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Making Sense of the Fed's Loans by Jordan at Investing Blog

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In this post I want to break down all the operations of the Federal Reserve, and what all these newly released massive numbers actually mean. By now I think we’re all confused. One media agency says $3.3 trillion, another says $9 trillion, and frankly, it seems like everywhere you go there’s a different answer. Let’s make sense of it, right here, right now.

First, we should make clear, that in no way did the Federal Reserve create, then lend, $9 trillion. Throwing this number around has become politicized and popular, but highly incorrect. The $9 trillion total includes all FED activity during the term. The $3.3 trillion includes all Fed to commercial bank activity. Most of which, mind you, is the same dollar counted over and over again.

Deep breath!

There are a multitude of different actions the Fed can take in an attempt to soothe the markets. First is called a “TOMO,” or a Temporary Open Market Operation. Next is a POMO, or Permanent Open Market Operation, which is, by definition, not a loan. Then you have basic lending operations as well as temporary windows opened as a result of the financial crisis.

Obviously, it’s easy to see why $9 trillion is so completely wrong. If I were to hand you $5, and you were to give it back, and then I gave it you again and you gave it back, that would be $10 in lending. Do that 100 times, that’s $500. But in reality, I have only $5. In many cases, the media is reporting that a debt held through an “overnight” window for 5 days is actually five individual loans of the total amount borrowed. If we had that same standard for mortgages, homeowners with a $100,000, 30 year loan would be reported as taking out more than $1 billion in loans. That’s a bit disingenuous, wouldn’t you say?

But worst of all is the response that followed news that the Federal Reserve was so active in the markets, and the number of people who now think $9 trillion in fresh cash has been created. If the Fed “printed” $9 trillion in new cash, I think you would have known months ago when bread was $1,000 a loaf and gas $3,000 a gallon.

TOMOs

Overnight Loans

Let’s start first with temporary open market operations. The Fed was engaged in plenty of temporary open market operations, lending cash to banks “overnight” to cushion reserves. This is a normal action of the Federal Reserve, however, as you can imagine these overnight loans become far more frequent during a “credit crunch.” These happen only at the bank reserve level. (Sidebar: actions at the bank reserve level are said to be “sterilized.”)

Term Auction Facility

Then there was TAF, the Term Auction Facility in which cash was “auctioned” off as a debt obligation. Banks could essentially bid on the interest rate of the loan with the highest bidder getting the loan. These were sold in 28, 56, and 84 day terms, the most common being 28 days. Again, much like the overnight loans, if a single bank borrowed $1 billion for 28 days then returned it to borrow another $1 billion for 28 days, that is recorded as $2 billion in lent cash.

Term Asset-Backed Securities Loan Facility

TALF was a very short term program designed to add instant liquidity in small business and consumer debt markets. Longer term loans were issued against small business and consumer debt obligations of up to five years. Needless to say, the money in this program was borrowed quickly and is being repaid slowly.

Term Securities Lending Facility

The TSLF was another popular facility at the Fed where institutions could trade collateral (nearly anything, mostly mortgage-backed securities) for what is known as “treasury general collateral.” That’s the fancy name for “T-bills.” Huge amounts of money flew through the TSLF as each loan was made for only 28 days. Why would they trade debt obligations for debt obligations? Well, for one, once the transaction is complete, the Fed allowed banks to borrow against 20% of the t-bill value. Second, following suspension of mark to market accounting, banks could offer up a MBS portfolio worth $1, say it was worth $500 million, and come away with $500 million in T-bills which could then be used for collateral in another loan.

How much money was actually printed?

This number can be found only by evaluating the net change in the Federal Reserve’s balance sheet. The balance sheet has grown from $800 billion at the start of the crunch to $2.3 trillion, though some of that change is only temporary. Most, however, is permanent, and after the 2008-2010 infusion as well as additional QE2, banks have three times more reserves than they did before the crisis.

Which Bank Benefited Most?

According to some early media reports, the banks who tapped the Fed for the most money were Merrill Lynch, Citigroup, and Morgan Stanley. JP Morgan Chase tapped the Fed the least. Keep in mind, though, that these are aggregate numbers. Total amount borrowed may have been fifty billion in several different transactions.

But the true winners weren’t banks at all. Nope, hedge funds with debt obligations on their books took their cash to TALF, borrowing huge amounts of money that was then put in riskier investments. According to the Wall Street Journal, hedge funds made up to 48% on borrowed funds, but average was around 20-40% before finally falling later in the year to 10%. Keep in mind that hedge funds were able to borrow with as little as 5-20% in cash. Not too shabby!

I hope this makes the recent data releases a little easier to understand. There’s almost too much information out there!

About Jordan

Jordan is the web master of www.investingblog.org, a site dedicated to skillful investing, news and recent trends. You can read the original article here.

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