Showing posts with label Fed Balance Sheet. Show all posts
Showing posts with label Fed Balance Sheet. Show all posts

08 October 2011

Modern Economics: The Money Masters and Modern Economic Theory - Credibility Trap



Yesterday it was Yves Smith who took Paul Krugman to task. And I defended him in that instance in the comments. But now alas it's my turn, and I don't take this up lightly.  So I must think it is important.

And I do.  Because a false premise is being used to justify a false conclusion and by extension a matter of serious public policy in an ongoing debate. And people are in the streets about it.

In a recent op-ed Way Off Base Paul Krugman says:
"I see some commenters reacting to the failure of major inflation to break out by insisting that inflation is defined as an increase in the monetary base — that is, the bank reserves plus currency that are what increases when the Fed “prints money”. As it happens, that’s wrong: very old dictionaries defined inflation as a rise in money and/or credit, but the modern usage is, of course, a rise in prices.

But that’s really a side issue. Nobody would care about the size of the monetary base except for the belief that increasing the base leads to a rise in prices. That’s not a question of definitions, it’s a question of your model of the economy."

For those unfamiliar with measures of money supply and the monetary base, see Money Supply: A Primer.

I don't know who these commenters are, but they *could be* those from the Austrian school, who tend to look to what they call True Money Supply. I would have to read up to find out what the anticipated lag times are between expansion and its aftereffects.  It could also be from those who are forecasting hyperinflation, but those are few and I am not among them.  My forecast has long called for a credit bubble followed by a financial collapse and stagflation as the most like outcome but it is no economic model, more of a judgement call.  The variables are too many and too exogenous for any model that I could possibly devise. . Or the model Paul references could be just a strawman.

Except for the Austrians, and of course perhaps Paul Krugman when it suits him, I don't know of many rational financial people who would look to a very narrow measure of money supply, especially the Monetary Base, and expect a simple causal effect in prices over a short period of time of even a few years, in an ongoing great recession with a very low velocity of money and little lending.  And of course the Fed is taking steps to ring fence their market operations.  And it seems to be working.

I thought the allusion to 'old dictionaries' versus 'new dictionaries' was an appeal to an authority that does not quite work anymore, as if Economics is somehow making steady progress, despite its most recent terrible flop and sometimes scandalous behaviour.   Yes Paul can point to a few timid warnings in old columns, but his models were remarkably silent in predicting the financial credit bubbles and collapse.

The answer of course is-- ta da, better models. And the definition is my shiny new model versus your old outdated model as I choose to define them.  But at the end of the day, the ideal economic model dictates policy with pristine mathematical objectivity.

Adjusted Monetary Base, who could care about it?

Well, the Fed spends quite a bit of time on it, and those who understand anything about economics know that in periods when the financial system breaks down, especially from some excesses promoted by central bank economists, the Fed becomes the 'lender of last resort.' And what they are lending is money they have created by expanding their balance sheet. If they were only providing temporary liquidity the balance sheet would not be expanding in such a parabolic manner and more importantly, remaining there.

In other words, the Fed becomes the 'money creator' and provider of last resort, expending a significant amount of effort to prevent monetary deflation which they find to be against their mandate of what-- a stable money supply and rate of inflation.

The monetary base is a source of money, not broad money in public hands, which the Fed provides under the duress of stressful financial conditions, rather than mere economic cyclical turns.   Which is fine, because that is their job as currently defined. And the Monetary Base is one way of measuring it.

The Monetary Base has a particularly long lead time, or lag as economists call it,  before even large changes appear in the real economy in the form of higher prices and a money supply that is growing in excess of some organic demand.   I am sure Paul is aware of the devaluation of the dollar and the dramatic expansion of the monetary base undertaken in the 1930's by FDR, and the rather dramatic change in trend for consumer prices that followed, albeit not only from that, but other price support programs.

