Is The Surging SOMA To Excess Reserve Differential Proof That Quantitative Easing Is A Failure?

Tyler Durden's picture

One of the more peculiar observations we noted in our analysis of the Fed's balance sheet yesterday, was that in the week just ended, reserves held by banks with the Federal Reserve dropped by a very material $64.2 billion even as the Fed ended up buying a net of $4 billion in securities: a $68 billion mismatch between an increase in reserves and Fed asset increases. A quick look at how this mismatch has progressed since the announcement of QE Lite (and QE 2) demonstrates this phenomenon very distinctly: while during the QE Lite phase, net holdings of the Fed were flat, bank reserves, which should have followed suit in fact declined notably, by almost $40 billion. Yet it is during the POMO phase of QE 2 that this difference become glaring. During a period when the Fed added a total of $88 billion (net of MBS paydowns) in securities, reserves increased by only $14 billion. This does not include the cumulative differential since QE Lite. And all this came to a head in the just ended week, when the difference between cumulative asset purchases and reserve changes hit a whopping $138 billion. This is very disturbing for a variety of reasons, the number of which is that, as Jim Bianco points out, banks are rapidly exchange securities with higher reserve requirements for those with lower: the net result is a far slower increase in reserves held with the Fed. It also means that banks ever since QE Lite have been stealthily offloading lower quality fixed income products to the market and replacing these with Treasuries (motivation being unclear but likely having to do with presenting a better capitalized state). If true, this would mean that during the entire orchestrated HY bond rally sine August, those who have been buying are in fact the greatest suckers, and have been buying hundreds of billions worth of lower quality paper from none other than the allegedly smart money banks. Alternatively, what this means, is that instead of opening up capacity for banks to bid up riskier corporates and thus stimulate the economy, banks are forced to gobble up the toxic treasuries, that the Treasury puts upon them each and every week. Should this divergent trend persist, we would be very mindful of obtaining verification of either of these two hypotheses.

Chart 1: Change in Various Open Market Securities held by the Fed since QE Lite

Chart 2: Difference between the cumulative increase in Fed holdings, and bank reserves. The highlighted block is the kicker.

We were so fascinated by this curious divergence that we inquired with our good friend Jim Bianco. Here is his response:

Some Specifics since QE2 was announced on November 3rd

                                                        Nov 3              Dec 15 Change
Fed Tsy Holdings                               839.9              960.8              +120.81
MBS Holdings (paydowns)               1051.04          1020.68               -30.36
   Net                                                                                                +90.48

Balance Sheet                                 2280.752        2374.33              +93.578

Since QE2 the balance sheet has expanded by $93.578 billion.  This largely can be explained by a $120.81 billion rise in Tsy holdings netted against a $30.36 billion paydown in MBS. 

Excess Reserves                               969.418          1024.811        +55.393
Total Reserves                                1036.654          1097.166        +60.512
Required Reserves                               67.233              72.355        +5.122

Even though the balance sheet expanded by $93.578 billion, total reserves have only increased by $60.512 billion.  Required reserves increased by $5.122 billion.  Net the two together and excess reserves are up $55.393 billion.

So, the question is why are total reserves rising so slowly?  Why are they not up by the same amount (or nearly the same amount) as the balance sheet?

The Fed does not break down the dirty guts of total reserves so we have to guess.  Here goes ….

Banks are buying $120 billion of Tsys from the Fed via QE2.  They are not letting their balance sheets expand by this $120 billion so they are selling other securities (or calling/refusing lending) to offset these purchases.  They are not selling $120 billion for a perfect offset but are selling some to partially offset it.

What they are selling has higher reserve requirements than Treasuries.  So sell some securities that requires more reserves and buy more Treasuries than require less reserves and net result is total reserves rises by about 2/3 the amount of the increase in the Fed’s balance sheet.

So thanks Ben, banks are now pulling back even more to make room for your QE2 purchases.

In other words, very much contrary to its purpose, QE is in fact forcing banks to retrench even more, merely to satisfy their Primary Dealer quotient and to provide the guarantee that the Primary Dealer take down is always roughly 50% of every auction. In yet other words, despite subsequent monetization, the bonds bought at auction are already at the very margin of the banks' holdings capacity, and result in far lower eagerness to lend out capital (collateralized with subpar assets - the kind of stuff that drives the economy). This goes against the very core premise of quantitave easing! We would love for Rep. Paul to inquire about this very interesting phenomenon at his earliest convenience.

