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    J Robie
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    Over the past few years, the Federal Reserve’s use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The asset purchases are intended to put downward pressure on longer‐term interest rates, but also affect the Federal Reserve’s balance sheet and income. We begin with a primer on the Federal Reserve’s balance sheet and income statement. Then, we present a framework for projecting Federal Reserve assets and liabilities and income through time. The projections are based on public economic forecasts and announced Federal Open Market Committee policy principles. The projections imply that for the next several years, the Federal Reserve’s balance sheet remains large by historical standards, and earnings remain high. Using the FOMC’s stated exit strategy principles and the Blue Chip financial forecasts of the federal funds rate, the projections have the Federal Reserve’s portfolio beginning to contract in 2015. The portfolio returns to a more normal size in early 2018 or 2019, and returns to a more normal composition a year thereafter. The projections imply that Federal Reserve remittances to the Treasury will likely decline for a time, and in some cases fall to zero. Once the portfolio is normalized, however, earnings are projected to return to their long‐run trend. On net over the entire period of unconventional monetary policy actions, cumulative earnings are higher than what they likely would have been without the Federal Reserve asset purchase programs. To illustrate the interest rate sensitivity of the portfolio and earnings, we consider scenarios where interest rates are 100 basis points higher or 100 basis points lower than in the baseline projections. With higher interest rates, earnings tend to fall a bit more and remittances to the Treasury stop for a longer period than in our baseline projections, while with lower interest rates earnings are a bit larger and remittances continue throughout the projection period. With either interest rate path, earnings follow the same general contour as in the baseline analysis.

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    Over the past few years, the Federal Reserve’s use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The asset purchases are intended to put downward pressure on longer‐term interest rates, but also affect the Federal Reserve’s balance sheet and income. We begin with a primer on the Federal Reserve’s balance sheet and income statement. Then, we present a framework for projecting Federal Reserve assets and liabilities and income through time. The projections are based on public economic forecasts and announced Federal Open Market Committee policy principles. The projections imply that for the next several years, the Federal Reserve’s balance sheet remains large by historical standards, and earnings remain high. Using the FOMC’s stated exit strategy principles and the Blue Chip financial forecasts of the federal funds rate, the projections have the Federal Reserve’s portfolio beginning to contract in 2015. The portfolio returns to a more normal size in early 2018 or 2019, and returns to a more normal composition a year thereafter. The projections imply that Federal Reserve remittances to the Treasury will likely decline for a time, and in some cases fall to zero. Once the portfolio is normalized, however, earnings are projected to return to their long‐run trend. On net over the entire period of unconventional monetary policy actions, cumulative earnings are higher than what they likely would have been without the Federal Reserve asset purchase programs. To illustrate the interest rate sensitivity of the portfolio and earnings, we consider scenarios where interest rates are 100 basis points higher or 100 basis points lower than in the baseline projections. With higher interest rates, earnings tend to fall a bit more and remittances to the Treasury stop for a longer period than in our baseline projections, while with lower interest rates earnings are a bit larger and remittances continue throughout the projection period. With either interest rate path, earnings follow the same general contour as in the baseline analysis.

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    49 views63 pages

    How Will Fed Unwind Balance Sheet?

    Uploaded by

    J Robie
    Over the past few years, the Federal Reserve’s use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The asset purchases are intended to put downward pressure on longer‐term interest rates, but also affect the Federal Reserve’s balance sheet and income. We begin with a primer on the Federal Reserve’s balance sheet and income statement. Then, we present a framework for projecting Federal Reserve assets and liabilities and income through time. The projections are based on public economic forecasts and announced Federal Open Market Committee policy principles. The projections imply that for the next several years, the Federal Reserve’s balance sheet remains large by historical standards, and earnings remain high. Using the FOMC’s stated exit strategy principles and the Blue Chip financial forecasts of the federal funds rate, the projections have the Federal Reserve’s portfolio beginning to contract in 2015. The portfolio returns to a more normal size in early 2018 or 2019, and returns to a more normal composition a year thereafter. The projections imply that Federal Reserve remittances to the Treasury will likely decline for a time, and in some cases fall to zero. Once the portfolio is normalized, however, earnings are projected to return to their long‐run trend. On net over the entire period of unconventional monetary policy actions, cumulative earnings are higher than what they likely would have been without the Federal Reserve asset purchase programs. To illustrate the interest rate sensitivity of the portfolio and earnings, we consider scenarios where interest rates are 100 basis points higher or 100 basis points lower than in the baseline projections. With higher interest rates, earnings tend to fall a bit more and remittances to the Treasury stop for a longer period than in our baseline projections, while with lower interest rates earnings are a bit larger and remittances continue throughout the projection period. With either interest rate path, earnings follow the same general contour as in the baseline analysis.

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    of 63

    Finance and Economics Discussion Series

    Divisions of Research & Statistics and Monetary Affairs


    Federal Reserve Board, Washington, D.C.

    The Federal Reserves Balance Sheet and Earnings: A primer and


    projections

    Seth B. Carpenter, Jane E. Ihrig, Elizabeth C. Klee, Daniel W.


    Quinn, and Alexander H. Boote

    2013-01

    NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary
    materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth
    are those of the authors and do not indicate concurrence by other members of the research staff or the
    Board of Governors. References in publications to the Finance and Economics Discussion Series (other than
    acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.
    TheFederalReservesBalanceSheetandEarnings
    Aprimerandprojections1
    SethCarpenter,JaneIhrig,ElizabethKlee,DanielQuinn,andAlexanderBoote2
    January2013
    Abstract

