Monthly Report on Credit and Liquidity Programs
and the Balance Sheet

System Open Market Account (SOMA)

Domestic SOMA Portfolio

Recent Developments

• The SOMA portfolio remained stable between August 25 and September 29, 2010, as maturities of federal agency debt securities and principal repayments on holdings of mortgage-backed securities (MBS) were offset by new purchases of Treasury securities. This is consistent with the Federal Open Market Committee's (FOMC's) August 10, 2010, announcement to maintain domestic securities holdings at their current level by reinvesting principal payments from agency debt and agency MBS in longer-term Treasury securities.¹
• On September 23, 2010, the Federal Reserve Bank of New York (FRBNY) published the Reverse Repurchase Transaction Eligibility Criteria for Money Funds II, allowing a second wave of money market mutual funds to apply to participate in reverse repurchase (reverse repo) transactions with the FRBNY. The FRBNY also published an updated version of the Reverse Repurchase Program Form Master Repurchase Agreement for Money Funds, including applicable Annexes, which sets out the legal terms and conditions under which the FRBNY and its money market mutual fund counterparties may undertake reverse repo transactions. (This information is available at www.newyorkfed.org/markets/rrp_counterparties.html.) The FRBNY may engage in these types of transactions at the direction of the FOMC in order to drain reserves.
• On October 12, 2010, the FRBNY announced another series of small-scale, real-value reverse repo transactions using all eligible collateral types. The first set of operations, conducted using only the expanded reverse repo transaction counterparties announced on August 18, 2010, commenced the following day, on October 13, 2010. The second set of operations, which was open to all eligible reverse repo counterparties, commenced on October 18, 2010. The results of these operations are available on the FRBNY website at www.newyorkfed.org/markets/omo/dmm/temp.cfm. The outstanding amounts of reverse repos are reported in tables 1, 2, 9, and 10 of the H.4.1 statistical release. The small-scale transactions are designed to ensure the operational readiness of the Federal Reserve, its counterparties, and the major clearing banks to engage in reverse repurchase agreements. These operations do not represent a change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.

Background

Open market operations (OMOs)--the purchase and sale of securities in the open market by a central bank--are a key tool used by the Federal Reserve in the implementation of monetary policy. Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate around the target federal funds rate established by the FOMC. OMOs are conducted by the Trading Desk at the FRBNY, which acts as agent for the FOMC. The range of securities that the Federal Reserve is authorized to purchase and sell is relatively limited. The authority to conduct OMOs is granted under Section 14 of the Federal Reserve Act.

OMOs can be divided into two types: permanent and temporary. Permanent OMOs are outright purchases or sales of securities for the SOMA, the Federal Reserve's portfolio. Permanent OMOs traditionally have been used to accommodate the longer-term factors driving the expansion of the Federal Reserve's balance sheet, principally the trend growth of currency in circulation. More recently, the expansion of SOMA securities holdings has been driven by large-scale asset purchase programs (LSAPs). Temporary OMOs typically are used to address reserve needs that are deemed to be transitory in nature. These operations are either repurchase agreements (repos) or reverse repurchase agreements (reverse repos). Under a repo, the Trading Desk buys a security under an agreement to resell that security in the future; under a reverse repo, the Trading Desk sells a security under an agreement to repurchase that security in the future. A repo is the economic equivalent of a collateralized loan; conversely, a reverse repo is the economic equivalent of collateralized borrowing. In both types of transactions, the difference between the purchase and sale prices reflects the interest on the loan or borrowing. The composition of the SOMA is presented in table 2.

Table 2. Domestic SOMA Securities Holdings
Billions of dollars, as of September 29, 2010

Each OMO affects the Federal Reserve's balance sheet; the size and nature of the effect depend on the specifics of the operation. The Federal Reserve publishes its balance sheet each week in the H.4.1 statistical release, "Factors Affecting Reserve Balances of Depository Institutions and Consolidated Statement of Condition of Reserve Banks" (www.federalreserve.gov/releases/h41). The release separately reports securities held outright, repos, and reverse repos.

In addition, the Federal Reserve has long operated an overnight securities lending facility as a vehicle to address market pressures for specific Treasury securities. Since July 9, 2009, this facility has also lent housing-related government-sponsored enterprise (GSE) debt securities that are particularly sought after. Amounts outstanding under this facility are reported in table 1A of the H.4.1 statistical release.

The FRBNY's traditional counterparties for OMOs are the primary dealers with which the FRBNY trades U.S. government and select other securities. In early 2010, the FRBNY revised its policy regarding the administration of its relationships with primary dealers in order to provide greater transparency about the significant business standards expected of primary dealers and to offer clearer guidance on the process to become a primary dealer. The revised policy offers a more structured presentation of the business standards expected of a primary dealer; a more formal application process for prospective primary dealers; an increase in the minimum net capital requirement, from $50 million to $150 million; a seasoning requirement of one year of relevant operations before a prospective dealer may submit an application; and a clear notice of actions the FRBNY may take against a noncompliant primary dealer. Since late 2009, the FRBNY has taken steps to expand the types of counterparties for some OMOs to include entities other than primary dealers. Details on the counterparty expansion effort are presented below.

