Technical Notes for ‘The Untold Story’

This is an appendix for our earlier post, “Where $1 of QE Goes: The Untold Story.” We’ll describe our use of the Fed’s flow of funds data in more detail, in Q&A format.

Why don’t the time periods on your chart match up exactly with QE start and end dates?  For example, why was the second quarter of 2010, when the Fed was winding down QE1, not included in the first period?

We grouped quarters into longer periods according to whether the Fed was using its balance sheet to expand the supply of credit, and by more than a token amount. In the second quarter of 2010, the Fed’s asset purchases were mostly offset by reductions in lending programs initiated during the financial crisis. The net lending amount was negligible (about $10 billion for the quarter or less than $50 billion annualized), and therefore, we grouped it with other quarters during which the Fed didn’t meaningfully expand its balance sheet.

What types of credit do you include in net lending?

From a recent post based on the same calculations:

Our borrowing and lending figures include the Fed’s “credit market instruments” category, repos and some types of interbank lending. The idea is to track any loan or debt security to its ultimate source of funding. For example, if a money market fund loans money to a dealer through the repo market and the dealer invests the proceeds in a Treasury bond (the collateral for the repo), then there’s no effect on the dealer’s net position as a lender/borrower. The dealer’s asset and liability flows can be netted out, leaving a borrowing by the Treasury that’s ultimately funded by money market fund shareholders through the repo loan.

What do you mean by “some types of interbank lending”?

There are two types of interbank lending that need to be considered when the goal is to track credit back to the ultimate source of funds. These are: 1) lending between U.S. banks and foreign banks and 2) loans from the Fed (e.g. through the AMLF facility). When a bank based in the U.S. borrows from a foreign bank, a matching amount of the U.S. bank’s lending should be traced to the foreign bank if you’re trying to establish the ultimate source of financing. The same logic applies to borrowing from the Fed.

Although the flow of funds report also includes reserves held at the Fed in its “interbank lending” category, reserves are basically deposits and should be excluded from net lending calculations. If we didn’t do this, the results would be nonsensical.

(Consider that deposits are created at the same time that loans are made and extinguished when loans are moved off bank balance sheets. Therefore, if you net out loans and deposits, you’re not measuring anything. The same goes for reserves, which are created at the same time that the Fed adds securities to its balance sheet.)

Other credit that the Fed classifies as interbank loans either nets out across different types of banks or isn’t relevant to net lending (namely, vault cash).

In other words, our net lending figures combine net positions in credit market instruments, repo loans and non-deposit, non-vault cash interbank loans.

I understand that banks were reducing their loan books during QE1, but what’s driving the reduction in net lending during QE2 and QE3?

Data points to several different factors. The biggest appears to be an increase in borrowing by U.S.-based banks from foreign banks. Moreover, most of the increased borrowing is by U.S. offices of foreign banks themselves, and the proceeds of the loans appear to be placed with the Fed as reserves. In other words, foreign banks are playing a large role in absorbing the additional liquidity provided by QE. (For more discussion, see this post by blogger Tyler Durden.) You might think of this as a substitution of reserves at the Fed for other types of dollar assets that foreigners would otherwise hold.

Anything else?

The second biggest factor is a reduction in net lending by broker-dealers. In between QEs, loan and bond portfolios held by broker-dealers grew more quickly than borrowings. During QE2 and QE3, borrowings grew more quickly than loan and bond portfolios, which shrank as dealers sold bonds to the Fed.

The third biggest factor is a slowing or reversal of net bond purchases by banks (referring to the Fed’s “depository institutions” category). While banks bought bonds at a pretty good pace in between QEs, they slowed or reversed these purchases during QEs.

Didn’t banks and broker-dealers front run QE, and doesn’t this explain some of the results in your chart?

Banks ramped up their bond holdings before the beginnings of QE2 and QE3, although they were buying mostly bonds not included in the Fed’s asset purchase program. In any case, some of their bond purchases were likely explained by banks anticipating QE. The broker-dealer data is more difficult to decipher, with one of the larger effects being a simultaneous reduction in “miscellaneous” assets and repo liabilities immediately after QE1 and QE2. These factors explain some, but not all, of the argyle pattern in our chart.

Can you send us more detail?

We can provide detailed calculations and spreadsheets, as well as other types of research or consulting on themes we’ve covered, although on a more commercial basis than the blog. If interested, e-mail

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