There is definitely a kernel of truth in what Paul says. "By contrast, the model of an economy in a liquidity trap, in which big increases in the monetary base don’t matter, comes through just fine."  And Ben and the Fed are managing their activity with an eye to targeting it to the banking system, and taking steps to keep it from moving into the broader money supplies too quickly.

Adding liquidity from the monetary base in the face of sagging aggregate demand is not having a profound effect on broad prices in the relatively short term. I mean, duh. If the model suggested this it is right.

But that does not imply that some connection is not there, that it is meaningless.  What it means is that so far at least, the Fed is managing their quantitative easing reasonably well.  Unfortunately so well that it is not having the desired effect on the real economy or the banking system for that matter, except that the zombies are still standing.  Just because something is not yet a smoking ruin does not bring cause for celebration.

The Fed is 'bottling up' the expansion of the monetary base in the banks, and quite a bit more of it than we had suspected as eurodollars, money provided to banks overseas.  And they stopped measuring eurodollars a few years ago in one of the broadest money measures, M3. 

The Fed, and I assume Paul Krugman know all this, but believe that they will have the tools, and knowledge, and the latitude to reduce their balance sheet when the time is appropriate and the real economy and banking system recovers. 'Volcker did it.' And so can we, because the models say so.

What the Fed and Paul Krugman are really saying is "Trust us."  And our models.  And don't think that the BLS and the government are tinkering with the econometric measures.  Are you kidding me?   It takes a willful blindness to ignore some of the more egregious tinkering that the government is doing in the name of perception management.

As for the comment about 'printing money,' it was Ben himself that said, 'the Fed owns a printing press.' And he was telling the truth.

I am not a believer in True Money Supply and greatly prefer broader money supply measures. And I know what the Fed is doing is providing an inflation risk that they believe that they know how to handle when the time is right.

And I also know that inflation is starting to pop up in certain sectors and items. And why it is not a broad increase yet, which is what we might call inflation. With most of the increase in money supply flowing to a very few in the form of income, well, this is all understandable.

So what was the point of Paul bringing all this up? It was this.
"Here are the data — I’ve included commodity prices (IMF index) as well as consumer prices for the people who believe that the BLS is hiding true inflation (which it isn’t)"
Let's see. The BLS is not distorting inflation measures because the model is working, and we know the model is working because of the BLS inflation measures.  That seems a little shaky to me.  Especially in light of the other data that shows that certain price sensitive assets are rising in price, and sharply, in response to negative real interest rates, as some other models and theories would hold.

Yes the US is in a liquidity trap.  And yes, the actions of the Fed so far have not triggered a broad monetary inflation because of the slack demand, and the consequent lack of lending and real economic growth.

And yes some well targeted stimulus could help to break this self-perpetuating situation. 

And anything that does not agree with my model is a bubble, and anomaly, or someone else's fault.

The root causes of the problems in the real economy have not yet been changed, and the system has not been reformed.  And the model which Paul points to is really only one correlation in a broader model that has failed, and badly, because it is an abstraction that only has a tenuous relationship with reality.

It is not so much that Paul Krugman is wrong.  There are others who are much, much worse, the purveyors of austerity, and efficient market based deregulation, and supply side economics.  

But Krugman is swinging open the door for the Modern Monetary Theory crowd whether he realizes it or not, by going a bridge too far in his misplaced conclusions and triumphalism.  Extremism in defense of stimulus is no vice, but it is an offense to reason. 

Hey, we haven't blown up the economy lately, so why worry?

Don't get me wrong.  I wish Keynes was still alive, so Keynesian economics could evolve based on new data, which I am quite sure it would.  In response to new data, JMK changed his mind.  And I am sure he would do so again.  I find myself at odds with almost every economic school because I am not an economist by training, and their dogmas and models grate on rational minds.

I liked Roosevelt, because as a non-economist he was open to trying things, but changing them if they didn't work.  If he would have had a model, he would have beaten the country to death with it.  That was the difference between Hoover and Roosevelt, the lack of intellectual pretension.

