fe442 midterm 2

fed reserve act of 1913 was the compromise

12 regional banks: sensitive to regional issues, all areas of country are rep in policy issues checks and balances diffused power: regionality, public/private, bankers/businesses/public quasi-public: reps gov and private sector

in addition to buying bonds and cutting rates, fed took steps to ensure banks are able to continue lending and that the credit markets don't seize up the way they did in 2008. meant to free up cash so that banks can keep lending at a time when companies are tapping on their lines of credit

8 largest banks announced that they will stop buying back shares so that they can support businesses and lend

benchmark rate

Also called base interest rate, it is the minimum interest rate investors will demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on the comparable-maturity treasury security that was most recently issued (on-the-run)

fomc makes decisions regarding OMO, to influence the monetary base

OMO are the most imp tool that the fed has for controlling the money supply (along with reserve requirements and the discount rate) all actions are directed by the FRB of NY, where secs are bought/sold as req 12 members, 7 members of the BOG, president of NY fed, and four other FRB presidents on a rotating basis chairman of the BOG is also the chair of this committee

during normal times, fed uses three tools to control money supply and interest rates

OMO, discount lending, reserve req

FED ON THE HOT SEAT Roger Lowenstein: Lowenstein described the Fed's role in terms of a historical perspective, starting with the inception of the Federal Reserve System in 1913. In 1912, amidst the pivotal presidential election, people wanted change and banking reform and were in favor of decentralization of the banking system. There was a theory up until the early 1900s that a central banking system was taboo and just a conspiracy for big banks favoring money to the elites. However, since no central bank existed, each bank had to hold its own reserve and the country was scattered about. This made things inaccessible for common purposes and each time that money was tight, each bank did what was sensible for it and tightened up, calling loans in and bolstering reserves, which drained cash from the system frequently and setting off a cash crunch, and sometimes even a depression. There was no central bank to smooth out this lumpiness or douse a large fire as these dispersed banks were only capable of handling smaller flames. A central bank would be able to act as a lender of last resort and prevent interest rates from soaring to almost 100%. Walburt was astonished by the primitive ways of the American banking system, but failed to understand the temper of the American people who did not want a central bank or large institution run by the government controlling their finances and economy. However, the Aldridge plan eventually came out to have banking reform, proposing a central, self governing banking system to centralize credit and organize the country's economics. Wilson added that this system would need a capstone, which would be the Federal Reserve Board to sit upon the Reserve System. Wilson further made the Fed more centralized and public to effectively support the country's monetary policy and status.

Peter Conti-Brown: He described how there is a conspiracy and nefarious perception of the Fed today that they are out to get us and have extraordinary powers. This is sometimes thought to be a result of a lack of misunderstanding by the people of what the Fed does due to its technical complexity, but that is not the case as all government entities have jargon that puts barriers around information. People don't fully believe that baked into the Fed's legal, institutional, and traditional DNA is the concept of independence and that the Fed exists apart from the usual political and government system. The reason for this is price stability. The focus of independence is to keep inflation from running away. Politicians are deeply interested in the work behind inflation and have goals to maintain their legacies with a robust economy that is illegitimately getting it on the cheap by inflating problems away. This legal separation, keeping the central bank legally distinct from other parts of the government allows the Fed to work with their heads down, since short term interests and long term interests conflict. There is a time consistency problem of wanting to achieve prosperity in the short run for all even if it comes at the expense of the soundness of our currency, but in the long run, we want reliability that the government won't debauch the currency. There is a tremendous amount of uncertainty that the Fed has to make decisions within. The central bankers are human and ideological in evaluating conditions of uncertainty. When we think about Fed reform, we should be mindful of the fact that the people of the Fed are important and we should know much about them.

the remarkable rise of ESG. responsible investing is widely understood as the integration of environmental, social, and governance ESG factors into investment processes and decision making. esg factors cover a wide spectrum of issues that traditionally are not part of financial analysis, yet may have financial relevance. this might include how corps respond to climate change, how good they are with water management, how effective their health and safety policies are in protection against accidents, how they manage their supply chains, how they treat their workers, and whether they have a corp culture that builds trust and fosters innovation

