The Mechanics of the Federal Reserve's Balance Sheet "Runoff"

The Federal Reserve's balance sheet "runoff" occurs when newly issued Treasury securities are purchased by various entities, including banks, money market funds (MMFs), levered nonbank financial institutions (NBFIs), and households. A recent post by the Liberty Street Economics team described the mechanics of the runoff when banks and MMFs purchase newly issued securities. In this post, we explore what happens when levered NBFIs and households purchase the newly issued securities. By understanding these mechanisms, we can better comprehend the implications of the Fed's actions on the financial system.

Key Takeaways:

• When levered NBFIs purchase newly issued Treasury securities, they finance the purchase through repos from banks and MMFs, increasing the size of their balance sheet by $1.
• The size of banks' and MMFs' balance sheets remains unchanged, but the composition of their assets is altered, with banks holding lower reserves and MMFs holding more repo lending.
• The Fed's balance sheet decreases in size, with a reduction of $1 in Treasury securities and a decrease of $0.5 in reserves held by banks and $0.5 in ON RRP take-up.
• Levered NBFIs increase leverage in the financial system, as they fund the purchases solely through borrowing in the repo market.
• Other NBFIs, such as open-ended mutual funds or pension funds, are un-levered and would fund their purchases through cash balances from households.
• Households purchase newly issued securities, increasing the asset side of their balance sheet, with Treasury securities, deposits at banks, MMF shares, and cash balances at NBFIs.

Statistics:

• The size of the Fed's balance sheet decreases by $1 in Treasury securities.
• Reserves held by banks decrease by $0.5.
• ON RRP take-up decreases by $0.5.
• Levered NBFIs increase security holdings by $1, funded solely through borrowing in the repo market.
• Households' balance sheet increases by $1 in Treasury securities, deposits at banks, MMF shares, and cash balances at NBFIs.

Sources:

• Liberty Street Economics post. (No date provided)
• Federal Reserve Board. (No date provided)