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furieus's picture

Beginning of the end, bitchez

Red Neck Repugnicant's picture

The "end" or the looming apocalypse has had more false starts than those hapless horny chaps in those god-awful Cialis commercials. 


Cheesy Bastard's picture

Just like the spring recovery just before the summer of recovery just like the Christmas recovery...After the recession ended in June back in 09.

furieus's picture

Slow motion progressive collapse... uhm, bitchez

Rogerwilco's picture

Failure in what sense? Based on the market indices, I'd say Dr. Ben has achieved his first-order goals rather nicely.

Terminus C's picture

The market is not the economy.

The market is easy to manipulate and pump, the economy is not.

jeff montanye's picture

very apt.  it shows another weakness in all the policies that flow from the concept of too big to fail.  

in yet other words, we (the tbtf) refuse to acknowledge we were wrong economically, legally and morally and should be punished by the market, the courts and history, so you (taxpayers, export surplus nations, etc.) must give us trillions to allow us more time to work our neo-feudalistic magic.  it won't get you a recovery (just look at japan) but that is not of concern to us.  

we care only for our pride and personal comfort and we have effectively threatened and bribed both political parties and the supreme court to allow us this, our constitutional right.

plocequ1's picture

Yes Houston, We have a problem. Its ok, Just add it to my tab. What is my bill now, $90,000?

Mr Lennon Hendrix's picture

The markets are selling off, not gold.

First I would like to point one thing out:  see how we are coming into the three day average (gold chart)?  This is very common.  Consolidation on the third day is standard.  I would not be surprised if silver made its way down and finished at $29.  Platinum is still the strongest of the three right now, and may finish on the high side, let us say, $1697.

I love having precious metals break out on a Friday.  It shows the real mentality and uncertainty of the market; for all of the talk by dollar bulls this week, precious metals still reign supreme.

nope-1004's picture

Uh oh.  Free speech?

Sancho Ponzi's picture

I believe the same logic can be applied to the millions of individuals and companies who have seen their credit card and line of credit limits slashed by C, BAC, etc. The banks firm up their balance sheets by swapping consumer and SMB liabilities (and potential write-downs) for low risk treasurys. 

Squid Pro Row's picture

Outstanding work, thank you Tyler.

Steak's picture

Last posting of this guy today.  On Sunday morning I will post a couple other playlists as a last hurrah.  A while back I noted when it would be the end of regular friday playlists, and I've posted many since then but not every week.  This marks the end of me posting playlists in this fashion (ZH mainpage, comments sections).

While it is not immediately apparent, there is a synergy between music and this site.  How that tradition will or won't continue in the future is something I'm not in a position to answer or influence, yet its my sincere hope that it does continue.  To all y'all who have enjoyed these: thanks for clicking, dancing, contributing and coming to ZH in the first place.  Mahalo

Artist of 2010 - Arty:

sandorgb's picture

thanks for the music. i like it

zero-g's picture

The music has been much appreciated Steak!

Hope you continue.

Captain Willard's picture


It might be helpful to compare these reserve movements on a year-on-year basis. At year-end, there is usually a lot of seasonal balance sheet adjustments by banks and by corporations. Generally, people at year-end are attempting to beautify their balance sheets: lines of credit contract and banks reduce risk assets. This could account for marginal reserve decreases as a % of growth, as required reserves are marginally less on prettier assets (T-bonds versus commercial loans)  as a result of balance-sheet beautification.

It doesn't negate your point at all, but there could be many more/other factors at work, including seasonally-weak loan demand at year-end. You also have to look at Non-borrowed/Required Reserves sequentially and seasonally-adjusted to see if in fact systemci lending capacity has declined.

Happy Holidays

goldmiddelfinger's picture

The point being that Bank comptrollers are rational people too!

RobotTrader's picture

Massive rally in bonds today.

Mr Lennon Hendrix's picture

Dead dollar bounce.  Dollar at top of range, dxy 80.5.

RmcAZ's picture

Not sure how 106.8 to 107.4 constitutes a "massive rally".