Well, if we only had more stimulus it would have worked.  Yes that is a thought, except the system is BROKEN.  The only thing we are stimulating is more money for the wealthy, more jobs for China, and more debt for the people.  Yes I think there is some short term benefit for those in the most distress in some of the programs, and that is a good thing.   But pouring stimulus into a broken system is only going to mask the rot, and hasten the final reckoning.  I thought this is what Greenspan tried after the tech bubble collapse.  And here we are again.

Better for the Fed and the economists to proceed in fear and trembling, showing their work clearly, and engaging in honest and open discussion, than risk the final, utter and total repudiation of their profession when 'trust us' fails again.

And I think it is incredibly naive to make that case that since the Fed has not blown the economy up yet, that all is well, and that printing money in whatever amounts has no significant consequences.  No one believes that except a few economists who frighten me in their slavery to their models, and I would hope that you are not one of them.

Perhaps the most useful thing that Paul Krugman could do is go join Occupy Wall Street, and demand the Congress and the President take some serious action in reforming the system, because that is the only thing that is going to provide a sustainable recovery.

"Economic models are no more, or less, than potentially illuminating abstractions...The belief that models are not just useful tools but also are capable of yielding comprehensive and universal descriptions of the world has blinded its proponents to realities that have been staring them in the face. That blindness was an element in our present crisis, and conditions our still ineffectual responses.

Economists – in government agencies as well as universities – were obsessively playing Grand Theft Auto while the world around them was falling apart."

John Kay, An Essay on the State of Economics
and the associated essay of mine, The Seduction of Science in the Service of Power

Paul Krugman has been good at calling Obama and his advisors on their financial policy errors, and was roundly and unjustly criticized for it. I link to his columns frequently, because he is good at what he does, and he often speaks his mind with honest authority.  And compared to many others in his profession he has been a paragon of virtue. But when it comes to their models, most economists have a fatal attraction that leads them astray.

As in all discredited professions, even if it has been due to the actions of a minority, the others must be beyond reproach, and take special care in choosing their words and their arguments.  I am sorry to say that is the case with other professions now, and it is also the case with economists.

As a great economist once said, "Economics is extremely useful as a form of employment for economists." As for the rest of it, well, they have their place. They just get giddy sometimes, especially when exposed to real power, and fawn all over it.

But don't most people. They just do it with a little more humility, and with more sense of uncertainty and attention to the downsides of risk, the so-called 'black swans' that economists' models do not describe or permit, and sometimes do not even acknowledge until face meets dirt.

Obama is failing, but the alternatives are worse. Small consolation. I think the US can do better.

A great leader in a similar crisis said,
"Confidence...thrives on honesty, on honor, on the sacredness of obligations, on faithful protection and on unselfish performance. Without them it cannot live."

If most leaders in Congress and the Administration stood up and said that today, the audience would be rolling in the aisles with laughter. And if anyone from the financial sector said that, well, I would not wish to be in the radius of a lightning strike, God's work notwithstanding.

And that points to the heart of the problem. We are caught in a credibility trap, in which the leaders are so complicit in the abuse and corruption of the system that they cannot even begin to speak to it honestly and plainly, with their pockets weighted down with corporate money.   And they are teaching the rest of us by their example.


October 7, 2011, 3:15 pm
Way Off Base
By Paul Krugman

I see some commenters reacting to the failure of major inflation to break out by insisting that inflation is defined as an increase in the monetary base — that is, the bank reserves plus currency that are what increases when the Fed “prints money”. As it happens, that’s wrong: very old dictionaries defined inflation as a rise in money and/or credit, but the modern usage is, of course, a rise in prices.

But that’s really a side issue. Nobody would care about the size of the monetary base except for the belief that increasing the base leads to a rise in prices. That’s not a question of definitions, it’s a question of your model of the economy. The underlying belief of all the people accusing Ben Bernanke of doing something dastardly is that “printing money” has caused or will cause high inflation in the ordinary sense.

