ACTV - Federal Reserve Watch: Getting Through The Banking Crisis

2023-03-24 11:23:38 ET

Summary

• Over the past two weeks, the Federal Reserve has managed its way through the failure of several commercial banks and the concern over the health of the banking system.
• One can see from the Fed's balance sheet that the Federal Reserve did some things that were out of the ordinary, but they were not that large in size.
• Furthermore, the financial markets remained relatively calm as deposit insurance for deposit holders was extended to all depositors regardless of the size of their deposit.
• Things were calm enough so that the Federal Reserve could raise its policy rate of interest by 25 basis points at last Wednesday's FOMC meeting.
• The Federal Reserve maintained its efforts at quantitative tightening even with everything else that was going on.

Over the past several weeks, the news world has been rocked with all sorts of discussions about the bank failures that have occurred and what the policymakers should be doing.

The question we have to ask is what has the Federal Reserve been doing with its balance sheet?

By balance sheet I mean the H.4.1 statistical release of the Federal Reserve System.

Let's look first at what has happened to the "excess" reserves of the commercial bank system. This will give us some indication of the amount of liquidity that exists within the banking system and how this has changed in recent weeks showing how the Federal Reserve responded to the banking disturbance.

Over the past three weeks, reserve balances with Federal Reserve banks, the line item we use to define the "excess reserves" in the banking system.

In the banking week ending Wednesday, March 8, reserve balances in the banking system dropped by $24.3 billion. This was the week before the news on Silicon Valley Bank and others, reached the public.

The next banking week, the week ending Wednesday, March 15, reserve balances in the banking system rose by $440.5 billion.

Obviously, there was a lot of activity in the Federal Reserve System that week.

In the next banking week, the one ending on Wednesday, March 22 reserve balances dropped by $72.2 billion.

Here is a picture of recent activity.

As can be seen, the liquidity present in the commercial banking system had been pretty steady in recent months, and then the bank failures hit.

I covered how the Federal Reserve reacted last week, in the banking week ending March 15, in last week's Federal Reserve Watch.

The Fed and other government agencies reacted quickly to stop the deposit loss at the various failing banks and did what it could to stabilize the financial markets.

At the same time, deposit insurance was extended to all depositors and this helped to steady banks and the banking system.

Furthermore, other institutions across the nation joined in the efforts to bring the banking crisis to a halt.

The Banking Week Ending March 22

In the past banking week, "excess reserves" fell in the banking system. Most of the action on the Fed's balance sheet appears to be in areas where the Federal Reserve can operate in the markets in order to maintain the stability of the banking system.

For example, in this past week, the Federal Reserve oversaw an increase of $226.9 billion in reverse repurchase agreements. The short-term selling of securities helped to account for the decline that took place in bank reserves over the week.

There was repurchase agreement activity on the other side of the balance sheet as well, transactions that put reserves into the banking system.

Interesting that these repurchase agreements were listed under "Foreign Official" repurchase agreements.

As is well known there were bank concerns in Europe and the U.K. last week and one wonders if the Federal Reserve played any role in helping out on these transactions.

Primary credit loans increased by $36.0 billion last week which brought the total of these Federal Reserve loans up to $354.2 billion at weekend.

This was the major activity going on at the Fed's balance sheet.

So, it looks as if the Federal Reserve felt it had to play a part in all the turmoil going on last week, but the numbers are not that great, leading me to conclude that the problems in the banking industry were not overwhelming.

Financial markets, especially the shorter-term end of the markets stay relatively steady also contributing to the conclusion that financial affairs were not getting "out of hand."

My feeling is that this behavior contributed to the Fed's confidence to go ahead and raise its policy rate of interest by 25 basis points.

Janet Yellen, U.S. Treasury Secretary, and others had already laid the groundwork for the move, seeing that deposit insurance was extended to all depositors regardless of the size of their deposit.

The policy rate move, I think, went well.

Although the S&P 500 Stock Index dropped by 65.9 points on Wednesday, it recovered by 11.75 points today.`

The Futures market seems to be poised for another rise in this index on Friday.

So, it looks as if the Federal Reserve did what it needed to do this past week or so, to stabilize financial markets so that Mr. Powell and the Federal Open Market Committee could go ahead and raise the policy rate of interest this week.

And, What About Quantitative Tightening

The Fed's quantitative tightening has continued.

Last week, the Fed's securities portfolio declined by $3.4 billion. The week before, the securities portfolio declined by $8.3 billion, and in the first full banking week of March, the securities portfolio dropped by $0.2 billion.

For the month of March, so far, the securities has declined by $11.9 billion.

Not much happened here, but during the distractions of the past couple of weeks, the Fed has continued to oversee the decline in its securities portfolio,

Mr. Powell and the Fed are not giving up on keeping the size of the securities portfolio on the decline.

The quantitative tightening effort is now one year old, and over this time the total decline in the Fed's securities portfolio, including accounting adjustments for recorded securities premiums and losses, total up to just over $600.0 billion.

As the Fed did with its four rounds of quantitative easing, the central bank has let the program continue even while lots of other "stuff" was going on in the banks and in the financial markets.

It is important, I believe, to continue to watch what the Fed is doing with the quantitative tightening so as to get an idea about its overall focus.

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