is this happening?

  • Posted by S

    ReformerRay Says:

  • Posted by S

    Reformer Ray

    Wells deal was a tax arbitrage. it says nothing of the value of banks per se other than the perpetual value of deposits. also wells has a massive valuation advantage vs. peers. This is where confidence trumps reality.

    if everyone agrees that the Fed was way too loose for too long and the base needs to contract how is it that adding more liquidity is the right answer? Hussman is correct in stating this is a asset., liability and equity issue. The assets have to fall and yet the Fed is making a stand that asset prices remain elevated at the Krugman high equilibrium point (an oxymoron). The stand is to protect the banks. but why is that good for everyone else. It is commonly accepted wisdom that credit is the problem and yet the fed adminsiters more of the same. That is the definition of insanity.

    The US policy to be the world’s financial champion is over. that means massive changes not trying to recap GS and kcik start the engine.

    Conspiracy aside what if the US uses the elastic clause to bolster short term cofidence buy back FCB debt and use the pent up demand domestically to absorb excess liquidity. Then like FDR devalue. Preserve the treasury funding window (public interest) mop up liquidity eviscerate debt – where the problem lies in the consumer side as much as the government? The problem with hyper arguments is that there is no wage nexus. Bernanke is playing the only hand he has and it is a losing one.

    The devalue scenario is a win win for treasury, fed, banks large debtors — lose lose for savers (small constituency in US) and or J6P

  • Posted by gillies

    i said that oil would go to a price of $40 / barrel. no one contradicted. i see that, from the peak, we are now half way there . . .

  • Posted by gillies

    lacking the technical background information to argue with the more econowonk detail above, i am driven as always to the childish questions –

    there is a big black toxic cake of negative equity on the table. it has to be swallowed. who gets to cut the cake and allocate the portions ?

    the detail only smokescreens the problem.

  • Posted by gillies

    mike shedlock –

    in his current offering, shares my view that printing money will make little difference if people remain unwilling to lend or to spend.

    so has the dollar collapse been cancelled – or just rescheduled ?

  • Posted by anon

    “Nouriel Roubini tells us that there are 800 billion dollars deposited in US banks by foreign counterparties. Up until this week, if you were a foreign operation, would you rather be in large money-center US banks or European banks? Tough choice, but on balance you would pick the US. Then this week Ireland decided to simply insure every deposit in Irish banks, no matter the size. Predictably, money started flowing from all over Europe into Ireland. National banks and finance ministers are furious with Ireland.


    But what if the various countries, one by one, decide to guarantee deposits in order to protect their own banks? If you are an international corporation, especially if you are outside the US, do you want your $10 million in Europe or the US if Europe guarantees your deposits with no limit? Could we see silent runs on US banks?

    I think it is about an even chance that the government will have to guarantee for a period of time (say 6 months to a year) every bank deposit, regardless of size, in the US.”

  • Posted by ReformerRay

    think it is about an even chance that the government will have to guarantee for a period of time (say 6 months to a year) every bank deposit, regardless of size, in the US.”

    I would say the odds are better than that.

    S says: The Wells Fargo offer for Wachovia is not typical because of tax advantage, the two parties had good assets.

    Fair enough. Probably true. Nevertheless, it points the way out of this mess. Other firms have assets and tax accountants. Federal employees in all agencies should bend all efforts to encourage such deals. I believe folks have been trying. But Paulson is not willing to wait to let this mess be rationalized on a case by case method.

    I’ll admit when we had mark-to-market accounting required and short selling permitted and FDIC insurance caped at $100,000, things were moving too fast, panic was expanding. Something had to be done. Something has been done.

    I am pleased that it will take weeks to set up the implementation of the bailout. I expect the situation to be much improved, by market forces, under current rules, before Paulson can act.

  • Posted by ReformerRay

    My local newspaper reports that Ohio State University owns 39.5 million dollars that it cannot access because it is in an account that is frozen. That account is frozen because its trustee was Wachovia bank, which has frozen all its accounts.

    That is the domino effect Twofish described. Note, however, that OSU is not going out of business. It can wait to see how much of its money it will recover.

    When the agents at the bottom of the pile – like OSU – can tolerate the delay in settlement, this particular event does not contribute to the panic.

    Without panic, this mess will unwind as it should unwind, with many parties going out of business. Less players is good. Credit that is more expensive is not good for economic growth but it is the only way to reduce over-reliance on debt.

    The past system must be destroyed and another, viable system, put in its place.

  • Posted by Howard Richman

    TwoFish wrote:

    “Right now the short term credit markets have completely broken down. The fact that few people on Main Street notice is because the Fed has pumped hundreds of billions of dollars into the financial system, but they are about to run out.”

    You are incorrect. To quote Milton Friedman, “There is no limit to the extent to which the [a central bank] can increase the money supply if it wishes to do so.” ( )

    Howard Richman

  • Posted by Michael


    You’ve probably already figured this out, but the “math” issue appears to be really about “time.” If you write a longish post, then submit, you’ll be told your “math” is wrong. It’s really not the numbers you add that matter, it’s how long between the time you started to write and you submitted. I can understand the value of limiting super-long posts. Yours do not seem excessive, so here’s the trick: You write your post first, copy it (Control + C), then add the numbers and submit. If it rejects you (’cause of “math”), go back, paste in your post (Control + V), add the new numbers and submit right away. That’ll work. It’s up to you to be responsible and not go excessive on length of post.

  • Posted by Soxfan

    Does anyone know if the Bailout Bill contained the acceleration of allowing the Fed to pay interest on reserves? I know it was in the version that was originally voted down in the House, but there is no press on this at all this weekend.

    Paying interest on reserves at the Funds rate would do away with the need for these Treasury supplemental financing bills by allowing the Fed to expand its balance sheet infinitely, without driving rates to zero.

  • Posted by flow5

    Explanations: Report lines & T account flows
    “Modern Money Mechanics” — Changes in Foreign-Related-Factors:
    #41 & #38 SWAP LINES

  • Posted by ReformerRay

    Thanks, Michael

  • Posted by Alan Gervasi

    To get people buying should be the goal of all efforts to stabilize the economy… And if it is too expensive for anyone here, then stabilize Asia and allow them to buy our goods.

    It is an open secret that Asia has been overproducing for some time…. So to get Asia to start buying merely takes making room somewhere for Asia to “dump” is surplus products…!

    I suggest Hawaii (primarily) for it’s relative remoteness and lack of productive capacity (…to be negatively affected by a relatively vast influx of Asian products.) Mainland-America would have to boost tourism-travel to the Islands to take advantage of the “low” prices….!

    Secondly I suggest Alaska… for the same reasons…. However, I suggest the second position as a spill-over because of it’s position on the Continental United States; and, being of the mainland might compromise the “growth” of our own factories.

    Just a note… or is it just a quirk…? …That the speech introducing Alaska’s Sarah Palin in the Republican Convention was made by Hawaii’s Governor Lingle…!!!

    Hmmm… I wonder…?