SRI socially responsible investment - based on ethical and moral criteria and uses mostly negative screens, such as not investing in alc, tobacco, or firearms, ESG investing is based on assumption that ESG factors have financial relevance. esg info about corps is vital to understand corp purpose, strategy, and mgmt quality of companies

One important tool is policy communication. Even if the overnight rate is close to zero, the Committee should be able to influence longerterm interest rates by informing the public's expectations about the future course of monetary policy. OTHER THAN policies tied to current and expected future values of the overnight interest rate, the Federal Reserve has and indeed, has been actively using a range of policy tools to provide direct support to credit markets and thus to the broader economy. As I will elaborate, I find it useful to divide these tools into three groups. Although these sets of tools differ in important respects, they have one aspect in common: They all make use of the asset side of the Federal Reserve's balance sheet. That is, each involves the Fed's authorities to extend credit or purchase securities

The first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short term liquidity to sound financial institutions. a second set of policy tools, involve the provision of liquidity directly to borrowers and investors in key credit markets. The Federal Reserve's third set of policy tools for supporting the functioning of credit markets involves the purchase of longerterm securities for the Fed's portfolio.

bernanke article: The Federal Reserve's Response to the Crisis The Federal Reserve has responded aggressively to the crisis since its emergence in the summer of 2007. Following a cut in the discount rate (the rate at which the Federal Reserve lends to depository institutions) in August of that year, the Federal Open Market Committee began to ease monetary policy in September 2007, reducing the target for the federal funds rate by 50 basis points. 1 As indications of economic weakness proliferated, the Committee continued to respond, bringing down its target for the federal funds rate by a cumulative 325 basis points by the spring of 2008. In historical comparison, this policy response stands out as exceptionally rapid and proactive. In taking these actions, we aimed both to cushion the direct effects of the financial turbulence on the economy and to reduce the virulence of the socalled adverse feedback loop, in which economic weakness and financial stress become mutually reinforcing

These policy actions helped to support employment and incomes during the first year of the crisis. Unfortunately, the intensification of the financial turbulence last fall led to further deterioration in the economic outlook. The Committee responded by cutting the target for the federal funds rate an additional 100 basis points last October, with half of that reduction coming as part of an unprecedented coordinated interest rate cut by six major central banks on October 8. In December the Committee reduced its target further, setting a range of 0 to 25 basis points for the target federal funds rate. The Committee's aggressive monetary easing was not without risks. During the early phase of rate reductions, some observers expressed concern that these policy actions would stoke inflation

participants: most mm participants operate on both sides of the market

US T: largest money market borrower. always issuer, never a supplier of funds. federal reserve system: responsible for money supply -> most influential participant. OMO

OMO 1. dynamic: change reserves and monetary base 2. defensive: offset factors affecting reserves, typically uses REPOs

advantages of open market operations: fed has complete control, flexible and precise, easily reversed, implemented quickly

in addition, open market desk has recently expanded its overnight term repurchase agreement operations. fed funds rate reduced to 0.5 to 0.75% at meeting

announced measures related to discount window, intraday credit, bank capital and liquidity buffers, reserve requirements, and us dollar liquidity swap line arrangements

yet what constitutes serving a social purpose can be very difficult to agree on and measure. some that oppose say that companies already serve a critical public purpose by supplying their goods or services to their customers, whom does fink think should be appointed to judge if companies adequately meet his objectives? to what extent should a public company spend shareholder money on its favorite causes, which shareholders may or may not support. where does social purpose investment stop and interference with shareholder rights begin?

any shareholder of any company can take his or her gain and put it to whatever good cause or social purpose desired or not. forcing a few people on boards of companies to pursue a social purpose is not a sustainable way of trying to change the world from top down. what happens to social purpose when a company loses $?

fed reserve b/s

assets: gov securities, discount loans liabilities: currency in circulation, reserves

MMs have a cost advantage over banks in providing ST funds

banks reserve req create an additional expense for banks. ceiling on interest rates that banks could pay until removed in 1985. initial goal was to limit risk from competition. became an issue when inflation in the 70s and 80s pushed ST int above rates banks could legally pay

