Question re. Net Financial Assets

[Joe Leote]

I am trying to verify the logic by which Treasury and Fed create net
financial assets NFA of the non-sovereign (private) sector. Below is my
provisional reasoning at this time if anyone cares to comment.

Define net financial assets NFA of the private sector as the net
liabilities of Fed/Treasury held as assets of the other sectors. A
liability to Fed or Treasury acts as an offset against the liabilities
of Fed/Treasury, so only net financial assets are counted.

Fed assets create matching Fed liabilities with four logical cases to
consider.

1. Treasury securities
2. Private securities
3. Repurchase agreements
4. Discount loans

Case 1. When Fed purchases a Treasury security into its System open
market account (SOMA), the Private sector swaps a Treasury security
asset (Treasury liability) for a monetary Fed asset (Fed liability) of
equal value, so there is no change in NFA.

Case 2. When Fed purchases a Privately issued security into its SOMA,
the Private sector swaps a private security asset (with a matching
private liability) for a monetary Fed asset (Fed liability) of equal
value, this appears to increase NFA.

Case 3. When Fed increases net repurchase agreements in SOMA, the
Private sector incurs a new liability to Fed to complete the reverse leg
of the repo and gains a monetary Fed asset (Fed liability), so there is
no change in NFA.

Case 4. When Fed issues a discount loan the Private sectors incurs a new
liability to Fed to repay the loan and gains a monetary Fed asset (Fed
liability), again there is no change in NFA.

Case 2 swaps out a private asset in which there is a private
counter-party holding the matching liability, for an asset in which Fed
as a Sovereign agent holds the matching liability, such as under
Quantitative Easing, and I think this creates net new NFA of the private
sector.

Treasury creates all the remaining NFA as the sum of its total
liabilities to the private sector less Treasury financial assets which
are liabilities of the private sector, where Treasury liabilities tend
to be much larger than financial assets, creating all the NFA with the
exception of case 2 Fed operations.

Any criticism or comments based on logic and reason are welcome.

Joe

[William Hummel]

Another version of Case 2 occurs when the Fed buys some capital equipment
for example. That increases NFA of the private sector.

William

[Joe Leote]

William,

Thanks for the feedback. I think you are correct, if Fed buys capital
equipment or real assets, the private sector gains monetary assets from
Fed with no matching liabilities to Fed.

However, on second thought, in case 2 the private security becomes a
liability to Fed from the Private sector, equal in value to the Fed
assets exchanged. The Private sector then owes repayment of principal
and interest to Fed.

Case 2 does not contribute to NFA either under this reasoning. That
leaves Fed purchase of non-financial goods as the only Fed source of
NFA, which is negligible in size to date.

Joe

[William Hummel]

Joe,

Besides the purchase of non-financial goods, the services the Fed buys are
not exactly trivial in terms of one-way flows. That includes software for a
very complex computer system and the salaries of Fed employees. These costs
all reduce the remittance to the Treasury of Fed earnings, and thus add to
the government deficit. However I suspect the operational costs of the Fed
are small compared to the losses it will be taking on its MBS portfolio it
bought during QE. As far as I know those losses have not been realized yet,
but that's another major one-way flow of base money.

[Joe Leote]

William,

Fed assets can have a simple model:

Total Assets = MPA + CPA + OA

where MPA + CPA (monetary and credit policy assets) are basically these
items (during lender of last resort discount loans includes special
funding):

1. Treasury securities
2. Private securities
3. Repurchase agreements
4. Discount loans

and I suspect those rather large costs of Fed operations that you
describe below are relatively small in comparison to the amount of MPA +
CPA, especially prior to the crisis in 1007-2008.

I agree with your reasoning on the subject at this time and will
consider the impact of bad debts in the MBS portfolio, I think if it
ever comes to a concern, Treasury may have some tools to absorb any Fed
losses anyway, so Fed would be made whole. But I have not thought the
matter through in terms of the mechanics and legal restrictions, etc.

Joe

[William Hummel]

Joe,

The largest part of MPA are acquired covering the growth in circulating
currency. More than half of new currency issued migrated overseas prior to
the financial crisis. The currency growth rate was about 30 to 35 billion
per year over the last decade. I don't know what the Fed's total operating
costs are but I suspect it is a few billion per year, smaller than MPA, but
not negligible.

Regarding the potential bad debts in the Fed's portfolio, if the Fed were a
private bank it might very well be insolvent at the present time. But what
does insolvency mean in the case of a bank that can issue legal tender in
unlimited amounts?

[Jean Erick]

     Kill this puppy.  :-)

 

James

[Jean Erick]

     The phraseology is instantly confusing to me.  I just can't spend all the time it would take to figure it out.  And I would spend that time at the risk that it is esstially non sensical

and I had wasted my time.

    And, in spite of what you would like to think, I have always been considered well above average in my reading comprehension.

    I did see the distinction between T's and privately issued but isn't that just the whole MBS thing that we covered?  A tremendous amount of reserves have been created but the economy is so bad it won't inflate and you, yourself, shared the cure, a "term deposit facility option" which demonstrated that the FED can just change the definition of reserves if inflation becomes a threat.  But I spent to much time on this.   You write eloquently but confusingly.

     How about writting directions to diaper a baby.  And the test will be, once it's understood, does the baby survive?

 

James

----- Original Message -----

From: Joe Leote

To: Money Group

Sent: Tuesday, May 22, 2012 4:22 PM

Subject: Question re. Net Financial Assets