    Overthepastfewyears,theFederalReservesuseofunconventionalmonetarypolicy
    toolshasledittoholdalargeportfolioofsecurities.Theassetpurchasesareintendedtoput
    downwardpressureonlongerterminterestrates,butalsoaffecttheFederalReservesbalance
    sheetandincome.WebeginwithaprimerontheFederalReservesbalancesheetandincome
    statement.Then,wepresentaframeworkforprojectingFederalReserveassetsandliabilities
    andincomethroughtime.
    TheprojectionsarebasedonpubliceconomicforecastsandannouncedFederalOpen
    MarketCommitteepolicyprinciples.Theprojectionsimplythatforthenextseveralyears,the
    FederalReservesbalancesheetremainslargebyhistoricalstandards,andearningsremain
    high.UsingtheFOMCsstatedexitstrategyprinciplesandtheBlueChipfinancialforecastsof
    thefederalfundsrate,theprojectionshavetheFederalReservesportfoliobeginningto
    contractin2015.Theportfolioreturnstoamorenormalsizeinearly2018or2019,andreturns
    toamorenormalcompositionayearthereafter.TheprojectionsimplythatFederalReserve
    remittancestotheTreasurywilllikelydeclineforatime,andinsomecasesfalltozero.Once
    theportfolioisnormalized,however,earningsareprojectedtoreturntotheirlongruntrend.
    Onnetovertheentireperiodofunconventionalmonetarypolicyactions,cumulativeearnings
    arehigherthanwhattheylikelywouldhavebeenwithouttheFederalReserveassetpurchase
    programs.
    Toillustratetheinterestratesensitivityoftheportfolioandearnings,weconsider
    scenarioswhereinterestratesare100basispointshigheror100basispointslowerthaninthe
    baselineprojections.Withhigherinterestrates,earningstendtofallabitmoreand
    remittancestotheTreasurystopforalongerperiodthaninourbaselineprojections,whilewith
    lowerinterestratesearningsareabitlargerandremittancescontinuethroughoutthe
    projectionperiod.Witheitherinterestratepath,earningsfollowthesamegeneralcontouras
    inthebaselineanalysis.

    1
    ThispaperisanexpansionoftheTheFederalReservesBalanceSheet:APrimerandProjections,FEDSWorking
    Paper#201256.
    2
    TheauthorsarestaffeconomistsandresearchassistantsintheDivisionofMonetaryAffairs,BoardofGovernors
    oftheFederalReserveSystem,Washington,D.C.20551U.S.A.WethankJamesClouse,BillEnglish,MichelleEzer,
    DonHammond,LawrenceMize,JulieRemache,ViktorsStebunovs,LisaStowe,JeffMoore,AriMorse,andBrett
    Schulteforthoughtfuldiscussionsandassistance.Theviewsinthispaperaresolelytheresponsibilityofthe
    authorsandshouldnotbeinterpretedasreflectingtheviewsoftheBoardofGovernorsoftheFederalReserve
    SystemorofanyotherpersonassociatedwiththeFederalReserveSystem.

    1 Introduction
    Inresponsetothefinancialcrisisthatbeganin2007andthesubsequentrecession,theFederal
    Reservehasbeenemployingavarietyofnontraditionalmonetarypolicytools.Theuseofthese
    toolshassignificantlyaffectedthesizeandcompositionoftheFederalReservesbalancesheet,
    aswellasitsearnings.3TheFederalReservesactionshavegarneredpublicattention,and
    FederalOpenMarketCommittee(FOMC)membershaveoftendiscussedinspeechesandpublic
    forumshowtheiractionshaveinfluencedthesizeofthebalancesheet.Theexpansionofthe
    balancesheethasalsopromptedquestionsabouttheinterestrateriskoftheportfolio.Using
    publicallyavailabledataandFederalReserveBankaccountingconventions,weprojectthe
    FederalReservesbalancesheetandincomethrough2025.Theprojectionsincludealternate
    scenariosformonetarypolicyin2013andaroughgaugeoftheinterestrateriskoftheFederal
    Reservesbalancesheet.

    AsshowninFigure1,through2007,thelargestassetitemoftheFederalReserve(reported
    abovethehorizontalaxis)wasTreasurysecurities.Thelargestliabilityitem(reportedbelow
    thehorizontalaxis)wasFederalReservenotesthatis,currency.Priortothefinancialcrisis,
    theFederalReservesbalancesheetgrewatafairlymoderatepace,withtheOpenMarketDesk
    (Desk)attheFederalReserveBankofNewYorkpurchasingadditionalTreasurysecurities
    roughlyonpacewiththeexpansionofcurrencyandFederalReserveBankcapital.

    Atthestartofthefinancialcrisis,theFederalReservesbalancesheetbegantoexpandata
    fasterpace,largelybecauseofanincreaseoflendingthroughtheliquidityandcreditfacilities
    thatwereestablishedatthattime.4Theseextensionsofcreditexpandedtheassetsideofthe
    balancesheet,whileasubstantialportionofthematchingincreaseontheliabilitysideofthe

    3
    TheFederalReservesbalancesheetispublishedeachThursdayintheH.4.1statisticalrelease,availableat
    http://www.federalreserve.gov/releases/h41/.TheFederalReservesincomestatementisfoundintheFederal
    ReservesAnnualReportavailableathttp://www.federalreserve.gov/publications/annualreport/default.htm.
    4
    ForadiscussionoftheFederalReservescreditandliquidityfacilities,see
    http://www.federalreserve.gov/monetarypolicy/bst.htm.

    balancesheetwasinreservebalances.5Theseliquidityfacilitiesbegantowinddownasthe
    FederalReservesassetpurchaseprogramsstartedtorampup.Asaconsequenceoftheasset
    programs,theFederalReservesSystemOpenMarketAccount(SOMA)portfoliothatis,its
    holdingsofsecuritiesmorethantripledfrom2008totoday,andinDecember2012exceeded
    $2.6trillion.

    AssociatedwiththesubstantialchangeintheFederalReservesbalancesheethasbeena
    notablechangeintheFederalReservesnetearnings.TheFederalReservegeneratesa
    substantialportionofitsincomefromtheinterestearningassetsheldbytheFederalReserve
    Banks,particularlyintheSOMAportfolio.FederalReserveexpensesincludeoperating
    expensesnecessarytocarryoutitsresponsibilities,aswellasinterestexpenserelatedto
    certainliabilitiesoftheFederalReserveBanks;currently,thelargestinterestexpensestems
    fromreservebalances.FederalReserveincome,lessexpenses,plusprofitandlossonsalesof
    securities,isreferredtoasnetincome.TheFOMCpursuesitsstatutorilymandatedgoalsof
    fullemploymentandstableprices,andtheresultingnetincomeissimplyabyproductofthe
    actionstaken.TheFederalReserveisstatutorilyrequiredtopaydividendsoncapitalpaidin.
    UnderBoardofGovernorspolicy,afterretainingsufficientearningstoequatesurpluscapitalto
    capitalpaidin,theFederalReserveBanksremitresidualnetincometotheU.S.Treasury.

