8/23/13 9:32 AM – Federal Reserve in the Spotlight

The Federal Reserve has built a huge balance sheet since 2008. It has also financed the U.S. federal deficit spending by buying newly issued U.S. Treasury securities issued when the country spent more than it had coming in. How big are these operations? Take a moment to make a guess.

In the five years since 2008, the U.S. has added a shocking $5.7 trillion to the national debt. To put that in some perspective, the entire federal budget for 2013 is $3.8 trillion. That’s an average annual deficit of roughly 30% during the last five years.

That increase in debt at low rates would have been impossible to achieve if not for the Federal Reserve emerging as a huge new buyer. By doing so, it kept the interest rates on the newly issued date at extremely low levels compared to what they would have been without Fed buying.

The Fed has also been a huge buyer of mortgages in an effort to drive down interest rates for home buyers and homeowners. it has been successful in that endeavor and that has likely been a huge factor in the recovery of the housing and construction markets.

Currently, the Fed owns $3.65 billion of securities, four times what it owned five years ago. For some perspective, the capital reserves of all the banks in the U.S. total $2 trillion. So, the Fed owns almost twice as much in bonds as the total capital reserves of all the banks in the country. Wow!

It now wants to get rid of this huge pile. Of course, selling a lot of bonds tends to drive down bond prices, raising interest sharply, which the Fed does not want to do. How can they get rid of this mountain of debt without driving up rates more than they have already just by talking about cutting back on buying?

The answer is apparently in the WSJ this morning. The Fed wants to open its window to not only banks, the traditional buyers, but now wants to sell to a wider range of investors. The market would not set the interest rate for these buyers though, the Federal Reserve would. The Fed also feels like that would give them more control over bank lending rates which it does not actually set but seeks to influence.

On a separate note of interest, the just-released notes of the Fed’s July meeting said that the market’s consensus expectations for the start of the Fed’s tapering off of its bond buying was close to the views of FOMC members. The consensus view is that the Fed would start tapering at the Fed’s September meeting, so there you have it.

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