SLIDES: response to a financial crisis revisited: fed cut benchmark rate to 0 to 0.25%

bond buying program to inject $ into economy. about 500bn T secs and 200bn agency MBS

participants cont: commercial banks: hold large % of US gov secs bc regulations prohibit banks from holding risky securities. major issuer of CDs, federal funds, repos, banker acceptances

businesses investment and securities firms: investment, finance, insurance companies and pension funds

by 1913, us was a major world player in production: high per capita income. model t ford assembly line

but had a third rate banking system. sweden and england had central banks in late 1600s, so why not US

summer 1906 no harvest: everything fine and banks were well supplied with money and interest rates were low, only lasted until the fall harvest

by 1900 this was a serious problem. no central bank existed, each bank had its own reserves. the monetary reserves in the country were scattered about in thousands of vaults across country, effectively inaccessible, at least inaccessible for any common purpose

capital adequacy mgmt: cushion against bank failure. if you have a loan loss, but have enough capital then the loss isn't so bad. so why don't banks want to hold a lot of capital? tradeoff between safety (high capital) and ROE. banks also hold capital to meet capital requirements

capital adequacy: regulation requirements. leverage tests (capital/total assets) to be classified as well capitalized > 5% below 3% triggers regulatory restrictions. doesn't capture off bs exposure. doesn't account for variations in asset risk. risk based capital ratios: effort to adjust leverage for off bs items that could add risk AND reduce req for items like cash. capital must exceed 8% of the banks risk-weighted assets and off bs activities. basel accord deals with risk-based capital requirements

money market: secs with initial mat less than one year. short term timing issues, greater liquidity, lower risk

capital market: secs with initial mat more than one year. LT investment projects, less liquidity, greater risk

gov secs: purch in the open market. in most circum, secs issued by the Treasury. provides reserves to the banking system by purchasing securities discount loans: to banks and other fin inst at the discount rate

change in assets lead to change in reserves -> change in the money supply assets earn more than the interest rate on liabilities -> fed makes money

functions of 12 FRBs

clear checks, issue new currency and remove damaged currency, administer and make discount loans to banks in their districts, eval bank mergers and expansions, liaison between local community and fed reserve system, perform bank exams, collect and examine data on local business conditions, conduct research related to monetary policy

FOMC statement

consistent with it statutory mandate, what fed seeks to foster is maximum employment and price stability. fed will use full range of tools to support flow of credit to HH's and businesses so that they can stay liquid and continue to operate. support fxing of markets by buying T bonds and buying agency backed securities

negotiable CDs: a bank issued security that documents a deposit and specifies the interest rate and maturity date. term security as opposed to a demand deposit. bearer instrument - can be bought and sold

denominations range from 100k to 10M. int rates similar to other MM instruments: low perceived risk

FOMC: 7 members of the BOG plus presidents of FRB of NY and four other FRBs

directs open market operations, advises for reserve requirements and advises for discount rate

OMO conducted through primary dealers, purchase or sale of bonds is a primary determinant of changes in reserves and interest rates

discount lending: loans to a bank loans or buying bonds increases reserves (the reverse decreases reserves)

discount loans: primary credit- healthy banks borrow as they wish from the primary credit facility or standing lending facility. short term: usually overnight

discount rate (set higher than fed funds target to encourage banks to borrow from each other) secondary credit: given to troubled banks experiencing liquidity problems seasonal credit: designed for small, regional banks that have seasonal patterns of deposits

12 federal reserve banks involvement in monetary policy

discount rate: establish the discount rate at which member banks may borrow from the fed reserve bank (subject to BOG review)

liquidity provisions

discount windows expansion - discount rate lowered several times term auction facility - another loan facility offering another $400 bn to inst new lending programs: incl lending to IBs, and lending to promote purchase of ABS

member banks: around 2000 member commercial banks,

elect 6 directors to each FRB

discount loans: det which banks receive loans

elect one member to federal advisory council FOMC: five of the 12 bank presidents vote in the FOMC

twelve FRBs: each with nine directors who appoint president and other officers of the FRB

establish the discount rate and select federal advisory council

CP: unsecured promissory notes, issued by corps that mature in no more than 270 days (to avoid SEC registration) most issuers back up CP with back up line at a bank - reduces the risk and lowers the interest rate. the use of CP inc significantly in the early 1980s bc of the risking costs of bank loans. 0.85$ trillion outstanding in 2013