    AsaresultoftheFOMCsactionstoachieveitsmonetarypolicygoals,theFederalReserve
    recentlyhasbeenremittingmoreincometotheTreasurythanwashistoricallythecase.As
    showninFigure2,interestincomehasincreasednotably,particularlytheportionattributable
    totheSOMAholdingsofagencyMBS.Moreover,interestincomehasrisensignificantlymore
    thaninterestexpenseand,asaresult,remittancestotheTreasuryhavegrownsubstantiallyin
    recentyears,fromroughly$25billionperyear,onaverage,from2001to2007,toalmost$80
    billionin2010and2011,andtonearly$90billionin2012,asshowninFigure3.And,although
    someattentionhasbeenfocusedonthechangeinthebalancesheetandthepotentialinterest

    5
    Throughoutthispaperthephrasereservebalanceswillbeusedtodenotedepositsofdepositoryinstitutions
    thatarenotintermdeposits.Thismeasureisreportedintables8and9oftheH.4.1statisticalreleaseas
    Deposits,Otherdepositsheldbydepositoryinstitutions.Thisconceptisslightlydistinctfromtheconceptof
    reservebalancesreportedintable1oftherelease.Thatconceptexcludes,amongotheritems,contractual
    clearingbalances.

    rateriskthattheFederalReservehasincurred,infact,theFederalReservessecuritiesportfolio
    currentlyhasanunrealizedgainpositionofroughly$249billionasofSeptember2012.6

    ThispaperdescribesaframeworkforconstructingprojectionsoftheFederalReservesbalance
    sheetandincomestatementunderavarietyofpossiblescenarios.Theseprojectionsarenot
    forecasts.Aswillbecomeclear,theprojectionsdependcriticallyonawholehostof
    assumptionsaboutfuturemonetarypolicydecisions,financialmarketdevelopments,andother
    issues.Theassumptionsandprojectionsofeachofthosefactorsimplyapathforthebalance
    sheetandremittancestotheTreasury.Theseprojectionsillustratehowthevariousfactorsthat
    affectthebalancesheetandincomeoftheFederalReservedosodynamically.Ofcourse,other
    assumptionsareplausible,andtheaimofthispaperistoillustratehowonecouldtakevarious
    assumptionstocreateprojections.

    Webaseourmodelingonthreekeyinputs.First,westartwiththeFederalReservesbalance
    sheetasofOctober31,2012andmodelassetprogramsannouncedthroughDecember2012.
    Inparticular,theFOMCsDecember2012statementindicatedthat:

    Tosupportastrongereconomicrecoveryandtohelpensurethatinflation,overtime,
    isattheratemostconsistentwithitsdualmandate,theCommitteewillcontinue
    purchasingadditionalagencymortgagebackedsecuritiesatapaceof$40billionper
    month.TheCommitteealsowillpurchaselongertermTreasurysecuritiesafterits
    programtoextendtheaveragematurityofitsholdingsofTreasurysecuritiesis
    completedattheendoftheyear,initiallyatapaceof$45billionpermonth.[]The
    Committeewillcloselymonitorincominginformationoneconomicandfinancial
    developmentsincomingmonths.Iftheoutlookforthelabormarketdoesnotimprove
    substantially,theCommitteewillcontinueitspurchasesofTreasuryandagency
    mortgagebackedsecurities,andemployitsotherpolicytoolsasappropriate,untilsuch
    improvementisachievedinacontextofpricestability.

    Theprogramoutlinedinthisstatementishighlyconditionalonmacroeconomicoutcomes.
    Modelingthejointmacroeconomicandmonetarypolicyinteractionsisoutsidethescopeofthe
    presentpaper.However,weconsiderthebalancesheetandincomeeffectsofthreealternative
    additionalassetpurchaseamounts:noadditionalpurchases;$500billioninadditional

    6
    ThequarterendmarketvalueoftheSOMAportfolioispublishedintheFederalReserveBanksCombined
    QuarterlyFinancialReports,availableathttp://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm#quarterly.

    purchasesin2013atapaceof$45billionpermonthofTreasurysecuritiesand$40billionper
    monthofagencyMBS;and$1trillioninadditionalpurchasesin2013atapaceof$45billionper
    monthofTreasurysecuritiesand$40billionpermonthofagencyMBS.BecausetheFederal
    Reservehaspurchasedsecuritiesin2013,thefirstscenarioisnotpossible,butitnevertheless
    providesagoodbenchmarkforcomparingtheoutcomesofthedifferentscenarios.

    Second,weinterprettheminutesoftheJune2011FOMCmeetingtoputsomestructureona
    plausibleexitstrategyfrommonetarypolicyaccommodation.Theseexitprinciplessuggesta
    sequenceofmonetarypolicyactions,startingwithallowingSOMAholdingstomatureandroll
    offtheportfolio.Inourprojections,weassumethisisthefirststeptoexitthecurrent
    unconventionalmonetarypolicyaccommodation.ThenweassumethattheFOMCbeginsto
    raisethetargetfederalfundsrate,andfinallyitsellsSOMAassets,inordertonormalizethe
    sizeandcompositionofthebalancesheetwithinanumberofyears.

    Finally,werelyontheDecember2012BlueChipEconomicIndicatorsforecastfornominalGDP
    growthandinterestrates.TheBlueChipEconomicIndicatorsisaconsensusforecastbasedon
    asurveyofprofessionalforecasters;weusethemeanoftheforecastforourselectedeconomic
    variablesforguidancewiththeirprojectedpaths.Weassumethatthetimingofthevarious
    elementsoftheexitstrategyistiedtothetimingoftheliftoffofthefederalfundsrate.Allof
    theseinputsarepubliclyavailableandinnowayrepresentaforecastfromtheFederalReserve
    oritsstaff.

    Keyfindingsusingtheassumptionsnotedabovearethefollowing.First,theprojectionsyielda
    FederalReservebalancesheetthatremainslargebyhistoricalstandardsforanumberofyears.
    Inparticular,theSOMAportfolioexpandswithassetpurchasesin2013andthencontractsat
    onlyaslowpacethroughthemediumterm,reflectingthefactthatasofDecember2012,the
    FOMCsuggestedthatconditionswillmostlikelywarrantkeepingthefederalfundsrateat
    exceptionallylowlevelsforsometime.7Undertheassumptionofnofurtherassetpurchasesin

    7
    TheDecember2012FOMCstatementexplicitlystatedthattheCommitteedecidedtokeepthetargetrangefor
    thefederalfundsrateat0to1/4percentandcurrentlyanticipatesthatthisexceptionallylowrangeforthefederal
    fundsratewillbeappropriateatleastaslongastheunemploymentrateremainsabove61/2percent,inflation
    betweenoneandtwoyearsaheadisprojectedtobenomorethanahalfpercentagepointabovetheCommittees

    2013,theSOMAportfoliodoesnotreturntoamorenormalsizeuntilearly2018.Underthe
    assumptionofanadditional$1trillioninassetpurchasesin2013,theportfolioreturnstoa
    morenormalsizeinearly2019.Ineithercase,thecompositionoftheportfoliodoesnotreturn
    tonormaluntilaboutayearafterthesizenormalizes.

