Friday, October 17, 2008

Foreign Central Banks buy Treasuries - The Fed dumps them!

Over the last 52 weeks, foreign central banks have added $321b to their Treasury holdings at the New York Fed (and no doubt more to other accounts) and $147b to their Agency holdings — for a total of $468b. And there clearly has been a big shift towards Treasuries recently. The rise in Treasury holdings over the last two weeks, annualized, tops $1 trillion. The fall in Agency holdings over that period (after the bailout of the Agencies), annualized, also tops $1 trillion.

Stunning? Yes. Stabilizing? Not really. There isn’t a shortage of demand for Treasuries right now. But there is a shortage of willing lenders of dollars to European banks and — to a degree, s shortage of buyers for the debt issued by the US Agencies (Freddie, Fannie and the like). And remember that the Agencies are the main current source of credit for American households looking to buy a home — without their lending, home prices would fall much much further.*
The Fed’s balance sheet by contrast is moving in the opposite direction — out of Treasuries. The Fed has been selling off its Treasury holdings for a while now. But there are limits to how many loans to banks and broker dealers and European central banks the Fed can finance through the sale of its existing stock of Treasuries. The recent increase in Federal Reserve lending has been financed by both the $500b in cash raised by the Treasury and deposited at the Fed through the supplementary financing facility — and a big rise in bank deposits at the Fed. Those two sources combined to provide the Fed with about $750b in financing.
The scale of the expansion of the Fed’s balance sheet is equally stunning. The Fed is currently provided at least $950b in dollar liquidity to the US financial system through various term facilities and its direct lending, and another $450b of dollar liquidity to European central banks — liquidity that is then lent to European financial institutions that are facing a shortage of dollars. Let there be no doubt that this is a systemic crisis.