eurodollars: rep Dollar denominated deposits held in foreign banks. depositors receive higher rates on dollar deposits in the eurodollar market than in the domestic market. borrowers receive rates as well - multinational banks. not subject to same regulations restricting US banks. willing to accept narrower spreads between interest paid on deposits and interest earned on loans. LIBOR: overnight LIBOR and fed funds rates tend to be close: near perfect substitutes

any time that $ was tight, each bank did what was sensible for it, tightened up, called loans in, bolstered its reserves, and that drained cash from the system, very frequently setting off cash crunch and depression

every fall, banks in countryside who needed cash for harvest drained cash from cities. since no central bank existed to smooth out lumpiness or act as a lender of last resort, interest rates in cities would soar to 100%. this was amid what was otherwise a very developed and modern economy

reserve req: req put on fin inst to hold liquid (vault) cash against checkable deposits

everyone subject to same rule for checkable deposits: 3% of first $48.3m, 10% above fed can change the 10% rarely used as a tool: raising causes liquidity problems for banks makes liquidity management unnecessarily difficult

fomc sets target for fed funds rate: interest rate on overnight loans of reserves between banks. rate the fed tries to influence directly

execution: FRB NY trading desk main way: temporary OMO: REPOs: the fed purchases secs with an agreement to sell them back in a short period (1-15 days) matched sales purchase transaction: essentially a reverse repo, where fed sells securities, but agrees to buy them back

the expansion of the fed reserve's bs during and after GFC

fed agency and debt mbs up, LT treasury purchases, traditional security holdings stable, lending gone up

NYT article

fed are trying to prevent near term disruptions caused by allowing businesses to default loans or close permanently, which could inflict LT damage that could take years to shake off. working on making sure inner workings of fin markets function smoothly at a time of intense volatility

fed cut the benchmark rate to 0-0.25%. they also talked about a bond buying program to inject $ into the economy. if the fed is all of a sudden buying a ton of bonds, increases liquidity bc cash in the market, money supply inc. if we are buying bonds, it means that we're supporting bond prices and that cash is going into the economy. if we buy bonds and support bond prices, that lowers interest rates

fed is using the same tools this time, but what's causing the problem now is completely different

monetary policy= actions that influence the avail and cost of $ and credit to help promote national economic goals

fed reserve controls three tools: discount rate (BOG), reserve req (BOD), OMO (FOMC)

committee will use tools and act as appropriate to support economy and adj. based on max employment obj. and 2% inflation obj. will take into wide range of info like measures of labor market conditions, indicators of inflation pressures and expectations, and readings on financial and int'l devo

fed reserve prepared to use full range of tools to support flow of credit to HH and businesses and promote max employment and price stabil goals. to support smooth fx of mkts for treasury securities and agency MBS that are central to flow of credit to HH and businesses, committee will inc holdings of T secs by 500$bn at least and agency by at least 200$bn. committee will reinvest principal pmts from fed reserve's holdings of agency debt and agency mbs in agency mbs

nonconventional monetary policy tools and QE

financial sys seized. zero lower bound problem, could take rates below zero non conventional tools: liquidity provision, asset purchases, commitment to future monetary policy plan

resistance to central bank grew out of fear of centralized power and distrusted of moneyed interests

first bank of US disbanded in 1811. second bank of US charter expired 1836. no lender of last resort to provide reserves to banking system to avert a panic. nationwide panics were a regular event. panic of 1907 was the political impetus for the federal reserve system

fed's dual mandate: jobs and inflation - meat and potatoes. new approach to financial stability: become a more integral part of the meal

first build up strength and resilience of the financial system second develop and apply a broad framework for monitoring financial stability on an ongoing basis third: explain a new approach as transparently as possible, so that the public and reps in congress can provide oversight and hold us accountable for this work

fed did a half percentage point interest rate cut last week. however, although fed has to ease credit conditions, ensuring market liquidity, and promoting confidence, the most important policy actions will be fiscal

first fiscal actions should be to ensure that hospitals and medical professionals across the country have all necessary resources. industries such as travel, hospitality, manufacturing, and others may require some form of targeted economic stimulus. so far bipartisan momentum is good

four lessons from 2008 that we can use against this new panic

first: transparency is essential. leaders should urge calm, but there must be a healthy balance between conveying calm and being frank about troubling facts. the public and financial markets are seeking UNATTAINABLE CERTAINTY, WHICH ADDS TO FEAR AND VOLATILITY

