Fed’s $4 Trillion in Assets Draw Lawmakers’ ScrutinyJeff Kearns
The Federal Reserve’s balance sheet is poised to exceed $4 trillion, prompting warnings its record easing is inflating asset-price bubbles and drawing renewed lawmaker scrutiny just as Janet Yellen prepares to take charge.
The Fed’s assets rose to a record $3.99 trillion on Dec. 11, up from $2.82 trillion in September 2012, when it embarked on a third round of bond buying. Policy makers meet today and tomorrow to decide whether to start curtailing the $85 billion monthly pace of purchases.
Among Fed officials, “there’s discomfort in the sense that the portfolio could grow almost without limit,” former Fed Vice Chairman Donald Kohn said last week during a panel discussion in Washington. Kohn said there was “discomfort in the potential financial stability effects” and added: “There’s some legitimacy in those discomforts.”
Fed Governor Jeremy Stein has said some credit markets, such as corporate debt, show signs of excessive risk-taking, while not posing a threat to financial stability. Representative Jeb Hensarling, chairman of the House committee that oversees the Fed, last week said he plans “the most rigorous examination and oversight of the Federal Reserve in its history.”
While any effort to rewrite the law establishing Fed powers lacks support from Democrats who control the Senate, the scrutiny is undesirable for central bankers who believe “independence is priceless,” said Laura Rosner, a U.S. economist at BNP Paribas SA in New York.
“It’s not a welcome development that a lot more time and focus is spent on answering questions” from Congress, said Rosner, a former researcher at the Federal Reserve Bank of New York. Lawmakers may also use the size of the balance sheet to “draw attention to concerns they have about the Fed’s responsibilities and growing role in financial regulation.”
Chairman Ben S. Bernanke, whose second four-year term ends next month, has quadrupled Fed assets since 2008 with bond purchases intended to lower long-term borrowing costs and reduce unemployment. Vice Chairman Yellen, who may win Senate confirmation this week to replace Bernanke, has been a supporter of the policy.
The Fed has said it will keep buying bonds until the outlook for the labor market has “improved substantially.” Thirty-four percent of economists surveyed by Bloomberg Dec. 6 predicted the Fed will start reducing purchases this month, while 26 percent forecast January and 40 percent said March.
The Fed’s balance sheet exceeds the gross domestic product of Germany, the world’s fourth-largest economy. It’s enough to cover all U.S. federal government spending for more than a year. It could pay off all student and auto loans in the country with $2 trillion to spare, Fed data show. The central bank’s assets are set to exceed the $4.1 trillion held by BlackRock Inc., the world’s largest asset manager.
The third round of quantitative easing probably will total $1.54 trillion before it ends, bringing the balance sheet to $4.36 trillion, according to economists in the survey.
“This is a stimulus of the first order. It’s just unprecedented,” Alabama Republican Senator Richard Shelby said in an interview last week. “The Fed is an independent body, but we can point out what they’re doing.”
Jeffrey Lacker, president of the Richmond Fed and a critic of the Fed’s bond buying, said in a Dec. 9 speech he expects the Fed policy makers to discuss reducing purchases at this week’s meeting. Adding to the balance sheet “increases the risks” associated with exiting stimulus, he said.
Shelby, a five-term senator and past chairman of the Banking Committee sees “a real risk” the balance sheet will ignite inflation. So far, there’s little sign that’s happening: a measure of prices watched by the Fed rose 0.7 percent in October from a year earlier, below the central bank’s 2 percent target and the least in four years.
At 22 percent of the $16.9 trillion U.S. economy, the balance sheet is surpassed by those of other major central banks as a percentage of gross domestic product, according to third-quarter data compiled by Haver Analytics in New York. In the euro zone, the figure is 24 percent, and in Japan, it’s about 44 percent.
That doesn’t mollify Republican critics. When Yellen started to make global comparisons at her Senate confirmation hearing last month, Shelby interrupted her.
“I’m asking about the Federal Reserve of the United States of America,” he said.
Yellen is set to take over amid warnings that assets from leveraged loans to farmland are showing signs of froth.
The Fed and other U.S. banking regulators have said they want to crack down on underwriting standards in the market for high-risk, high-yield loans.
Non-bank lenders such as mutual funds, hedge funds and pools of collateralized loan obligations, bought $630 billion of the loans this year, surpassing the 2007 peak of $581.5 billion, according to data compiled by Bloomberg.
Sales of high-yield, high-risk bonds, rated below Baa3 by Moody’s Investors Service and lower than BBB- at Standard & Poor’s, soared to an annual record of $373.2 billion this year, data compiled by Bloomberg show. That compares with $149.2 billion in 2006, the year before the start of the credit crisis.
The extra yield investors demand to hold speculative-grade bonds rather than government debt reached 411 basis points, or 4.11 percentage points, last week, the least since October 2007, according to Bank of America Merrill Lynch index data. Spreads ended the week at 412 basis points.
Sales of institutional loans have also reached an annual record, soaring 71 percent from 2012 to $627.1 billion, according to data compiled by Bloomberg.
Potential losses on the Fed’s investments are also cause for concern and “something we will be watching,” Representative John Campbell, a California Republican who leads the House Financial Services subcommittee on monetary policy and trade, said in February.
The Fed sent a record $88.4 billion to the Treasury in 2012 and $75.4 billion in 2011, up from $31.7 billion in 2008. Most of the income was from interest on assets bought under the quantitative easing program.
The risk for the Fed is that rising interest rates reduce the value of its bond holdings, potentially causing losses if the central bank had to sell the securities back into the open market.
“Losses are dangerous for the Fed from a political perspective because they would be a risk to its independence,” said Roberto Perli, a partner at Cornerstone Macro LP in Washington.
Campbell and Hensarling also say the Fed’s purchases of government debt are encouraging deficit spending by allowing the government to borrow cheaply. The yield on the 10-year Treasury note has averaged 2.31 percent this year, compared with a 6.61 percent mean over the past half century.
“The Fed’s additional extraordinary purchases of Treasury bonds have supported the Obama administration’s trillion-dollar deficits,” Hensarling said at a Dec. 12 hearing.
Yellen says bond purchases have put Americans back to work. Asset purchases helped the private sector add 7.8 million workers since 2010 and boosted home prices and auto sales, Yellen said in her confirmation hearing, adding that the progress will let the central bank get back to more normal monetary policy.
The jobless rate has fallen to 7 percent from a 26-year high of 10 percent in October 2009. Since then, the economy has regained most of the jobs it lost during the 18-month recession ended in June 2009.
“The balance sheet is growing because that’s how the Federal Reserve thinks it’s going to accomplish the mandates that Congress gave to it” for full employment and price stability, Kohn, now a senior fellow at the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy in Washington, said in an interview last week.
Still, policy makers haven’t spurred the growth they expected. Officials forecast 2013 growth of 2 percent to 2.3 percent in September, down from a 2.3 percent to 2.8 percent estimate in March.
“QE turned out to be a safety net, a floor, a way to catch the economy to keep it from crashing,” said Steve Blitz, chief economist at ITG Investment Research Inc. in New York. “A safety net to catch a falling economy is not the same thing that can springboard the economy to a higher rate of growth.”