Monthly Report on Credit and Liquidity Programs
and the Balance Sheet

System Open Market Account (SOMA)

Recent Developments

• The SOMA portfolio has continued to expand, although the Federal Open Market Committee (FOMC) continues to gradually slow the pace of purchases under the large-scale asset purchase programs (LSAPs) to facilitate a smooth transition in financial markets.
• Under the FOMC's LSAPs, as of February 24, 2010, the Federal Reserve held about $168 billion in agency debt and, in addition, had purchased a total of $1.21 trillion of agency mortgage-backed securities (MBS), of which $1.03 trillion had settled. Purchases of $1.25 trillion of agency MBS and about $175 billion of agency debt are expected to be executed by the end of March 2010.
• As of March 2, 2010, the Federal Reserve Bank of New York (FRBNY) began to use its own staff on select days to transact directly in the secondary market for agency MBS as part of the LSAPs, consistent with previously announced plans.
• On March 8, 2010, the FRBNY announced the beginning of a program to expand its counterparties for conducting reverse repurchase agreement transactions ("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 FRBNY's traditional counterparties. 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 also published the Reverse Repurchase Transaction (RRP) Eligibility Criteria for Money Funds, for the first set of expanded counterparties, domestic money market mutual funds. The FRBNY anticipates publishing a legal Master Repo Agreement for money market mutual funds in April 2010. This expansion of counterparties for the reverse repo program is a matter of prudent advance planning, and no inference should be drawn about the timing of any prospective monetary policy operation. Further program parameters will be decided and announced at future dates.

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 have traditionally 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 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 shown in table 2.

Table 2. System Open Market Account (SOMA) Securities Holdings
Billions of dollars, as of February 24, 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.

To help reduce the cost and increase the availability of credit for the purchase of houses, on November 25, 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 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 determined that supporting the MBS "dollar roll" market promotes the goals of the MBS purchase program. Dollar roll transactions, which consist of a purchase or sale of securities combined with an agreement to sell or purchase securities in the future, provide short-term financing to the MBS market. Because of principal and interest payments and occasional delays in the settlement of transactions, the Federal Reserve also holds some cash associated with the MBS purchase program.

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 LSAP, 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. The FOMC anticipates that these transactions will be executed by the end of the first quarter of 2010. 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 (www.newyorkfed.org/markets/soma/sysopen_accholdings.html).

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 decided to gradually slow the pace of these transactions in order to promote a smooth transition in markets as purchases of these Treasury securities are completed. The FOMC anticipated that the purchases would be completed by the end of October; the purchases were completed as planned.

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 lent housing-related government-sponsored enterprise (GSE) securities that are particularly sought after. Amounts outstanding under that program are reported in table 1A of the H.4.1 statistical release.

In December 2009, the FRBNY conducted a set of small-scale, real-value, triparty reverse repurchase transactions with primary dealers. Reverse repurchase agreements 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.

On January, 11, 2010, the FRBNY published a revised policy regarding the administration of its relationships with primary dealers intended 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. Substantive changes from the previous policy included: 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.

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