    Second,theprojectionsimplythatremittancestotheTreasurycontinueatarobustpace
    through2015.However,whenthefederalfundsrateincreasesandsecuritiessalescommence,
    remittancesmightbehaltedforafewyears,reflectingtheelevatedinterestexpenseonreserve
    balancesandcapitallossesassociatedwithsalesofMBS,bothofwhichoffsettheinterest
    incomefromtheportfolio.FederalReserveBankaccountingrulesstipulatethatwhenincome
    isnotsufficienttocoverexpenses,remittancestotheTreasurycease,andtheFederalReserve
    booksadeferredasset.8Inthescenariowithnoadditionalpurchasesin2013,theprojection
    suggestsalowlevelofremittancesforafewyears,butnodeferredasset.However,larger
    amountsofsecuritiespurchasedin2013increasethelikelihoodofadeferredasset.The
    projectionwith$1trillionofadditionalpurchaseshasadeferredassetforabout4years,witha
    peakvalueof$45billion.Itisimportanttonotethatadeferredassetwouldnothaveany
    implicationsfortheFOMCsabilitytoconductmonetarypolicy,butremittancestotheTreasury
    wouldhalt.Thatsaid,projectionsforcumulativeremittancesfrom2009and2025are
    projectedtobeatleast$720billion,orover$40billionperyear,substantiallymorethanthe
    roughly$25billionperyearremittedpriortothefinancialcrisis.Thislongerrunperspectiveon
    remittancesisimportant,becausetheremittancesfluctuatesubstantiallyfromyeartoyearin
    ourprojections,withearningsbeingelevatedintheneartermandfallinglaterasassetsales
    incursomerealizedcapitallossesandinterestexpenserisestemporarily.Attheendofthe
    projectionperiod,whentheSOMAportfoliogrowsatitslongruntrend,remittancestothe

    2percentlongerrungoal,andlongerterminflationexpectationscontinuetobewellanchored.Moreover,the
    statementalsoindicatedthatthesethresholdswereconsistentwiththeearlierdatebasedguidancethat
    suggestedthatexceptionallylowlevelsofthefederalfundsratewerelikelytobewarrantedatleastthroughmid
    2015.
    8
    ThedeferredassetissubsequentlyrealizedasareductionoffutureremittancestotheTreasury(whichare
    accountedforasinterestonFederalReservenotesexpense).Thus,itisanassetinthesensethatitembodiesa
    futureeconomicbenefitthatwillberealizedasareductionoffuturecashoutflows.Iftherealizationoftheassetis
    expectedtooccuroverseveralyears,somevaluationtechnique,suchasnetpresentvalue,wouldbeappliedto
    measurethevalueoftheasset.ThisaccountingtreatmentisconsistentwithU.S.GAAPandissimilartotheway
    thatprivatecompaniesreportdeferredlosscarryforwardsasanasset.

    Treasuryareabout$45billionperyear.Morebroadly,theintentoftheassetpurchasesisto
    stimulateeconomicactivityandhelptheFederalReservetofosteritsdualobjectivesof
    maximumemploymentandstableprices.Chungetal.(2011)providesomeestimatesofthe
    macroeconomiceffectoftheassetpurchases,whichwouldlikelyresultinhighertaxrevenue,
    andthiseffectwouldlikelybesubstantiallylargerthananyfluctuationinremittancesbythe
    FederalReserve.

    Third,FederalReserveearningsandremittancestotheTreasuryexhibitsensitivitytothe
    forecastforinterestrates.Toillustratetheseriskstotheprojections,weconsiderascenario
    wherebothshorttermandlongerterminterestratesare100basispointshigherthaninthe
    baselineprojection.Relativetothebaselineprojections,underthisassumption,remittancesto
    theTreasuryceasefor2to3additionalyears,andthedeferredassetspeakatlargeramounts.
    Inessence,highershortterminterestratesmakeinterestonreservesmorecostly,andhigher
    longterminterestratesmakesellingMBSmorecostly.Wealsoconsiderascenariowhere
    ratesare100basispointslowerthaninthebaselineprojection.Thelowerratesdampen
    realizedlossesandinterestexpense,andasaresult,theFederalReserveremitsearningstothe
    Treasurythroughouttheprojectionandnodeferredassetisrecorded.Underanyofthe
    interestratepathsstudiedhere,however,onnet,theFederalReservesnontraditionalpolicy
    tendstoboostremittancestotheTreasuryovertheprojectionperiodinitsentirety.

    Thepaperisorganizedasfollows.Section2providesaprimerontheFederalReservesbalance
    sheetandaccounting,includingtheSOMAportfolioandtheFederalReservesincome
    statement.Section3outlinestheassumptionsusedasinputstotheprojectionsofthebalance
    sheet.ThebalancesheetandincomeprojectionsarediscussedinSection4,boththe
    projectionsforthethreepurchaseoptionsunderthebaselineassumptionforinterestrates,
    andthesameprojectionswithinterestrateshocksthatillustratetheinterestratesensitivityof
    theportfolio.Section5concludes.Twoappendixesarealsoincluded.Appendix1provides
    moredetailontheassumptionsunderlyingtheprojections.Appendix2describesthemethod
    usedtoderiveprojectionsoffuturevaluationsandincomefromSOMAsecurities.

    2 The Federal Reserves balance sheet, income statement, and


    valuation of the SOMA portfolio
    Inthissection,wereviewkeybalancesheetcomponentsinourprojections,aswellasthe
    incomegeneratedfromthebalancesheet.Wealsoprovidesomehistoricalcontextforthe
    evolutionoftheseitems.DiscussionofotherassetsandliabilitiescanbefoundinAppendix1.

    2.1 The Federal Reserves balance sheet


    OurdiscussionoftheFederalReservesbalancesheetwillrefertotheconsolidatedbalance
    sheetsofthe12individualReserveBankbalancesheets.9Inreality,theaccountingthatwillbe
    discussedbelowisdoneattheReserveBanklevel;however,forsimplicity,wefocusonthe
    FederalReserveSystemsaggregatebalancesheet.

    Likeanybalancesheet,theFederalReservehasassetsononesideofthebalancesheet,which
    mustequalliabilitiespluscapitalontheotherside.AsshowninTable1,attheendof2006,
    totalassetsoftheFederalReservewere$875billion,withthesinglelargestassetitembeing
    theSOMAportfolio,atabout$780billion.Priortothefinancialcrisis,thedomesticSOMA
    portfoliocomprisedonlyTreasurysecurities,ofwhichroughlyonethirdwereTreasurybillsand
    twothirdswereTreasurycouponsecurities.Ontheothersideofthebalancesheet,thelargest
    liabilityitemwaspapercurrency,orFederalReserveNotes(FRNotes),atabout$785billion.

