The SFP, the U.S. Treasury’s program for assisting with the balance sheet of the Federal Reserve, is making a sudden and dramatic comeback.
First a little background. Whenever the Federal Reserve buys an asset or makes a loan, it simply credits new reserve deposits to the account that the receiving bank maintains with the Fed. The bank would then be entitled to convert those deposits into physical dollar bills that it could ask the Fed to deliver in armored trucks. Banks currently hold $1.2 trillion in such reserves, or more than a hundred times the average level of these balances in 2006, and more than the total cash the Fed has delivered since its inception a century ago. The traditional way the Fed would bring those reserves back in (and thus prevent them from ending up as circulating cash) would be to sell off some of its assets.
The Treasury’s Supplementary Financing Program was introduced in the fall of 2008 to assist the Fed in its massive operations to prop up the financial system at the time. The SFP represents an alternative device by which the Fed could reabsorb the reserves it created. Essentially the Treasury borrows on behalf of the Federal Reserve, and simply holds the funds in the Treasury’s account with the Fed. When a bank delivers funds to the Treasury for purchase of a T-bill sold through the SFP, those reserve deposits move from the bank’s account with the Fed to the Treasury’s account with the Fed, where they now simply sit idle, and aren’t going to be withdrawn as cash. In a traditional open market sale, the Fed would sell a T-bill out of its own portfolio, whereas with the SFP, the Fed is asking the Treasury to create a new T-bill expressly for the purpose. But in either case, the sale of the T-bill by the Fed or by the Treasury through the SFP results in reabsorbing previously created reserve deposits.
The Treasury’s press release says only this:
Treasury anticipates that the balance in the Treasury’s Supplementary Financing Account will increase from its current level of $5 billion to $200 billion. This will restore the SFP back to the level maintained between February and September 2009.
This action will be completed over the next two months in the form of eight $25 billion, 56-day SFP bills. Starting tomorrow, SFP auctions will be held each Wednesday at 11:30 a.m. EST, unless otherwise noted.
So this is going to be implemented immediately and on a large scale. But why? If the goal were indeed to drain reserves, the Fed could do this by selling some T-bills out of its own holdings, currently some 3/4 trillion, or could do this with reverse repos or the Term Deposit Facility, not to mention selling some of its trillion dollars worth of MBS. And just two weeks ago Fed Chair Ben Bernanke seemed to be saying that such steps were still far in the future, and did not even mention the possibility of a surge in the SFP.
You want more information? We’ve got this:
“We’re committed to working with the Federal Reserve to ensure they have the flexibility to manage their balance sheet,” a Treasury official said on background.
Anonymous and on background in order to say nothing at all? What’s the big secret?
An alternative hypothesis is that the Fed intends not to retire reserves but instead to expand its balance sheet without increasing reserves, that is, use the funds to make new asset purchases or loans with the SFP sterilizing the operations. But what loan is the Fed about to make or asset is it about to purchase? WSJ Real Time speculates:
The practical effect of this move is that the Fed will be able to finish $1.25 trillion of purchases of mortgage backed securities by the end of March without printing more money. Instead, it will have the cash on hand from the Treasury deposits to fund the purchases. As of February 17, the Fed’s portfolio of mortgage backed securities had reached $1.025 trillion, roughly $200 billion short of the objective.
The Fed purchased a net total of $12 billion of agency-backed MBS through the week of February 3, bringing its total purchases up to $1.177 trillion, and by the end of the first quarter 2010 the Fed will have purchased $1.25 trillion (thus, it is 94% complete)…. the Fed needs to purchase only about $9.2 billion per week through March 2010 to reach its goal.
The discrepancy seems to arise from the fact that the Fed’s February 18 H41 release listed its MBS holdings on Feb 17 as $1,025 billion, or $152 billion less than the $1,177 billion that the Federal Reserve Bank of Atlanta claimed the Fed had purchased as of Feb 3. The Atlanta numbers seem to be the accumulation of weekly net MBS purchases (that is, gross purchases minus gross sales) reported by the Federal Reserve Bank of New York. Perhaps it takes a while between the time the NY Fed executes the purchases and the time they are settled and show up on the Fed’s H41 balance sheet, or perhaps there is some separate device for accounting for maturation and prepayment on the MBS. If the latter, then at a minimum the WSJ and FRB Atlanta had a different understanding of how far the Fed intended to go with its MBS program. And under either interpretation, if the $200 billion in new funding is just for something that was already etched in stone weeks ago, the sudden announcement that it is going to be implemented with an immediate resurrection of the SFP seems all the more mysterious.
WSJ Real Time offers this perspective from Lou Crandall:
The intention always was to resume SFP issuance when the debt ceiling was increased on a permanent basis, which finally happened earlier this month.
So maybe this has been in the cards for a while, with the apparent suddenness and clunkiness from the perspective of an outsider like me having an explanation in the fact that the political negotations behind such a move may in fact force a certain suddenness and clunkiness on steps that the Federal Reserve on its own might wish to see implemented with more transparency and predictability.
Still, one is led to wonder whether there might be a connection between today’s announcement about the SFP and last week’s announcement of an increase in the Fed’s discount rate. Numerous Fed officials encouraged us to interpret the latter as a routine and technical management tool. Are the discount hike and SFP renewal separate and purely technical developments, or is something more involved?
Perhaps Bernanke’s remarks tomorrow will give us more to go on.