Flakmeister's picture

you obviously have never traded bonds....

jeff montanye's picture

long bond 3.52% 8-31, 4.59% 12-15.  4.41% 12-17.  to put that rally in perspective, a bit.  remember price moves inversely to yield.  

tom's picture

Now that the Fed site is working normally, I can see that there really was a big $64b drop in bank reserves from $1059 to $995b, on a Wed. to Wed. basis. All I could see yesterday was the weekly averages, which were up from $1051b to $1054b. So I guess the entire draw down of reserves happened late on Wednesday.

However, the reason for it is actually pretty obvious: a huge $72b worth of deposits by Treasury into its general account. The pace of Treasury's revenue collections, borrowings, redemptions and spending are all uneven, so some weeks revenues and borrowings outnumber redemptions and spending, which reduces reserves, and other weeks redemptions and spending outnumber revenues and borrowing, which increases reserves. This is a meaninglessly randomly volatile factor affecting reserves, not really worthy of much attention.

Since the net result of POMOs and MBS redemptions was only +$4b, a prettly slow week for QE, that was pretty easily dwarfed by the Treasury cash movements-induced volatility.

You also had a $1b increase in currency, which has been pretty steadily increasing since mid-August, and is linked to the explosion of growth in M1 since then.

Tyler Durden's picture

You may want to check that currency stat: decline both SA and NSA:

M2 Climbs Again: 20 Out Of 22 Consecutive Increases In Broad Money

gkm's picture

Part of the missing puzzle is that the Fed is paying interest on reserves held.  The banks are incented to hold as much money at the Fed with the lowest reserve requirement possible.  

Say the banks have $1 trillion at the Fed and the Fed pays 1% interest.  That's about $1.25 billion of interest over 1.5 months.  The banks then can leverage that up on the outside and loan about 9x that amount or $11.25 billion.  Therefore, they've turned the Fed's free money into more loans that may or may not be net new loans  There are probably other ways for them to maximize the return that could increase that amount. 

So essentially the banks are printing more money thanks to the Fed's generosity and it is entirely unencumbered money.  Even if they take a loss on that money it will be at the very least be replaced with more interest the next month.  They can average down on something held in that portfolio and they will never lose money on it.  If you were one of the banks, wouldn't you just "loan" this money to one of your funds and tell them to buy the market on every dip with an ever increasing stream of funds?  If the fund blows up, oh well since it's liability is limited and they can't lose more than their margin.

Their traders are therefore in heaven.

jeff montanye's picture

or just keep the interest earning interest, compounding daily, at the fed (eighth wonder of the world, according to baron rothschild).  

again another systemic weakness of too big to fail: in trying to get the badly wounded behemoths healthy again, the fed offers interest on reserves kept at fed, discouraging more risky lending on the outside which would actually help the general economy and, possibly, employ the unemployed.

bbtrader's picture

TD, quite a bit off-topic, but could please dispatch someone to investigate the increased recent chatter about a forthcoming Iraqi Dinar (IQD) reval?  I've read that both JPM and BAC have been authorized to perform currency transactions - in which case, if the reval occurs at any decent rate, they have to potential to make a fortune = the next scam by the big banks.

tmosley's picture

The Iraqi dinar is a scam.  Only stupid people "invest" in it.  Sorry if you did, because you will probably never get your money back.  There is NO market for them outside of Iraq.

Fiat currencies are NEVER revalued higher.  NEVER.  The dinar is trash.  You might as well invest in Zimbux and hope they go back to their former value of three Zimbux to the dollar.

bbtrader's picture

Actually I own 5MM, purchased @ $900 p/MM; the current price for 1MM is $1160.  So I'm actually up.  And they're just sitting in a box.  For me the $4500 is chump change.  I make more than that in a slow week trading futures.

And I'm not stupid enough to think that they will reval back to 3-1.  I'm only saying, both JPM and BAC will now be able to perform IQD transactions, as will some other large banks.  The banks need a scam to make easy money, so I'm asking, is this what's next?

jeff montanye's picture

if fiat currencies are never revalued higher, what happened to the yen in 1985 after the plaza accords?  used to trade 300+ to the $.  now not so much.  may have helped give them two lost decades starting about 1990.  and china some serious second thoughts on revaluing the renminbi/yuan.  

japan should have spent a bit of their dollar reserves on gold in the mid/late '80's.  china seems to have learned that lesson too. 