The thing is, of course, that the past three years — the post-Lehman era during which the Fed presided over a tripling of the monetary base — have been an excellent test of that model, which has failed with flying colors. Here are the data — I’ve included commodity prices (IMF index) as well as consumer prices for the people who believe that the BLS is hiding true inflation (which it isn’t):


A couple of notes: for the commodity prices it matters which month you start, because they dropped sharply between August and September 2008. I use the IMF index for convenience– easy to download. (Thomson Reuters I use when I just want to snatch a picture from Bloomberg). But none of this should matter: when you triple the monetary base, the resulting inflation shouldn’t be something that depends on the fine details — unless the model is completely wrong.

And the model is completely wrong. You don’t get more conclusive tests than this in economics. By contrast, the model of an economy in a liquidity trap, in which big increases in the monetary base don’t matter, comes through just fine.

And this in turn tells you something about the people pushing this stuff. They had a model; it made predictions; the predictions were utterly, totally wrong; and they have just dug in further.

I do not know who 'the people pushing this stuff' are, but that last sentence applies to almost every economist and financial pundit that I can think of, with only a few notable exceptions.

A great economist would come up with something new from this, some variation on a theme, would have LEARNED something. The original thinkers are often geniuses, but their adherents are too often true believers and interpreters of doctrine. My graduate academic experience with economists of some years ago is that they lag reality, and especially the sea changes, by quite a few years, always making plans for the last war and crushing the data to fit their abstractions.

And this sadly is what may have brought the Austrian, Classical, Marxist and Keynesian schools into a type of relative stagnation, with a lack of original thought and an adherence to learned models and learned dogma.  Monetarism seems to be waning as well into an American obsession with statistics, often for hire.   Each of the schools have something to contribute.  I have long been convinced however, that out of this new experience we are having that a new school of economic thought would rise out of the ashes.    So far it is not apparent, just attempts to revive the old ideas.

Perhaps this 'digging in' is the natural reaction to a crisis. Who has the presence of mind to 'think differently.' But it is killing off the ability of the country to move forward, especially given the media's penchant for airing an issue for the public by bringing out two professional 'strategists' who throw lies and distortions and cartoon examples at one another for ten minutes, and then call it a discussion. Ok, time to vote.

No wonder the people are confused and afraid. And beginning to take to the streets. And I shudder to forecast the outcome.

By the way, Robert Reich has a nice description that touches on the credibility trap in Occupiers of Wall Street and the Democratic Party.

And Michael Hudson does a fine job describing the heart of the Occupy Wall Street phenomenon and their desire for reform and their resistance to being used and diverted as has happened to the Tea Party. As he goes into his own economic prescriptions, I obviously do not agree with all his views, but he certainly makes some interesting points.

The system is broken. It needs to be reformed. People are tired of being used and lied to. They voted for change and were ignored when they expressed their views and quite strongly. And when they complain, they are ridiculed. And now they are getting really angry. And the powers-that-be are trying to figure out how to play them for their own ends.

As Dr. Zoidberg would say, 'Wow, the President is gagging on my gas bladder. What an honor.'

30 November 2009

Draining the Swamp: The Fed's Tri Party Repo Machine


A triparty repo transaction is a transaction among three parties: a cash lender acting on behalf of all holders of dollars (the Fed), a borrower that will provide collateral (dodgy debt holder in shaky financial condition), and a clearing bank, most likely a primary dealer like J.P. Morgan, which is only too happy to collect its fees as an agent of the Fed.

The triparty clearing bank provides custody (agency) accounts for parties to the repo deal and collateral management services. These services include ensuring that pledged collateral meets the cash lenders’ requirements, pricing collateral, ensuring collateral sufficiency, and moving cash and collateral between the parties’ accounts. What if any liabilities the clearing bank such as J.P.Morgan might obtain for the mispricing of risk remain undisclosed, but are probably negligible at worst.