    Withthelendingthattookplaceduringthefinancialcrisis,foratime,lendingofvarioussorts
    surpassedthesizeoftheSOMAportfolio.AsofDecember26,2012,however,theSOMA
    portfoliowasagainthelargestassetitem,andithadgrownto$2.6trillionbecauseoftheasset
    purchaseprograms.Ontheliabilitysideofthebalancesheet,FRNotes,atabout$1.1trillion,
    werenolongerthelargestliabilityitem.Instead,astheFOMCincreaseditsassetpurchases,
    reservebalancesincreasedcorrespondinglytoalevelabout$1.5trillion.

    9
    TheBoardofGovernorsdoesnotholdassetsandliabilitiesinthesamewaythattheReserveBanksdo.Section
    10oftheFederalReserveActauthorizestheBoardtolevysemiannuallyupontheReserveBanks,inproportionto
    theircapitalstockandsurplus,anassessmentsufficienttopayitsestimatedexpensesforthehalfoftheyear
    succeedingthelevyingofsuchassessment,togetherwithanydeficitcarriedforwardfromtheprecedinghalfyear.

    Table1:FederalReserve'sBalanceSheet,end2006andpresent
    Balancesheetend2006 BalancesheetDecember26,2012
    billionsof$ billionsof$

    Assets Liabilities Assets Liabilities


    SOMA 779 DepositsofDIs 13 SOMA 2,661 DepositsofDIs 1,533
    Otherassets 95 FRnotes 783 Otherassets 248 FRnotes 1,125
    Otherliabilities 49 Otherliabilities 198

    memo:Capital 31 memo:Capital 55

    Source:H.4.1StatisticalRelease

    ThenextfewsubsectionsreviewthekeycomponentsoftheFederalReservesbalancesheet
    andhowtheyhavechanged.10

    2.1.1 The SOMA portfolio: Composition, size, and maturity structure


    Overmostofthepostwarperiod,theSOMAportfoliowasthelargestassetitemontheFederal
    Reservesbalancesheet.11Duringthattime,theSOMAportfolioessentiallyheldTreasury
    securities;however,theportfoliohasheldothertypesofsecuritiesinitsportfoliooverits
    history.12Forexample,from1971to1981,theFederalReservepurchasedlimitedquantitiesof
    agencysecurities;thelastofthesesecuritiesmaturedintheearly2000s,andnonewas
    purchaseduntil2008.13

    Historically,thesizeoftheSOMAportfolioandthebalancesheetmoregenerallyreflected
    growthinFRNotesandReserveBankcapital.Whencurrencyisputintocirculation,itis
    shippedtoadepositoryinstitutionandthatinstitutionsaccountattheFederalReserveis
    debitedbyanequivalentamount.Becausecurrencyoutstandingtendstotrendupward,over
    timecurrencygrowthwouldtendtoreducetheamountofreservebalancesinthebanking
    system.TheFederalReservewouldpurchasesecuritiesinopenmarketoperationstooffsetthis
    drainofreserves.Onnet,therefore,thegrowthrateofcurrencytendedtodrivethesizeofthe

    10
    Foradescriptionofadditionalcomponentsofthebalancesheet,seetheinteractiveguidestotheH.4.1tablesat
    http://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm,ortheFinancialAccountingManualat
    http://www.federalreserve.gov/monetarypolicy/files/bstfinaccountingmanual.pdf.
    11
    ForadescriptionoftheFederalReservesbalancesheetpriortoWorldWarII,seeBankingandMonetary
    Statistics,19141941(1943).
    12
    RefertoEdwards(1997).
    13
    RefertoMeltzer(2010).

    balancesheet.Similarly,whenadepositoryinstitutionisrequiredtosubscribetoalarger
    amountofFederalReservecapitalortheFederalReserveaddstoitssurplusaccount,theresult
    wouldbeallelseequalareductioninreservebalances.14Asaresult,theSOMAportfolio
    mustincreasetooffsettheseincreasesaswell,creatingalargerbalancesheetoverall.

    ThishistoricalpatternisillustratedinFigure4.Ascanbeseen,through2007,boththeSOMA
    portfolioandcurrencyandcapitaltrendedupwardtogether.Whentheassetprogramsbegan
    inlate2008andearly2009,andcontinuingthroughthesecondroundofpurchasesin2010and
    2011,theSOMAportfolioincreasedmarkedlyandataratethatfaroutpacedthegrowthof
    currencyandcapital.Withtheinitiationofthematurityextensionprogramin2011,thesizeof
    theportfolioremainedroughlyconstant;however,asdepictedinFigure5,theweighted
    averagematurityofTreasurysecuritiesintheSOMAportfolioincreasedmarkedly.Froma
    longerperspective,overtime,theSOMAportfoliohashadarangeofmaturitiesofTreasury
    securitiesinitsholdings.15Priortothefinancialcrisis,theDesktendedtopurchasesecurities
    acrosstheentireyieldcurvetoavoiddistortingtheyieldcurve.Butafterthestartofthe
    financialcrisis,thematurityofTreasurycouponsecuritiesintheSOMAportfoliolengthened
    notably,reflectingtherunoffinbillstosterilizethecreditandliquidityprogramsin2008,and
    thepurchaseoflongerdatedsecuritiesmorerecently.

    2.1.2 Deposits of depository institutions


    DepositsofdepositoryinstitutionsincludealldepositoryinstitutionsbalancesattheFederal
    Reservethatareusedtosatisfyreserverequirementsandbalancesheldinexcessofbalance
    requirements.Depositsofdepositoryinstitutionsgrewdramaticallythroughthecrisis,andare
    currentlyquiteelevatedbyhistoricalstandards.Whenwerefertoreservebalances,weare
    usingthedepositsofdepositoryinstitutionsconcept.Thesedepositsrepresentfundsthat
    depositoryinstitutionsowntheyarealiabilityoftheReserveBank,butanassetofthe
    depositoryinstitution.Thesefundsarealsousedforpaymentsystemsettlementforexample,
    apaymentfromonebanktoanother(orfromonebankscustomertothecustomerofa

    14
    Aswillbemorefullyexplainedlaterinthepaper,eachmemberbankofaReserveBankisrequiredtosubscribe
    tothecapitalofitsdistrictReserveBankinanamountequalto6percentofitsowncapitalstock.
    15
    IntheweeklyH.4.1statisticalrelease,inadditiontotheFederalReservesbalancesheet,thematurity
    distributionofassetholdingsisalsopublished.

    differentbank)typicallyresultsinadebittothepayingbanksaccountandacredittothe
    receivingbanksaccount.Lendingofreservebalancesandpaymentactivityresultonlyina
    movementofreservebalancesfromonedepositoryinstitutionsaccountattheFederalReserve
    toanotherinstitutionsaccount;theaggregatequantityisunchanged.