Big Ben's picture

The reason that QE1 didn't produce much price inflation is that most of the money that the Fed created went into excess bank reserves where it didn't compete with existing dollars for purchases. But the figures above indicate that only about two-thirds of the QE2 dollars are going into excess reserves. The other third are presumably circulating out there and being used to purchase things (equities perhaps?).

So this ratio could well be a harbinger of future inflation, if it persists. We will see whether the Fed has the stomach to raise interest rates and pull money back out of the system in order to prevent inflation. With the exception of the Volker era, it has not shown much inclination to do this in the past. If it had, gold would still be $20.67/ounce.


flacon's picture

Also don't forget all the $$$ being spent on the salaries of the unemployed and the $$$ being spent to "feed the hungry" through the use of "charity food stamps". They are just doing "god's work", remember. That money is instantly injected into the economy - like the scene in Pulp Fiction where they injected adrenaline directly into the heart.


jeff montanye's picture

i don't know.  that lady got up fast, talking a blue streak.  the u.s. economy, not so much.  p.s. the quotation about god's work refers to that of goldman sachs (lloyd blankfein, november 2009). 

New_Meat's picture

Flacon, is it effective, this "instant injection"?  If so, maybe we all oughtta' do it.

But it feels more like slow, unlubricated injection to me.

- Ned

Bruce Krasting's picture

Very interesting question. I would love to see QE get another black eye.

I am confused by Bianco. He says:

Banks are buying $120 billion of Tsys from the Fed via QE2. 

That' wrong. Banks aren't buying Treasuries from the Fed.  I think he means, "The Banks are buying Treasuries from Treasury", perhaps?

Am I confused? Who is buying and who is selling? Or is Jim? Heaven help us if he is backward on the "whose doing what to whom" thing.

Tyler Durden's picture

I believe Jim had it inverted and refers to PD takedowns.

DavidRicardo's picture

You forgot the third hypothesis: Andrew Mellon i still alive, is still Secretary of the  Treasury, and told the banks to do this.


The third hypothesis is the correct one.  Have a nice day!

NumberNone's picture

There's no such thing as market manipulation, there's no such thing as market manipulation...


gwar5's picture

QE II is proof QE doesn't work.

FrankenFed not looking good. Cringe.

BurningFuld's picture

Pull money out of the system??? Isn't all the printed money going to fund USGov?  That is where the inflation comes in.  5% of GDP is printed money paying Government spending is it not?  At this point it time?

TooBearish's picture

Lets add this up:

1) Treasury issues debt to provide TARP funding to insolvent banks

2) Banks buy Treasuries issued to bail them out to earn 300 basis point spread

3) Banks sell Treasuries back to FED in QE1, QE lite and QE2 for capital gains and buy more Treasuries to pay for state bailouts and unemployment insurance, and repeat

4) Middle class gets wiped out - zero sum game -

5) Mayhem ensues....

treemagnet's picture

I believe the technical term for this is  "stepping on your dick".

tom's picture

Bianco tried to answer a different question from the one you asked about last week's drop in reserves. He addresses the longer-term divergence between the scale of QE and the growth of reserves during the seven-week period from Nov. 3 to Dec 15. But Bianco's answer is nonsensical.

"Banks are buying $120 billion of Tsys from the Fed via QE2. They are not letting their balance sheets expand by this $120 billion so they are selling other securities (or calling/refusing lending) to offset these purchases. ... What they are selling has higher reserve requirements than Treasuries. So sell some securities that requires more reserves and buy more Treasuries than require less reserves and net result is total reserves rises by about 2/3 the amount of the increase in the Fed’s balance sheet." 

Pure gobbledy-gook. Banks are not buying Treasuries from the Fed, they are selling Treasuries to the Fed. Those sales are not from the banks' own book, they are pass-throughs as they constantly buy similar amounts from Treasury. The banks were simply a conduit for monetization, as the Fed bought $120b worth of Treasuries from the banks, and banks bought a similar amount from Treasury.

Actually, banks did buy another $2b of Treasuries for their own books between Nov 3 to Dec 8, the most recent data, but that had no effect on required vs excess reserves, let alone total reserves, which is what we are looking for here.