This is the method of obtaining toxic assets from the books of non-primary dealers, and providing stability and liquidity from the aggregate value of all dollar holders to cover the misdeeds of diverse financial institutions and other favored parties.

In other words, the Fed is draining the financial debt swamp and toxic waste dumps into your basement, if you hold Federal Reserve Notes. Your IRA's, your 401k's, your savings, as long as you hold Federal Reserve Notes, which are claims on their balance sheet loosely backed by the Treasury. When the Fed's balance sheet contained nothing but Treasuries and explicity backed agencies that relationship was firmer. Now, we are into the realm of make believe and Timmy's credibility.

The Fed pledges Morgan assure them that there will be no radioactive material in the sludge pond headed your way, and levels of carcinogenic and toxic contamination will be within levels that they believe are adequate based on the non-binding estimates.

In practice the Fed has a defaults account on its book for the shortfalls from fat valuations due to the toxic debt it has already assumed on your behalf.

The source and composition of the sludge will remain a secret among the bankers, without oversight. This seems like taxation without representation, at least for holders of dollars that are US citizens, since the Fed is engaging in the expenditure of public money without hearings, votes, public oversight, or controls. The Fed seeks to become a financial Star Chamber, dispensing 'justice' as it pleases.

WSJ
Tri-Party Repo Could See 1st Round Of Reforms By Year-End
By Deborah Lynn Blumberg
NOVEMBER 30, 2009, 5:20 P.M. ET.

NEW YORK (Dow Jones)--Progress is being made in reaching agreement on a first round of reforms for the crucial tri-party repo market and details could be revealed as early as the end of this year, according to people familiar with ongoing discussions.

The reforms, which focus on margin requirements and intraday credit, are a first step in making security repurchase transactions more secure and preventing this $4.3 trillion over-the-counter market, where firms raise cash against collateral, from becoming a source of instability for the broader financial system.

They also come at a time when the repo market will be in the spotlight as the Fed plans for the day when it will start to pull the massive amounts of cash it has extended to markets from the system. The Fed is planning to use reverse repo operations--selling dealers securities such as Treasurys for cash with the agreement to buy them back later at a higher price--as one tool to achieve that goal.

The drive to reform the repo market--whose smooth functioning is key to the health of the financial system--has recently gained traction, in part due to the expiry of the Fed's primary dealer credit facility in February 2010. The facility serves as the current borrowing backstop for the big banks that deal directly with the central bank. Without it, the banks will have to rely more on repo for funding, which adds to the need to strengthen its functioning.

According to one person involved with the talks, the New York Fed-sponsored Tri-Party Repurchase Agreement Infrastucture Task Force could issue a progress report on repo reform discussions and seek feedback from the broader market as early as December.

The New York Fed was unavailable for comment.

The reforms will focus on the tri-party repo market, which makes up the biggest chunk of the repo market. In this market, a clearing bank stands between the borrower and the lender, holding collateral and facilitating the trades. The two dominant clearing banks in the U.S. are J.P. Morgan Chase & Co. (JPM) and the Bank of New York (BK).

In a first step, reform will focus on steps that market participants can address without outside input: standardizing margin requirements and tackling the issue of the intraday extension of credit in the market. Longer-term reforms to reduce systemic risk in tri-party repo are still being debated.

Standardized, or minimum margin requirements, would add security for the two clearing banks. Higher margins could be required for certain types of securities, such as commercial paper, or high-yield debt, or for riskier banks.

Intraday credit has also been a top concern. Currently, for operational efficiency, the two clearing banks extend intraday credit on term repos, or repos longer than overnight, meaning they return cash to the lender and securities to the borrower each day even though the contract continues to run. That leaves the clearing bank on the line should either counterparty falter.

One possible solution is to bring the U.S. term repo market more in line with overseas markets, by not allowing term repos using less liquid securities, such as corporate debt, to unwind every day. Other transactions, such as those using the more liquid Treasury securities, would still unwind every day.

