Once, I thought that the 2008 crisis would be the biggest historical event I would live through. Wrong! Both the crisis of 2008 and the COVID-19 pandemic had huge effects on relations of work and production. Such changes in economic relations are reflected in changes in the balance sheet structure of the central bank. As a post-crisis, post-pandemic monetary framework for the US begins to clarify, I found it helpful to trace the Fed's financial position starting with the pre-2008 period. In future posts, I'll look at how this position fits into the Fed's policymaking. I'll also look at other central banks.
Before the global financial crisis, the Fed's balance sheet looked like this:
Fed Jan 4 2007 Assets Liabilities ────────────────┬──────────────── Treasuries 0.8T │ Currency 0.8T │ │ Other 0.1T │ Other 0.1T │ │ Reserves .01T ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ Total 0.9T │ Total 0.9T
(Note that this and all of my T-accounts are schematic: I'm showing only a very high-level summary.) The total size of the balance sheet was less than one trillion dollars, and most of that was Treasuries—government debt—on the asset side and currency on the liability side. The Fed, that is, held a portfolio of Treasury debt financed by money issuance.
I show also the tiny entry for reserve balances, commercial banks' deposit accounts at the Fed. Quantitatively it was small, but it played an important role in the pre-crisis monetary policy framework. That framework relied on a target for the overnight interest rate in the market for federal funds, interbank loans of those reserves. By adjusting this balance-sheet quantity, the Fed was able to peg the fed funds rate, which in turn moved other interest rates and prices.
The epicenter of the financial crisis of 2008 was the US housing market. The effects of the crisis were so severe and widespread because of the way that housing finance, mortgages, were connected to the wholesale money markets. Trading in mortgage-backed securities depended on the system of securities dealers. These dealers were unable to facilitate a smooth exit from excessive investment in MBS. The Fed intervened, after which, eventually, its financial position looked like this:
Fed Jan 2 2020 Assets Liabilities ────────────────┬──────────────── Treasuries 2.3T │ Currency 1.8T MBS 1.4T │ Treas. dep 0.4T Repo 0.2T │ Reverse 0.3T Other 0.3T │ Other 0.1T │ │ Reserves 1.6T ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ Total 4.2T │ Total 4.2T
The balance sheet had been expanded by more than three trillion dollars. The biggest asset position was still in Treasuries, but now accompanied by a big entry for mortgage-backed securities. The Fed had acted as a dealer of last resort here: the market wanted to sell; no one wanted to buy, so the Fed bought rather than let markets fail.
On the liability side, the big shift from before to after the crisis was in the expansion of the reserve account. This is unhelpfully referred to as "excess reserves." (They are in excess of the regulatory minimum reserve requirement as a function of banks' liabilities; but clearly banks did not view these levels as excessive, other things equal, or they would have drawn them down.)
This post is about the Fed's financial position: what the Fed's balance sheet looked like, not how or why (which I will come back to in future posts). But a quick word on reserve balances is called for. Because the fed funds rate had been driven to zero early in the crisis, monetary policymaking could not ignore the so-called zero lower bound—the central bank wanted to ease more even when the fed funds rate was already zero. The Fed decided against negative interest rates and instead made monetary policy through asset purchases—quantitative easing. Reserves were the liability side of this operation, and the Fed began paying interest on them to support banks' holding them.
More than a decade on from the crisis, the COVID-19 pandemic again put the Fed on a crisis footing. Now the central bank's balance sheet looks like this:
Fed March 18 2021 Assets Liabilities ────────────────┬──────────────── Treasuries 4.9T │ Currency 2.1T MBS 2.2T │ Treas. dep 1.6T │ Reverse .2T Other 0.6T │ Other 0.1T │ │ Reserves 3.7T ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ Total 7.7T │ Total 7.7T
The balance sheet is 3.5T larger. On the asset side, the Fed has purchased some two-and-a-half trillion in government debt, and a bit less than a trillion of mortgage-backed securities. This was funded by expansions in reserve deposits and Treasury deposits.
How this portfolio will be managed is the subject of recent conversations by the FOMC, and will be the subject of future discussion here.
Here are the same three snapshots of the Fed's balance sheet all together:
Fed Jan 4 2007 Fed Jan 2 2020 Fed March 18 2021 Assets Liabilities Assets Liabilities Assets Liabilities ────────────────┬──────────────── ────────────────┬──────────────── ────────────────┬──────────────── Treasuries 0.8T │ Currency 0.8T Treasuries 2.3T │ Currency 1.8T Treasuries 4.9T │ Currency 2.1T │ MBS 1.4T │ Treas. dep 0.4T MBS 2.2T │ Treas. dep 1.6T │ Repo 0.2T │ Reverse 0.3T │ Reverse .2T Other 0.1T │ Other 0.1T Other 0.3T │ Other 0.1T Other 0.6T │ Other 0.1T │ │ │ │ Reserves .01T │ Reserves 1.6T │ Reserves 3.7T ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ ┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┼┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈┈ Total 0.9T │ Total 0.9T Total 4.2T │ Total 4.2T Total 7.7T │ Total 7.7T
My focus in this post has been on the central bank's position—its financial relationships with the other entities. The balance sheet captures those relationships at a specific moment in time. The comparison shows that the central bank's books carry a record of both the crisis and the pandemic, inscribed as a legacy of debt relationships.
As I've said, this picture of the Fed's position doesn't say much about what the Fed does. Monetary policy is a pattern of actions and transactions in response to changing circumstances. These transactions have an effect on the balance sheet, but we can't read monetary policy directly off the balance sheet. That's work for another day.