So, brushing aside that wacky answer, why the gap?

Two reasons: first, obscurely, the Fed is temporarily hanging on to some cash from sales of AIG assets, which absorbs reserves. Second, as expected, part of QE resulted in monetary expansion, in which part of the newly created money shows up as increased currency in circulation rather than as reserves.

Also, when you use end-of-day numbers, instead of weekly averages, you accentuate the volatility of Treasury's deposits into and draws from its general account, making the data very noisy. This way, the gap between the scale of QE and the growth in reserves looks huge: $91b of QE produced only $15b of added reserves (Bianco's numbers on reserves are wrong), a whopping $76b gap.

But $56b of that gap is due to the noisy Treasury general account. Another $11b is due to monetary expansion, ie growth of currency in circulation, $8b is due to the Fed hanging on to receipts from sales of AIG assets, and the sum of various other factors accounts for another $1b.

Using a weekly averages basis helps filter out most of the noise: QE was $89b, reserves grew by only $62b, for a gap of $27b. The Fed hanging on to cash from sales of AIG assets accounted for $18b, currency in circulation grew by $14b, while the net of other factors including Treasury's general account increased reserves by $5b.

I don't know how long the Fed plans to hang on to that cash from AIG asset sales, which totals $26b, but that's basically delayed QE, which will turn into some combination of reserves and circulating currency later down the road.

The number to really watch here is currency in circulation. As it grows, M1 and M2 grow multiples faster.

Derp2012's picture

Thanks for the well-reasoned comment

Pure gobbledy-gook. Banks are not buying Treasuries from the Fed, they are selling Treasuries to the Fed. Those sales are not from the banks' own book, they are pass-throughs as they constantly buy similar amounts from Treasury. The banks were simply a conduit for monetization, as the Fed bought $120b worth of Treasuries from the banks, and banks bought a similar amount from Treasury.

I'm no expert in this field, but this was my take as well. It would be great to have more discussion of this apparently garbled explanation.

When the rate of QE exceeds PD takedown in current auctions, the dealers must either sell out of their existing book or purchase more treasury securities on the open market, to channel to the Fed.  Ultimately this liquidates treasury debt out in the world, pumping fresh cash into the system, outside of the reach of the Fed's liquidity mop/vacuum.

I must not have a Ph.D. in econ, because that seems like it would be inflationary.

Update: I do have a degree in math, can we get this captcha fixed?  It needs to accept 3 digit responses.

AUD's picture

You write;

during the entire orchestrated HY bond rally sine August, those who have been buying are in fact the greatest suckers

but then you write;

banks are forced to gobble up the toxic treasuries, that the Treasury puts upon them each and every week.

Who is the sucker? The banks got caught holding the MBS, CDO, OAS (other assorted shit) bag in 2008. What makes you think that they will not get caught holding the Treasury bag too? Are they too 'smart'? What's the Treasury going to do, bail them out?

Sure, anybody holding bank deposits will in turn get caught holding the bank bag, which is almost everybody, which brings us back to the 2008 bailout.


max2205's picture

Can we just say it. The POMO is just a way to prop up PD that are insolvent without congressional approval. Geeeez

BW's picture

The difference is the loss on its portfolio.

b_thunder's picture

I've not hear any Fed official saying or even hinting that the purpose of QE2 is to increase lending.  The stated purpose is asset price inflation.  QE1 didn't lead to increase in lending, so now The Fed isn't even trying.  All they do is funnelling $$$ to the banks, and letting other 98% of Americans descend into poverty.


tom's picture

Actually I don't think the Fed has ever clearly stated the purpose of QE2.

The FOMC has said that consumer price inflation is below "what a majority of members consider to be consistent with (the Fed's) mandate". So that implies the purpose of QE2 is to increase consumer price inflation, although the literal mandate is "stable" prices, ie as close as possible to zero inflation. Most people are interpreting the statement to mean that boosting CPI would also boost employment up closer to full, which is the other half of the Fed's mandate, but neither Ben nor the FOMC has ever said that publicly in so many words. Ben has also said that higher asset prices are good because they boost growth, so another interpretation is that he's trying to indirectly boost CPI and employment by directly boosting asset prices. Again, never said so in so many words.