    2.1.3 Federal Reserve Notes


    FederalReservenotes,orcurrency,arealiabilityoftheFederalReserve.Asapracticalmatter,
    thequantityofcurrencyoutstandingisnotdeterminedbytheFederalReserve.Instead,when
    adepositoryinstitutionwantstoholdcurrencyinitsvaultorautomatictellermachinesinorder
    tomeetcustomerneeds,itrequestsashipmentfromitsFederalReserveBank.Whenthat
    shipmentismade,thedepositoryinstitutionsreserveaccountattheReserveBankisdebited
    bytheamountofthecurrencyshipment.OneimportantsourceofdemandforU.S.currencyis
    fromoverseas.Althoughitisimpossibletoknowwithcertaintywhatportionofcurrency
    outstandingisoutsideoftheUnitedStates,estimatessuggestthatthefractionisonehalfor
    more.16Priortothefinancialcrisis,currencywasthelargestliabilityitemontheFederal
    Reservesbalancesheet.

    2.1.4 Capital paidin, surplus, and interest on Federal Reserve notes due to U.S.
    Treasury
    ThecapitaloftheReserveBanksisdifferentthanthecapitalofotherinstitutions.17Itdoesnot
    representcontrollingownershipasitwouldforaprivatesectorfirm.Ownershipofthestockis
    requiredbylaw,theReserveBanksarenotoperatedforprofit,andthestockmaynotbesold,
    traded,orpledgedassecurityforaloan.AsstipulatedinSection5oftheFederalReserveAct,
    eachmemberbankofaReserveBankisrequiredtosubscribetothecapitalofitsdistrict
    ReserveBankinanamountequalto6percentofitsowncapitalstock.Ofthisamount,half
    mustbepaidtotheFederalReserveBanks(referredtoascapitalpaidin)andhalfremains
    subjecttocallbytheBoardofGovernors.Thiscapitalpaidinisarequiredassessmentonthe
    memberbanksanditssizechangesdirectlywiththecapitalofthememberbanks.Also

    16
    RefertoJudsonandPorter(1996).
    17
    SeetheFinancialAccountingManualforFederalReserveBanks,whichreportstheaccountingstandardsthat
    shouldbefollowedbytheFederalReserveBanksat
    www.federalreserve.gov/monetarypolicy/files/bstfinaccountingmanual.pdf, pageI68.

    10

    stipulatedbylawisthatdividendsarepaidatarateof6percentperyear.Overthepast
    decade,reflectingincreasesincapitalatmemberbanks,ReserveBankcapitalhasgrownatan
    averagerateofalmost15percentperyear.Inaddition,ReserveBankshavesurpluscapital,
    whichreflectswithheldearnings,andFederalReserveBankaccountingpoliciesstipulatethat
    theReserveBankswithholdearningssufficienttoequatesurpluscapitaltocapitalpaidin.Asa
    result,ascapitalofmemberbanksgrowsthroughtime,capitalpaidingrowsinproportion.
    Becausesurplusissetequaltocapitalpaidin,itlikewisegrowsatthesamerateasmember
    bankcapital.

    Oneliabilityitemisdistinctfromtheothers.Asnotedabove,underitsremittancepolicythe
    FederalReserveremitsallnetincometotheU.S.Treasury,afterexpensesanddividendsand
    allowingforsurplustobeequatedtocapitalpaidin.Asthoseearningsaccrue,theyare
    recordedontheFederalReservesbalancesheetasInterestonFederalReservenotesdueto
    U.S.Treasury.Intheeventthatearningsonlyequaltheamountnecessarytocoveroperating
    costs,paydividends,andequatesurplustocapitalpaidin,thisliabilityitemwouldfalltozero
    becausetherearenoearningstoremitandthepaymenttotheTreasurywouldbesuspended.
    Ifearningsareinsufficienttocoverthesecoststhatis,thereisanoperatinglossinsome
    periodthennoremittanceismadeuntilearnings,throughtime,havebeensufficienttocover
    thatloss.Thevalueoftheearningsthatneedtoberetainedtocoverthislossiscalleda
    deferredassetandisbookedasanegativeliabilityontheFederalReservesbalancesheet
    underthelineitemInterestonFederalReservenotesduetotheU.S.Treasury.Asdiscussed
    aboveinfootnote8,itisanassetinthesensethatitreflectsareductionoffutureliabilitiesto
    theU.S.Treasury.

    OneconsequenceofthecurrentimplementationofFederalReserveBankaccountingpolicyis
    thattherecordingofadeferredassetimpliesthatReserveBankcapitaldoesnotdeclineinthe
    eventofanoperatingloss.Fromtimetotime,individualReserveBankshavereporteda
    deferredasset;however,thesedeferredassetsweregenerallyshortlived.18Ithasneverbeen

    18
    Forexample,asshownontheH.4.1StatisticReleasefromNovember3,2011,theFederalReserveBankofNew
    YorkrecordedalargeenoughdeferredassetsothattheFederalReserveSystemalsodid.

    11

    thecasethattheFederalReserveSystemasawholehassuspendedremittancestothe
    Treasuryforameaningfulperiodoftimebecauseofoperatinglosses.

    2.2 The Federal Reserves income statement


    AstheFederalReservesbalancesheethasexpandedinrecentyears,theincomederivedfrom
    thebalancesheethasalsogrown,thoughthekeylineitemsfromthebalancesheetthat
    generatedthisincomearethesame.AsshowninTable2,netincomeinboth2006and2011
    wasdrivenbyinterestincomefromtheSOMAportfolio.Despitethedifferenceinmagnitude,
    inbothyears,SOMAinterestincomewasmorethan95percentoftotalincome.Thatsaid,
    SOMAinterestincomegrewsubstantiallyoverthisperiodastheSOMAportfolioexpanded.
    Interestexpense,ontheotherhand,wasminimalinbothyears.Inparticular,FRnotesarea
    largeliabilitywithoutanassociatedinterestexpense.And,althoughtheFederalReservehas
    paidinterestonreservebalancessinceOctober2008,thisliabilityitemhasincurredlittle
    interestexpensebecausetheinterestonexcessreserves(IOER)ratehasbeenat25basispoints
    sinceDecember2008.Inbothyears,otheritemsintheincomestatementweresimilar.In
    total,remittancestotheTreasurywerepositiveinbothyears,butmuchlargerin2011because
    oftheexpandedSOMAportfolio.

