Bernanke Edges Closer to Closing the Cash Floodgates

Federal Reserve Chairman Ben Bernanke is starting to look at ways to back off from the central bank’s heroic efforts to keep the nation’s economy afloat through the financial crisis of the past 18 months. The trick to raising short-term interest rates, which have been at historic lows for more than a year, is to time them with extraordinary precision to avoid new damage to the still-fragile economy.

At present, the Fed has $2.29 trillion on its balance sheets, an increase from the $934 billion reported in September, 2008, when the financial crisis was at its worst. Bernanke plans to sell some of the Fed’s mortgages, Treasuries and debt by offering reverse repurchasing agreements.  Under these arrangements, the Fed sells its securities to a third party while agreeing to re-buy them at some point in the future.

The Fed’s next step is to sell banks and financial firms the equivalent of certificates of deposit.  In these cases, the Fed gets a portion of the bank’s reserves in exchange for paying interest at a fixed rate.  Called a “term deposit facility,” these deposits would be auctioned off and banks couldn’t count their investment in the Fed as cash or reserves.

“These programs, which imposed no cost on the taxpayer, were a critical part of the government’s efforts to stabilize the financial system and restart the flow of credit,” Bernanke said in testimony at a Capitol Hill hearing.  “As financial conditions have improved, the Federal Reserve has substantially phased out these lending programs.”