The Evolving State of the Fed’s Security Holdings
Prior to the financial crisis, the Fed’s security holdings were restricted to a mix of Treasury securities, which consisted of a combination of short-term bills and longer-term notes and bonds. At the start of the crisis, the balance of Treasury bills fell. This dip turned out to be the beginning of a major evolution in the composition of the Fed’s portfolio. As a result of the crisis, the Fed’s security holdings have been completely transformed.
Beginning in the summer of 2007, the Fed introduced a number of programs intended to provide liquidity to the markets. Initially, as this liquidity was added, the Fed was selling Treasury bills in the open market to maintain the federal funds rate at its target. At that point in time, the rate had not yet hit the zero bound.
In November 2008, the first round of large-scale asset purchases was introduced. A total of $100 billion of agency debt securities and $500 billion of agency mortgage-backed securities (MBS) were to be purchased. The program was soon expanded in March 2009 to include $300 billion of Treasury securities, as well as additional amounts of agency debt and MBS. Treasury purchases continued through the end of October 2009, and the agency securities were purchased throughout the first quarter of 2010.
Between the first and second rounds of the large-scale asset purchases, maturing securities were not replaced. Allowing these securities to mature would have effectively resulted in a passive contractionary policy. To prevent this contractionary action, the FOMC decided in August 2010 to reinvest the principal payments from the agency securities into long-term Treasury securities. Just a few months later, a second round of asset purchases was announced, with an extra $600 billion of Treasury securities to be purchased over the following eight months.
Three months after the end of the second round of large-scale purchases, in September 2011, the FOMC decided to extend the maturity of its portfolio through a new action called the Maturity Extension Program. The purpose of the program, which is still ongoing, is to lower longer-term rates relative to shorter-term rates—and for that reason it is referred to as “operation twist.” This result is accomplished by selling Treasury securities with remaining maturities of 3 years or less and purchasing Treasury securities with remaining maturities of 6 years to 30 years. Along with the Maturity Extension Program, the Fed switched from reinvesting the principal payments from agency securities into agency MBS instead of long-term Treasury securities.
Using disaggregated data on the securities in the Fed’s balance sheet, we can track the history of these programs and actions, and the effect that they have had on the Fed’s balance sheet. Of particular interest is the breakdown of the Treasury notes and bonds into groups associated with both rounds of asset purchases, the reinvestment of maturing Treasury securities, the reinvestment of maturing agency securities, and the Maturity Extension Program. Note that data on the Fed’s balance sheet is often presented in an aggregated form—the Cleveland Fed’s credit easing charts being an example. The disaggregated data allow us to separate each individual security into one of the Fed’s programs.
We look first at mortgage-backed securities and estimated what portion of the current holdings was originally purchased and what portion resulted from the reinvestment of principal payments. We found that a large portion of these holdings were original purchases made during the first round of large-scale asset purchases. The longer maturity of the agency holdings has minimized the need for reinvestment. Still, the low-interest-rate environment has likely contributed to the level of reinvestment by encouraging homeowners to refinance their mortgages, which increases the rate of repayment.
Of the Fed’s Treasury holdings, the largest portions are the notes and bonds that are attributable to the two rounds of asset purchases. Most of those purchases have yet to mature, although there was some reinvestment into long-term Treasury securities from maturing agency securities. The holdings of Treasury securities have remained level since the reinvestment of agency debt and MBS into Treasuries concluded and the second round of asset purchases was completed.
However, due to the Maturity Extension Program, the composition of Treasury holdings continues to change. The fraction of Treasury securities that are considered longer-term (those with a maturity greater than 6 years) continues to grow, and consequently, the fraction of Treasury holdings that is considered shorter-term (less than 3 years) continues to shrink. These fractions are shifting due to the proceeds from the sale and maturity of short-term Treasury securities being reinvested in longer-term notes and bonds. In its latest policy action, the FOMC decided to continue this program through the end of 2012.