early 20th century, we did not have a central bank. 1906 summer, we don't have a harvest, farms don't need cash yet to pay harvesters. but after harvest starts, people need cash in midwest, and huge interest rates. rates could swing a lot based on if you needed cash or not

from lowensteins remarks, this was a serious problem. since no central bank existed, each bank had its own reserves. the monetary reserves were scattered, effectually inaccessible for any common purpose. when money was tight, each bank tightened up, draining cash from system and setting off a depression sometimes. no cb existed to smooth out lumpiness or act as lender of last resort and rates soared to sometimes 100%

basic banking business: accept deposits and make loans. loan portfolio: commercial and industrial, RE, consumer and other. sources of capital: liabilities = checkable deposits, non transaction deposits (higher interest rates), borrowings. Bank capital

how does a bank make money? selling liabilities and using the proceeds to buy assets (asset transformation) ex: taking deposits -> making loans. fee business. loan sales. trading activities

fomc meets 8x a year (about every 6 weeks)

important agenda items: reports on OMO (foreign and domestic), national economic forecasts are presented, discussion of monetary policy and directives, including views of each member, formal policy directive made, post-meeting announcements as needed

QE vs Credit Easing. fed chairman bernanke argued that the fed engaged in credit easing, actions to impact credit markets

improve the fxing of credit markets, unfreeze the markets, purchase assets - lower int rates on securities and reduce borrowing costs to stimulate spending

former un secretary general kofi annan wrote to 50 ceos of major financial institutions inviting them to an initiative to integrate esg into capital markets. a report was produced called "who cares wins" which made the case that embedding environmental, social and governance factors in capital markets makes good business sense and leads to more sustainable markets and better outcomes for societies.

institutional investors were initially reluctant to embrace the concept, arguing that their fiduciary duty was limited to the maximization of shareholder values irrespective of environmental or social impacts, or broader governance issues such as corruption. but evidence has grown that ESG issues have financial implications, the tide has shifted. ESG integration is increasingly seen as part of fiduciary duty

revisit T bills auction.

int rates on MM securities move together. fed funds, t bills, CDs, CP

trump says he could demote fed chair powell, risking more market turmoil. this threat risks further destabilizing markets by worrying investors, who are already fretting over the economic fallout from shut down businesses, quarantined workers, and curtailed acitivty

investors are looking to the fed to help contain the fallout, powell has led his colleagues in slashing interest rates by half a percentage point in one of the earliest global central bank responses to the coronavirus. trump cannot fire powell, but can demote him, but if he tried, the FOMC which sets interest rates, could still select powell as its leader

BOG of the FRS also does a lot of research

largest employer of economists in the world, offers insight on incoming economic data and interprets where it suggests economy is heading provide briefs for formal meetings on the economic outlook of us provide support for supervisory staff in decisions about bank mergers, lending activities, and other technical advice produce reports on the devo in major foreign economies public edu

open market purchase from primary dealer. fed assets inc with the securities, banking system assets decrease. fed liabilities for the reserves inc, banking system gets inc of reserves

leads to expansion of reserves and deposits in the banking system -> expansion of monetary base and money supply

discount lending: fed assets: discount loans inc, liabilities: reserves inc banking system: assets reserves inc, liabilities: loans inc

leads to expansion of reserves which can be lent out as deposits -> expansion of the monetary base and the money supply

commercial bank bs: cash: reserves, cash in process of collection, deposits at other banks. secondary reserves: securities. primary source of profit: net loans and leases (gross - reserve) other assets, physical aka buildings etc

liabilities and equity: deposits 2% checkable, 69% nontransaction-> primary source of bank funds. borrowings inc over time. equity cushion against drop in asset value & insolvency

asset management: loans (risk assessment and monitoring) securities, diversification, liquidity of its assets (in order to satisfy reserve req)

liability mgmt: sources of funds: deposits, cds, fed funds, other debt. prior to 60s, 60%of funds came from demand deposits. banks now manage both sides of the bs together: asset liability mgmt committee (ALM)