Large-Scale Asset Purchase Programs (LSAPs)

In November 2008, the Federal Reserve announced that it would buy direct obligations of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, and MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae. The goal of these debt purchases was to reduce the cost and increase the availability of credit for the purchase of houses. In March 2009, the FOMC authorized purchases of up to $1.25 trillion of agency MBS and up to $200 billion of agency direct obligations. Subsequently, in November 2009, the FOMC announced that agency debt purchases would be about $175 billion. This amount, while somewhat less than the previously announced maximum of $200 billion, was consistent with the path of purchases and reflected the limited availability of agency debt.

The Federal Reserve also determined that supporting the MBS "dollar roll" market promoted the goals of the MBS purchase program. Dollar roll transactions consist of a purchase or sale of "to be announced" (TBA) MBS combined with an agreement to sell or purchase TBA MBS on a specified future date. Because of principal and interest payments and occasional delays in the settlement of transactions, the Federal Reserve also holds some cash and short-term investments associated with the MBS purchase program.

In March 2009, the FOMC announced that it would also purchase up to $300 billion of longer-term Treasury securities to help improve conditions in private credit markets. The Federal Reserve has purchased a range of securities across the maturity spectrum, including Treasury Inflation-Protected Securities (TIPS). The bulk of purchases have been in intermediate maturities. In August 2009, the FOMC announced that it would gradually slow the pace of these transactions in order to promote a smooth transition in markets as purchases of these Treasury securities were completed. As anticipated, the purchases were completed by the end of October 2009.

The FRBNY announced in August 2009 that it would streamline the set of external investment managers for the agency-guaranteed MBS purchase program, reducing the number of investment managers from four to two. As of March 2, 2010, the FRBNY began to use its own staff on select days to transact directly in the secondary market for agency MBS as part of the FOMC's LSAPs, consistent with the announcement of November 2009. These changes were not performance-related: the FRBNY had anticipated that it would adjust its use of external investment managers as it gained more experience with the program.

In September 2009, the Federal Reserve began to purchase on-the-run agency securities--the most recently issued securities--in order to mitigate market dislocations and promote overall market functioning. Prior to this change, purchases were focused on off-the-run agency securities.

On September 23, 2009, the FOMC announced its intention to gradually slow the pace of its purchases of agency-guaranteed MBS and agency debt. In implementing this directive, the Trading Desk of the FRBNY announced that it would scale back the average weekly purchase amounts of agency MBS and reduce the size and frequency of agency debt purchases. As anticipated by the FOMC, these transactions were completed by the end of the first quarter of 2010. As of August 19, 2010, the settlement of all remaining outstanding MBS from these purchases was complete. The Federal Reserve's outright holdings of MBS are reported weekly in tables 1, 3, 10, and 11 of the H.4.1 statistical release. In addition, detailed data on all settled agency MBS holdings are published weekly on the FRBNY website at www.newyorkfed.org/markets/soma/sysopen_accholdings.html.

On August 10, 2010, the FOMC announced that the Federal Reserve will maintain the level of domestic securities holdings in the SOMA portfolio by reinvesting principal payments from agency debt and agency MBS in longer-term Treasury securities. As of August 4, 2010, outright holdings of securities in the SOMA portfolio totaled roughly $2 trillion. The FRBNY has published a tentative schedule for Treasury security purchases at www.newyorkfed.org/markets/tot_operation_schedule.html.

Reverse Repurchase Agreements (Reverse Repos)

In December 2009, the FRBNY conducted its first set of small-scale, real-value, triparty reverse repos with primary dealers. Reverse repos are a tool that could be used to support a reduction in monetary accommodation at the appropriate time. These transactions were conducted to ensure operational readiness at the Federal Reserve, the major clearing banks, and the primary dealers, and had no material impact on the availability of reserves or on market rates. In August 2010, the FRBNY conducted another series of small-scale, real-value reverse repos with primary dealers using all eligible collateral types, including, for the first time, agency MBS from the SOMA portfolio. The results of these operations are available on the FRBNY website at www.newyorkfed.org/markets/omo/dmm/temp.cfm. The outstanding amounts of reverse repos are reported in tables 1, 2, 9, and 10 of the H.4.1 statistical release.

On March 8, 2010, the FRBNY announced the beginning of a program to expand its counterparties for conducting reverse repos. This expansion is intended to enhance the capacity of such operations to drain reserves beyond what could likely be conducted through primary dealers. The additional counterparties will not be eligible to participate in transactions conducted by the FRBNY other than reverse repos. Over time, the FRBNY expects that it will modify the counterparty criteria to include a broader set of counterparties and anticipates that it will publish criteria for additional types of firms and for expanded eligibility within previously identified types of firms. In this context, the FRBNY published the Reverse Repurchase Transaction Eligibility Criteria for Money Funds for the first set of expanded counterparties, domestic money market mutual funds, and on April 30, 2010, published the Reverse Repurchase Program Form Master Repurchase Agreement for Money Funds, which sets out the legal terms and conditions under which the FRBNY and its money market mutual fund counterparties may undertake reverse repos. Updated versions of these publications were released by the FRBNY in September 2010 for a second wave of money market mutual fund counterparties.

