from Follow the Money

Extraordinary times

September 26, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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In the last two weeks -- if I am reading the Federal Reserves’ balance sheet data correctly -- the Fed has:

Increased "other loans" to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its "other assets" by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

And what have the rest of the world’s central banks done over this period?

There has been a lot of talk that central banks would abandon US assets because the perceived risk of holding dollars (and Treasuries) has gone up.

The custodial data though don’t provide much evidence to support this theory.

Over the last two weeks, the Fed’s custodial holdings have increased by over $40b, rising from $2394.7b to $2435.9b. Treasuries account for over $30b of the increase, but Agency holdings are rising as well. Chalk up one (minor) success for Paulson.

Right now, it seems like central banks are running into the safest US assets, not running away from the dollar. That of course could change. But it is hard to square a $20b weekly increase in the New York Fed’s custodial holdings with a story based on a fall in central bank demand for dollars. For that matter, it is hard to square the $425b increase in the New York Fed’s custodial holdings since last September with all the of the angst about the dollar’s status as a reserve currency.

If anything, the pace of growth in the Fed’s custodial holdings over the past two weeks strikes me as stronger than the likely pace of global reserve growth. That suggests to me that central banks are shifting funds out of the commercial banks (and money market funds) into Treasuries that can be held at the Fed’s custodial accounts. I would bet that central banks are shifting money to the BIS as well.

Remember, most central banks do not have a mandate to take credit losses. They can take currency losses -- as currency risk is implicit in the notion of foreign exchange reserves. But having money in a bank that fails would be very hard for most to explain.

Note that all my data compares the data for the end of the reporting week, i.e the data for September 24 to the data for September 10.

UPDATE: I should have noted a fall in the Fed’s repos with the banks in my initial post. The changes in the Fed’s balance sheet are so large that I am not sure that I still know how to read the report, so please attach an error bar to the numbers above (apart from the numbers on the custodial holdings). I may have missed some additional credit extension, or some offsetting items. The basic story though is clearly true: the changes in the Fed’s "other loans" alone are enormous.

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