    Table2:Incomeandexpenses,2006and2011

    Incomeandexpenses,2006 Incomeandexpenses,2011
    billionsof$ billionsof$

    Income Expense Income Expense


    Interestincome 36.8 Interestexpense 1.3 Interestincome 84.5 Interestexpense 3.8
    Otherincome 1.6 Otherexpense 3.7 Otherincome 0.7 Otherexpense 4.5

    memo:Additions/deductions, 4.3 memo:Additions/deductions, 1.5


    dividends,andtransfers dividends,andtransfers

    Source:FederalReserveAnnualReport

    ThenextfewsubsectionsreviewthekeylineitemsoftheFederalReservesincomestatement
    inmoredetail.

    12

    2.2.1 SOMA interest income


    Asnotedabove,incomeonthesecuritiesheldintheSOMAportfolioconstitutesthevast
    majorityofinterestincome.SOMAinterestincomeprimarilyreflectsthesizeoftheportfolio
    andtheweightedaveragecoupon(WAC)oftheportfolio,lessanyamortizednetpremiums
    paidonsecurities.19Asnotedabove,priortothefinancialcrisis,thesizeoftheportfolio
    increasedsteadilyatamoderaterate.Withtheadoptionoftheassetprograms,thesecurities
    portfolioexpandedrapidlyandnowstandsatalevelnoticeablyaboveitslongerruntrend.The
    WAC,asshowninFigure6,fluctuatedovertime,risingandfallingwiththemarketratesand
    theSOMAportfoliosholdings.ThispatternprimarilyreflectsthefactthattheFederalReserve
    reinvestsmaturingTreasurysecuritiesatauction,andthecouponatauctiontendstobeinline
    withmarketrates.Althoughtheassetpurchaseprogramsresultedinasignificantaccumulation
    oflongertermdebtinrecentyears,muchofitwasissuedinalowinterestrateenvironment
    and,therefore,theWACoftheportfoliodecreasedsomewhat.

    PuttingthesizeoftheportfolioandtheWACoftheportfoliotogether,asshowninFigure7,
    interestincomeclimbedatamoderatepaceintheyearspriortothefinancialcrisis,primarilyas
    aresultofthesteadyincreaseinthesizeofSOMA,whichroseinlinewiththegrowthofFR
    notesandcapital.Beginningin2009,interestincomefromtheportfoliorosenoticeablyas
    largescaleassetpurchasesincreasedthesizeoftheportfolio.

    2.2.2 Interest expense


    Withtheintroductionofinterestonreservesinthefallof2008andtheconcurrentriseinthe
    levelofreservebalances,interestexpenserose.Asmentionedabove,theIOERratehasbeen
    25basispointssinceDecember2008,andasaresult,evenwithasubstantialvolumeofreserve
    balances,interestexpensefromreservebalanceshasbeenlowcomparedtointerestincome
    andwasroughly$3.8billionin2011.

    Inadditiontointerestexpensefromreservebalances,thereisalsointerestexpensefrom
    reverserepurchaseagreements(RRPs),mostlygeneratedbytheforeignrepurchaseagreement

    19
    SOMAinterestincomeisdefinedastherateofreturnontheportfolio(theproductofthesizeoftheportfolio
    timestheWAC)minusamortizednetpremiums.Netpremiums,thoughimportantinderivingtheprecisevalueof
    interestincome,willnotbeaprimarydriverofthecontouroftheprojectionsofinterestincome.

    13

    (RP)pool.20,21InterestratespaidontheforeignRPpoolaregenerallyinlinewithmarketrates,
    andwhenreservebalancesarerelativelylow,interestexpenseontheforeignRPpoolcan
    representalargeshareoftotalinterestexpense.

    Reverserepurchaseagreementswithprimarydealersandotherinstitutionsandtheterm
    depositfacility(TDF)alsohaveassociatedinterestexpense.Inadditiontotheprimarydealers,
    theFederalReserveselectedmoneymarketmutualfunds,FederalHomeLoanMortgage
    Corporation(FreddieMac),FederalNationalMortgageAssociation(FannieMae),andsome
    banksaspotentialcounterpartiesforRRPs.BycontrasttotheRRPs,onlybanksarethe
    counterpartiesinTDFtransactions.AlthoughtheFederalReservehasdevelopedthecapability
    ofconductinglargescaleoperationsineithertheRRPsorTDF,neitherhasbeenusedina
    materialsizetodate,andasaresult,interestexpenseassociatedwiththesefacilitieshasbeen
    minimal.

    2.2.3 Capital gain (loss)


    UnderFederalReserveaccountingrules,aFederalReserveBankrealizesgainsorlossesona
    securityonlywhenthesecurityissold.Atsale,wecalculatetheFederalReservesgainorloss
    asthemarketvalueminustheparvalueandunamortizednetpremiumsonthesecurity.
    Historically,theFederalReservedidnotgenerallysellsecurities,becausetheseculargrowthin
    currencyresultedinaneedforalongtermincreaseinsecuritiesholdings.In2008,however,
    theDeskdidsellsomesecuritiestooffsettheexpansionofthebalancesheetthatresultedfrom
    theintroductionoftheliquidityfacilitiesattheearlystagesofthefinancialcrisis.Inthatyear,
    theFederalReserverealizedacapitalgainofroughly$3billionbecausemarketrateshadfallen,
    pushingupthemarketpriceofthesecuritiessold.Withthematurityextensionprogram,the
    FederalReservehasalsosoldsecurities.In2011,thesesalesrealizeda$2.3billioncapitalgain.

    20
    BeforeDecember13,2002,repotransactionswereconductedasmatchedsalespurchasetransactions,where
    theFederalReservesoldasecuritywithanagreementtopurchaseitagainatalaterdate.However,because
    matchedsalepurchasetransactionswereaccountedforasanoutrightsaleratherthanasafinancingtransaction
    thewayreverserepurchaseagreementsare,thetransactionsdidnotresultininterestexpense.
    21
    EverybusinessdaytheFederalReserveconductsovernightreversereposwithforeigncentralbanksthathold
    dollarsintheiraccountsattheFederalReserveBankofNewYork.Thesetransactionsareoneoftheservicesthat
    centralbanksprovideoneanothertofacilitatetheirinternationaloperations.