mgmt tasks for banks: liquidity management: ensure enough liquid assets on hand to meet obligations to depositors. asset management: asset risk diversification -> revenues and loan losses. liability mgmt: funding bs -> impacts net interest income. capital adequacy mgmt, two key areas of risk management: credit risk and interest rate risk

liquidity mgmt: sufficient liquidity to meet deposit outflows. adequate reserves to maintain req reserve levels or sources of liquidity to replenish reserves

fomc

max employment and price stability

fed reserve banks are quasi-public institutions owned by member banks

member banks have stock in their district fed reserve bank, receive dividends, and elect 6 directors NY, Chi, SF, own 50% of the assets of the Fed Res Sys. NY Fed owns 25% national banks (banks chartered by the Office of the Comptroller of the Currency) are req to be members state commercial banks may elect to join. currently about 1/3 of the commercial banks in the US are members of the sys all depository institutions are req to maintain reserves as deposits at the FRBs

mgmt of expectations: commitment to future policy actions. by committing to maintain short term rates near zero, future short term rates should also be zero, meaning long term rates fall. this is known as management of expectations

money markets: t bills, bankers acceptances, CD's, eurodollar time deposits, federal funds, repos

role of the fed from powell's remark. fed's dual mandate: jobs and inflation - meat and potatoes

new approach to financial stability - become a more integral part of the meal first build up strength and resilience of the financial system two: develop and apply broad framework for monitoring fin stabil on an ongoing basis third: explain the new approach as transparently as possible, so public and reps in congress can provide oversight and hold fed accountable for the work

asset purchases: QE

nov 2008, QE1 est purchasing 1.25T in mbs goal: prop up mbs market, lower int rates on residential mortgages and stimulate housing market nov 2010, QE2, fed purch 600bn in LT t's goal: lower long term interest rate -> stimulate investment spending sept 2012: QE3, elements of the first two, mbs and long term Ts quadrupled the fed's b/s

frb of NY: responsible for oversight of some of the largest fin inst hq in manhattan

ny fed houses the open market desk. all of the feds OMO are directed through this trading desk chairman of NY fed is the only permanent member of the FOMC NY fed is the only member of the Bank for Int'l Settlements providing close contact with other foreign central bankers

off bs items: commitments to lend, letters of credit (trade, standby, commercial), options (fx forwards, swaps, FRA's)

off bs activities: loan sales, fee income, trading activity -> ways to inc earnings that don't require reserves. but some off bs activities do have capital adequacy implications

fomc is the most imp tool fed has for money supply

other tools like reserve req are not as essential. open market operations are the most imp.

12 banks: quasi-public

owned by member commercial banks in the district member banks elect 6 directors, while 3 directors appointed by BOG directors rep professional bankers prominent business leaders, and public interests (3 from each group)

henry paulson article on how the 2008 financial panic can help us face coronavirus

paulson is a former US treasury secretary. in 2008 he worked to help stem the panic and restore the economy amid a witches' brew of a bursting housing bubble, collapsing financial system, rapidly spreading fear, and deeply polarized politics. now we are on the prospect of another panic, with the immediate cause being a virus, not financial markets or the economy, which remain strong, but fear again is the enemy

Our gradual pace of raising interest rates has been an exercise in balancing risks. We know that moving too fast would risk shortening the expansion. We also know that moving too slowly--keeping interest rates too low for too long--could risk other distortions in the form of higher inflation or destabilizing financial imbalances. Our path of gradual increases has been designed to balance these two risks, both of which we must take seriously

powell cont.

THESE THREE SETS OF POLICY TOOLS lending to financial institutions, providing liquidity directly to key credit markets, and buying longerterm securities have the common feature that each represents a use of the asset side of the Fed's balance sheet, that is, they all involve lending or the purchase of securities. The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound

powell: Congress assigned the Federal Reserve the job of promoting maximum employment and price stability. I am pleased to say that our economy is now close to both of those objectives. The unemployment rate is 3.7 percent, a 49-year low, and many other measures of labor market strength are at or near historic bests. Inflation is near our 2 percent target. The economy is growing at an annual rate of about 3 percent, well above most estimates of its longer-run trend. For seven years during the crisis and its painful aftermath, the Federal Open Market Committee (FOMC) kept our policy interest rate unprecedentedly low--in fact, near zero--to support the economy as it struggled to recover. The health of the economy gradually but steadily improved, and about three years ago the FOMC judged that the interests of households and businesses, of savers and borrowers, were no longer best served by such extraordinarily low rates. We therefore began to raise our policy rate