The need for repo reforms has been apparent to policymakers for years, but was paid greater heed after severe disruptions in the market during the recent financial crisis.

Borrowers, lenders, clearers, industry groups and the Fed came together in September to form the repo task force and have been meeting every few weeks since then. Members have been working on crafting an initial set of reforms that would help to protect the tri-party repo market from future financial market disruptions.

25 September 2009

Do Ben and Tim = Thelma and Louise?


One cannot help but note that Team Obama is trying to derail serious proposals regarding financial reform for Wall Street at the G20 meeting, as we suggested they would.

The concerns raised by US revelations at the G20 today about new intelligence regarding Iran's secret underground nuclear facility have overshadowed financial reform and economic problems, and Gordon Brown's prescription yesterday that the G20 would become the new governing council for the world. It also stepped rather heavily on the House Hearings on HR 1207 "Audit the Fed" bill sponsored by Ron Paul and a good part of the Congress.

Why waste a crisis indeed. Especially when you can cop a two-fer.

Yesterday we put forward a somewhat lengthy piece on the Fed and reverse repos being considered titled Fed Eyes US Money Market Funds.

There is a key quote in there that we would like to highlight today.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion... Money market mutual funds have about $2.5 trillion under management..."
Only 100 billion in available capital for a relatively risk free short term investment in the global banking system including the Primary Dealers, does seem a bit tight for a set of such 'well capitalized' banks, especially since they aren't making many commerical loans, preferring to speculate in the commodity and equity markets for daytrading profits.
BNP Paribas Securities Corp., Banc of America Securities LLC, Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Daiwa Securities America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc. , Jefferies & Company, Inc., J. P. Morgan Securities Inc., Mizuho Securities USA, Morgan Stanley & Co. Incorporated, Nomura Securities International, Inc., RBC Capital Markets Corporation, RBS Securities Inc., UBS SecuritiesLLC.

Couple that with the revelation reported some time ago at ZeroHedge and covered here, that the Fed is taking on more than 50 percent of the longer dated Treasuries, and there is only about Ten Billion left on their balance sheet for expansion, and you get the picture of a financial system not cruising into recovery but heading straight at a confrontation with harsh reality.

We have considered the possibility that the Fed is doing this to place exclusively AAA and Treasuries on the balance sheets of the Funds, aka the Shadow Banking System, who are holding some seriously awful garbage. But this does not quite make sense unless those reverse repos are of a very long duration or rolled over automatically for a long period of time. A proper program such as was extended to the banks where the Fed buys the assets outright would be that solution. It made more sense to us that the banking system is still very tight on good capital assets and liquidity.

Here is an update from ZH that is somewhat compelling if one understand the implications. Visualizing the Upcoming Treasury Funding Crisis.

"Summary: foreign purchasers are congregating exclusively around the front end of the Treasury curve, meaning that the primary net purchaser of dated bonds has been the Federal Reserve. As everyone knows by now, the Fed only has $10 billion left out of the $300 billion total allotted for Treasury QE. That should expire next week. ... The time of unravelling may be upon us sooner than most think."
Do Tim and Ben = Thelma and Louise?

As the Eagles sang:

"Take it, to the limit, one more time..."


22 August 2009

When At First You Don't Succeed, Bring In the Reserves


Someone asked why Bernanke seemed so positive about the US recovery, and what he would do if his prediction turned out to be incorrect.

The first answer is rather straightforward. He is 'jawboning' or trying to increase confidence in the system to motivate businesses to spend and consumers to buy. The Fed can only set the playing field, but the players have to be confident enough to take the field. We think he is underestimating the neglect that the American consumer has taken over the last twenty years in terms of their overall poor condition (real income), and the disrepair of their equipment (household balance sheets), not to mention the rocks and snares and pitfalls remaining on the field from the gangs of New York and the economic royalists.

But let's assume Bernanke's first major gambit does falter. What is he likely to do next?