On August 18, 2010, the FRBNY published a list of money market funds that are now eligible to participate as counterparties to reverse repos with the Federal Reserve. Each listed fund submitted an application and meets the criteria published by the FRBNY on March 8, 2010. Inclusion on the list does not constitute a public endorsement by the FRBNY of any listed counterparty and should not substitute for prudent counterparty risk management and due diligence. The list is available on the FRBNY's website at www.newyorkfed.org/markets/expanded_counterparties.html.

These activities with respect to reverse repos are a matter of prudent advance planning by the Federal Reserve. They do not represent any change in the stance of monetary policy, and no inference should be drawn about the timing of any change in the stance of monetary policy in the future.

Liquidity Arrangements with Foreign Central Banks (FCBs)

Recent Developments

• Amounts outstanding under the dollar liquidity swap arrangements rose very modestly in September 2010. As presented in table 3, the total amount of liquidity provided under these lines was $0.1 billion as of September 29, 2010.

Background

Because of the global character of bank funding markets, the Federal Reserve has at times coordinated with other central banks to provide liquidity. During the financial crisis, the Federal Reserve entered into agreements to establish temporary reciprocal currency arrangements (central bank liquidity swap lines) with a number of foreign central banks (FCBs). Two types of temporary swap lines were established: dollar liquidity lines and foreign currency liquidity lines. These temporary arrangements expired on February 1, 2010. However, in May 2010, temporary dollar liquidity swap lines were re-established with certain FCBs in order to address the re-emergence of strains in global U.S. dollar short-term funding markets.

The FRBNY operates the swap lines under the authority granted under Section 14 of the Federal Reserve Act and in compliance with authorizations, policies, and procedures established by the FOMC.

Dollar Liquidity Swaps

On December 12, 2007, the FOMC announced that it had authorized dollar liquidity swap lines with the European Central Bank and the Swiss National Bank to provide liquidity in U.S. dollars to overseas markets. Subsequently, the FOMC authorized dollar liquidity swap lines between the Federal Reserve and each of the following FCBs: the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, the Bank of Japan, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges Riksbank, and the Swiss National Bank. These temporary dollar liquidity swap arrangements expired on February 1, 2010. In May 2010, the FOMC re-authorized dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank through January 2011.

Table 3. Amounts Outstanding under Dollar Liquidity Swaps
As of September 29, 2010

Swaps under these lines consist of two transactions. When an FCB draws on its swap line with the FRBNY, the FCB sells a specified amount of its currency to the FRBNY in exchange for dollars at the prevailing market exchange rate. The FRBNY holds the foreign currency in an account at the FCB. The dollars that the FRBNY provides are then deposited in an account that the FCB maintains at the FRBNY. At the same time, the FRBNY and the FCB enter into a binding agreement for a second transaction that obligates the FCB to buy back its currency on a specified future date at the same exchange rate. The second transaction unwinds the first at the same exchange rate used in the initial transaction; as a result, the recorded value of the foreign currency amounts is not affected by changes in the market exchange rate. At the conclusion of the second transaction, the FCB compensates the FRBNY at a market-based interest rate.

When the FCB lends the dollars it obtained by drawing on its swap line to institutions in its jurisdiction, the dollars are transferred from the FCB account at the FRBNY to the account of the bank that the borrowing institution uses to clear its dollar transactions. The FCB is obligated to return the dollars to the FRBNY under the terms of the agreement, and the FRBNY is not a counterparty to the loan extended by the FCB. The FCB bears the credit risk associated with the loans it makes to institutions in its jurisdiction.

The foreign currency that the Federal Reserve acquires in these transactions is recorded as an asset on the Federal Reserve's balance sheet. In tables 1, 10, and 11 of the weekly H.4.1 statistical release, the dollar value of amounts that the FCBs have drawn but not yet repaid is reported in the line entitled "Central bank liquidity swaps." Dollar liquidity swaps have maturities ranging from overnight to three months. Table 2 of the H.4.1 statistical release reports the maturity distribution of the outstanding dollar liquidity swaps. Detailed information about drawings on the swap lines by the participating FCBs is presented on the FRBNY's website at www.newyorkfed.org/markets/fxswap.

Foreign-Currency Liquidity Swap Lines

On April 6, 2009, the FOMC announced foreign-currency liquidity swap lines with the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. These lines were designed to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in foreign currency should a need arise. These lines mirrored the existing dollar liquidity swap lines, which provided FCBs with the capacity to offer U.S. dollar liquidity to financial institutions in their jurisdictions. Foreign-currency swap lines provided the Federal Reserve with the ability to address financial strains by providing foreign currency-denominated liquidity to U.S. institutions in amounts of up to £30 billion (sterling), €80 billion (euro), ¥10 trillion (yen), and CHF 40 billion (Swiss francs). The Federal Reserve did not draw on these swap lines, and they expired on February 1, 2010.

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