lender of last resort function: to prevent banking panics, ex continental illinois

really needed? what about FDIC? problem 1: fdic only has about 1% of deposits in the insurance trust problem 2: over $1.1T are large deposits not insured by the fdic

monetary policy impacts: money supply and interest rates, level of economic activity

reminder: fed's mandate is to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates

fed funds: ST Funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day. used by banks to meet st needs to meet reserve requirements. borrow or invest dep on whether they have deficit or excess reserve req. competitive market. fed reserve does not control fed funds rate but it does indirectly influence it

repos: these work similar to the market for fed funds, but nonbanks can participate. a firm sells T secs, but agrees to buy them back at a certain date (usually 3-14 days later) for a certain price. this set up makes a repo agreement essentially a ST collateralized loan. low risk, low int rates. fed uses repos to conduct monetary policy

currency in circulation: dollars in the hands of the public, obligation of federal reserve reserves: banks deposits at the fed plus currency physically held by banks

required reserves + excess reserves fed sets the required reserve ratio currency in circulation + reserves = monetary base

policy tools

reserve req, OMO, discount rate

changes in the banking system: shadow banking system - lending via the securities market (securitization). bank consolidation. financial engineering - responses to changes in demand and supply conditions ex electronic banking. separation of banking and other financial services

risks faced by FI's credit, fx, liquidity, interest rate, market, off bs, tech, operational, sovereign, reputation impact: asset values (loan losses, fx changes, interest rate changes), profits, liquidity and solvency

federal advisory council: twelve members (bankers) one from each district

selected by the twelve FRBs

barron's trouble with larry. blackrock ceo larry fink is saying that society is demanding companies serve a social purpose. to prosper over time, every company must not only deliver financial performance but also show how it makes a positive contribution to society. socially responsible investing approach. ESG environmental social and governance factors mentioned in fink's letter. companies should be run for the benefit not only of shareholders, but all stakeholders including customers employees suppliers the environment and other potential constituencies

serving a social purpose is now much more prevalent of a characteristic of a company to elicit respect asides from just having strong management. ethical business practices now encompass serving a social purpose. fink alludes to the fact that if we want to survive and prosper as a society, we need to address challenges like unemployable people in a time of globalization and environmental issues. companies making positive contributions to society foster a healthy, symbiotic relationship between business and people

7 BOG appointed by the president, and confirmed by senate for 14 year terms on a rotating schedule. all board members are members of FOMC

set reserve req and effectively set the discount rate serve in an advisory capacity to the president, represent US in foreign economic matters

BOG has been given other roles through legislation

sets margin req for stock purchases. sets the salary of the president and all officers of each FRB and reviews each bank's budget. other duties as est by legislation (eg regulation Q, credit control act of 1969)

BOG: 7 members including the chair, appointed by president and confirmed by senate

sets the reserve requirements and reviews and determines the discount rate. they appoint three directors to each FRB

potential impediments to ability of these efforts to expand money supply and stimulate the economy

short term rates were already near zero. inc monetary base did not lead to inc lending - banks added to excess reserve holdings. expansion of the fed's bs did not result in a large inc in the money supply

chairman of the fed reserve system

spokesperson for the entire fed reserve system, supervises the board's staff negotiates as needed with congress and the president with these, the chairman has effective control over the system, even though he doesn't have legal authority to exercise control over the system and its member banks

design intended to diffuse power along regions of US, gov and private sector interests, needs of bankers, businesses, and the public

system now includes: 12 fed reserve banks, BOG board of governors, FOMC, federal advisory council, member banks (around 2000)

t bills: 28, 91, 182 day maturities. issued at a discount from par: return computed using face amount in the denominator. 360 day year. virtually zero default risk (risk free). deep, liquid markets. sold at auctions

t bills are auctioned to the dealers every thursday. the treasury may accept both competitive and noncompetitive bids, and the price everyone pays is the highest yield paid to any accepted bid