Beranke's Fed does have a printing press, and he has been using it as we all know. Here is a chart showing the expansion of the credit side of the Fed's Balance Sheet. This is from the top line labeled "Reserve Bank Credit" from the weekly H.41 report which is becoming more popularly followed these days. If one adds the Feds gold holdings, currency in circulation, and Special Drawing Rights, we get the Total Factors Supplying Reserve Funds.

http://www.federalreserve.gov/releases/h41/Current/



So what would Ben do for "Plan B?" Would he merely add more programs, expand the Fed's Credit Items even more aggressively?

There was an important function added to the Fed's bag of tricks during this crisis that has not received sufficient attention perhaps: their ability to pay interest on reserve funds on deposit with the Fed from the Member Banks.

As can be seen from this next chart, this amount is now substantial running close to a trillion dollars. A portion of this would be characterized as 'excess reserves.' The Fed should be able to motivate banks to use these reserve by adjusting the riskless interest rates they pay.

This was a much desired tool by the monetarist Fed because it enabled them to expand their Balance Sheet and add a significant amount of credit to the banks system immediately, but to keep 'a bit of a leash' on the downstream effects of this liquidity even after it was deployed.

As the Fed's interest rate remains sufficiently high, the reserves, especially the excess reserves, remain in the banking system, and are not deployed actively as loans and inflationary additions to the financial system.

The Fed issues an H3 report, Aggregate Reserves of Depository Institutions and the Monetary Base. In their latest report, they characterize $708.5 Billion of these reserves as 'Excess Reserves.'

So, what we might expect to see is the Fed, as the banking system stabilizes after perhaps some new programs and credit facilities, begin to slowly unleash these excess reserves by reducing the interest to the Member Banks, which would lower the bar and motivate them to engage in more commercial loan activity.

We think one problem is that the banks have more options than merely keeping their excess capital at the Fed or loaning it out to private companies.

Certainly Goldman Sachs has shown that it can defy all the odds and make millions each day by aggressively playing the equity, bond and credit markets. It is also more likely that banks would be inclined to invest their excess capital through acquisitions of other banks, which might represent a moral hazard in creating fewer, and more "too large to fail" institutions.

Therefore we might see the first serious moves towards financial reform before the Fed begins to really unleash the liquidity which they have created in the banking system.

There is of course also their monetization of Treasury Debt, to support the stimulus programs being run from the fiscal side of the US financial apparatus. That would be included in the expansion of their Balance Sheet, and we would expect that to continue on at the very least indirectly, if not overtly on the Fed's balance sheet.

An Aside on the Gold Stock of the Fed

By the way, one method the Fed might use to immediately expand its Balance Sheet would be to recognize that their gold stock is significantly undervalued.

In the H.41 Report, the Fed shows a credit of $11 billion dollars in Gold Stock held primarily in New York, Chicago, Atlanta, and San Francisco, with lesser amounts at each of the Regional Banks. This gold is part of the collateral against the Federal Reserve Notes in circulation, and has been valued at an official rate of $42.22 per troy ounce for many years.
1. Gold held "under earmark" at Federal Reserve Banks for foreign and international accounts is not included in the gold stock of the United States; see table 3.13, line 3. Gold stock is valued at $42.22 per fine troy ounce
By calculation the Fed has 261,511,132 fine troy ounces on its books. If the Fed revalued their gold stock at a more reasonable market price of let's say $1000 per ounce, then this would immediately add $261 billion to the Fed's Balance Sheet IF the gold is really held by the Fed without encumbrances.

One has to wonder why the Fed has never taken the revaluation on its Balance Sheet for gold since the value of $42.22 is so clearly an historic artifact. They perform much more market based calculations for the Special Drawing Rights and their Foreign Exchange holdings. One certainly does not need to sell the gold in order to monetize it, since that has already been accomplished, albeit at a much lower rate.

One can only wonder.

Federal Reserve H3.1.2 US Reserve Assets