Monday, October 9, 2017

"So I was looking at the Fed's 2016 annual report" (Fed IOER payments to big banks)

Following up on Sept. 26's "Questions America Wants Answered: 'Why Pay Interest on Required Reserve Balances? - New York Fed'".

From the Macro Musing's Blog:

From a Floor System to A Corridor System 

So I was looking at the Fed's 2016 annual report and was able to construct the following chart:

https://1.bp.blogspot.com/-bVat4bfsT2o/WdqrzsPNWUI/AAAAAAAAgNc/OIPmZVs-wD4oak2p5yADIv5RTBIS9fseQCLcBGAs/s1600/Screen%2BShot%2B2017-10-08%2Bat%2B6.44.59%2BPM.png
Several observations from this figure. First, the sharp growth in the Fed's income is unsurprising as it is a natural consequence of the Fed's QE programs. These large scale asset purchase programs expanded the Fed's assets from around $900 billion in late 2008 to $4.5 trillion today. Moreover, the Fed's portfolio has changed from being mostly short-term treasury securities to one of long-term treasury and agency securities. In addition, the Fed also started paying interest on excess reserves (IOER) to banks during this time. Together, these two developments have effectively turned the Fed into the largest fixed-income hedge fund in the world. Hence, the surge in the Fed's income. 
Second, the Fed's net expenses have also grown rapidly since 2008. Fed officials will point to new financial regulations they have to enforce as the main culprit, but there is arguably a political economy story to the surge as well. Interestingly, this surge accelerated between 2015 and 2016 as seen in the figure. There is no mystery behind this uptick. It is almost entirely the result of the larger IOER payments going to banks as interest rates have gone up. This can be seen in the following numbers:
https://3.bp.blogspot.com/-zHAoSPKAwd0/WdrNZlYsjMI/AAAAAAAAgNw/FtGvRkextu8mJgtFbrB8FIrbHq4Ss68VwCLcBGAs/s1600/Screen%2BShot%2B2017-10-08%2Bat%2B9.12.58%2BPM.png
The IOER payments are expected to grow as the Fed continues to tighten policy. Assuming this tightening does not get ahead of the recovery and cause a recession, future IOER payments should grow as seen in this chart from The Economist:
The Fed estimates these payments could hit $50 billion by 2019. And, as a reminder, most of these payments will be going to large domestic banks and foreign banks as they hold most of the excess reserves. This can be seen in the figure below....MORE
If interested see also:
Aug 2014
New Fed Exit Strategy Emerges and Foreign Banks Big Winners
Feb 2016
Negative Interest Rates: Learning From The Swiss and Swedish Examples