MM instruments

t bills, federal funds, repos, negotiable CDs, CP, eurodollars, banker's acceptances

interest income - int exp - loan loss provision: net interest income + non-int fee income, gain/loss on secs - non-int expense - taxes = net income

the bs: deposits -> loans deposit $100 check. bank assets: reserves $100. liabilities: checkable deposit of $100. $10 of the deposit must remain with the bank to meet fed regs. bank is free to work with the $90. the bank loans $90 to its customers. assets: req reserves $10 and loans of $90. liabilities: checkable deposits $100

tools from bernanke 2009. although these sets of tools differ in imp respects, they have one aspect in common: they all make use of the asset side of the fed reserve's b/s. that is, each involves the fed's authorities to extend credit or purchase securities

the first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of ST liquidity to sound financial institutions second set of policy tools involve the provision of liquidity directly to borrowers and investors in key credit markets third set of policy tools for supporting the functioning of credit markets involves the purchase of longer term securities for the fed's portfolio

second: in a crisis, leaders can never gather all the facts before they need to act. cannot wait too long. crises demand nimbleness and FLEXIBILITY as facts evolve and leaders have to change course

third: the economic impact of this crisis and the hardships on the american people will be greater than necessary unless dems and repubs and congress and the executive branch COME TOGETHER quickly to take actions that are politically difficult but necessary

in 2008 when investors lost confidence in all forms of credit and retreated to T bills, repubs and dems came tog to give the executive branch expansive but necessary authorities and funding

today fear is as big an enemy as the virus itself. challenges are greater in 2008 bc leaders must balance their responsibility to protect the health of citizens with their obligation to manage the economic impacts on those same citizens. scope of the virus is unknowable but we do know that unlike 2008, our financial institutions are well capitalized and prepared to withstand a financial shock

issues: moral hazard

too big to fail

influences the demand for and supply of, balances that depository inst hold at the FRBs and in this way alters the federal funds rate

triggers a chain of events that affect other ST interest rates, FX rates, LT interest rates, amt of money and credit, and ultimately a range of economic variables, including employment,output, and prices of goods and services

regulatory entities: FDIC federal deposit insurance corp. OCC office of the comptroller of the currency (treasury dept) federal reserve system. state banking authorities

types of reg: safety and soundness - capital adequacy basel II/III. monetary policy - reserve req. credit allocation regs - social issues. consumer protection - home mortgage, disclosure, retail credit. investor protection - sec. chartering and entry - occ, state bank regs

full article fomc on qst tools

us economy has come into this challenging period with a strong footing. labor market strong and economic activity was rising at a moderate rate in february. committee seeks to foster max employment and price stability, lowered target range for fed funds rate to 0 to 0.25%. committee expects to maintain this target range until it is confident economy has weathered recent events and is on track for maximum employment and price stabil goals. will support economic activity, strong labor market conditions, and inflation at 2% obj

in 1913 us was a major player in world production: high per capita income, model t ford assembly line, but had a third rate banking system. sweden and englad had cb's in the late 1600s

us hx politics has a major characteristic of fear of centralized power. resistance to cb grew out of fear of centralized power and distrust of moneyed interests

fourth lesson from 2008 is that notwithstanding tensions between parties and branches it may be necessary to give the administration broad authority and flexibility to act. congress can't design and implement every stimulus program when facts on the ground change

we are more polarized today than in 2008, and unlike in 2008 the incumbent president is on the ballot. but we have the world's most tech savvy HC system and strongest financial institutions and financial sys that is much more resilient today than it was then. economy is broader, strong, and more diverse than any other

risk adjusted assets: on bs assets. off bs contingent or guarantee contracts (letters of credit, repos, loan commitments). off bs market contracts or derivatives: counterparty exposure (risk that the other side will default) potential exposure, current exposure.

what is the leverage ratio. maybe the bank capital over total liabilities? risk adjusted assets: weights applied to each item on assets

MM: short term and highly liquid securities - not money, but close to money. whole sale market - most transactions very large, usually 1M or more. active secondary market - highly liquid. low default risk. mature in one year or less from their issue date, although most mature in less than 120 days

who uses them? firms "warehouse" surplus funds. low cost source for ST funding needs. hold liquid funds for investment opportunities. meet investment or deposit outflows. bridge timing issues: inflows and outflows rarely synchronized. not a high yield, but better than no yield