    14

    2.2.4 Payment of dividends, transfers to surplus, and interest on Federal Reserve


    notes due to the U.S. Treasury
    Asnotedabove,memberbanksarerequiredtosubscribetothecapitalstockoftheReserve
    Banks,andtheActstipulatesthattheFederalReservepaya6percentdividendonthiscapital.
    UnderpolicyprescribedbytheBoardofGovernors,excessearningsareretainedassurplus
    capitalinanamountequaltocapitalpaidin.BeforeremittancestotheTreasuryaremade
    dividendsarepaidandearningsareretainedtoequatesurplustocapitalpaidin.Dividendsare
    paidevenifremittancestotheTreasurywouldbezero.Asdiscussedearlier,intheeventthat
    earningsfallshortoftheamountnecessarytocoveroperatingcosts,paydividends,andequate
    surplustocapitalpaidin,theFederalReservebooksaliabilityofinterestonFederalReserve
    notesduetoU.S.Treasury.ThislineitemisrecordedinlieuofreducingtheReserveBanks
    surplus,andrepresentstheamountofearningstheFederalReserveneedstoaccumulate
    beforeitresumesremittingresidualearningstoU.S.Treasury.

    2.2.5 Remittances to the Treasury


    TheFederalReserveremitsanyearningsinexcessofoperatingexpensesanddividendstothe
    Treasury.22TheuseofthesefundsisstipulatedintheFederalReserveAct,whichstates:

    ThenetearningsderivedbytheUnitedStatesfromFederalReservebanksshall,inthe
    discretionoftheSecretary,beusedtosupplementthegoldreserveheldagainst
    outstandingUnitedStatesnotes,orshallbeappliedtothereductionoftheoutstanding
    bondedindebtednessoftheUnitedStatesunderregulationstobeprescribedbythe
    SecretaryoftheTreasury.23

    Overtime,asshownearlierinFigure3,remittancesremainedinarelativelysmallrange,
    averagingabout$25billionintheyearsimmediatelyprecedingthefinancialcrisis.Duringthe
    crisis,asFederalReserveincomeincreasednotably,sodidremittancestotheTreasury.Still,
    remittancesremainedarelativelysmallshareofgovernmentreceiptsdwarfedbyindividual
    incomeandcorporateincometaxes,asshowninFigure8,andaboutinlinewithcustoms
    deposits(notshown).

    22
    Occasionally,statutorytransfersoccur,whichmandatethattheFederalReservetransferaportionofitssurplus
    totheTreasury.Thelasttimethisoccurredwasin2000,whenapproximately$3.8billionheldinthesurplus
    accountwastransferredtotheTreasury.
    23
    FederalReserveAct,Section7,UseofEarningsTransferredtotheTreasury,12USC290,subsection(b).

    15

    2.3 Valuation of the SOMA portfolio


    ThereareanumberofdifferentwaystorecordthevalueoftheSOMAportfolio.ReserveBank
    accountingrecordstheSOMAportfolioatparvalue.Theparvalueoftheportfolio,reportedin
    line1ofTable3,givesthefacevalueofthesecuritiesintheportfolio.Thisisthevalueofthe
    portfolioreportedintheweeklyH.4.1statisticalrelease.Theamortizedcostoftheportfolio,
    alsocalledthebookvalueoftheportfolioandshowninline3,istheparvalueoftheportfolio
    plusanyunamortizednetpremiumsassociatedwiththesecurities.Athirdvaluationofthe
    portfolioisthemarketvalue,line4.TheFederalReserveBanksCombinedQuarterlyFinancial
    ReportsandtheAnnualReportalsoreportthefairvalue(essentiallythemarketvalue)ofthe
    portfolio.24Asinterestrateschange,themarketvalueofthesecuritiesintheportfoliochanges.
    Thedifferencebetweenthemarketvalueandthebookvalueistheunrealizednetgain(orloss)
    positionoftheportfolio,line5.AsoftheendofSeptember2012,theportfoliohadan
    unrealizedgainof$249billion,reflectingagainoneachofthethreetypesofsecurities
    holdings.25September2012isthelastpublishedinformationonthepositionoftheportfolioas
    ofthewritingofthispaper;however,asimilarcalculationispossibleatanytime.Inparticular,
    theFederalReserveBankofNewYorkpublishestheCUSIPofeverysecurityheldintheSOMA
    portfolio.CombiningtheseCUSIPswithmarketpricesforthesecuritiesallowsforthe
    calculationonanydayofthemarketvalueoftheFederalReservesportfolio.Arough
    calculationoftheunrealizedgainorlosspositionoftheportfolioisalsopossible.26

    24
    ThequarterendmarketvalueoftheSOMAportfolioispublishedintheFederalReserveBanksCombined
    QuarterlyFinancialReports(Unaudited),availableat
    http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm#quarterly.Alternatively,theFederal
    ReserveBankofNewYorkpublishestheCUSIPsofallofthesecuritiesintheFederalReservesportfolio.Matching
    theseCUSIPswithcurrentmarketpricesallowsforanestimateofthecurrentmarketvalueoftheportfolio.
    25
    Importantly,eveniftheSOMAportfoliowasinanunrealizednetlossposition,theabilityoftheFederalReserve
    toimplementmonetarypolicywouldnotbehampered.
    26
    Inadditiontothemarketpriceoftheportfolio,theamortizedcostoftheportfolioisrequiredtocalculatethe
    unrealizedgainorlossposition.Inrealtime,amortizedcostcanbeeasilyapproximatedbytheparvalueofthe
    portfolio,whichispublishedweekly,andthenetunamortizedpremiums,whichareincludedintheweekly
    publicationofthebalancesheetandareexplicitlypublishedquarterly.

    16

    Table3:ValueoftheSOMAportfolioasofSeptember30,2012
    ($billions)
    Treasuries AgencyDebt AgencyMBS TotalSOMA
    1.Parvalue* 1,648 85 848 2,581
    2.Netpremiums 131 1 3 135
    3.Amortizedcost 1,779 86 851 2,716

    4.Marketvalue 1,968 92 904 2,964
    5.UnrealizedGain/Loss 189 6 53 248
    *ParvalueasofSeptember28,2012fromtheH.4.1StatisticalRelease.
    Source:FederalReserveBanksCombinedQuarterlyFinancialReport,September2012.

    3 Projections assumptions
    InordertoconstructprojectionsoftheFederalReservesbalancesheet,assumptionsabout
    manyofthedetailsofthebalancesheetanditsevolutionmustbemade.Thefollowing
    subsectionsreviewassumptionsmadeaboutkeylineitemsofthebalancesheet.Adetailed
    descriptionoftheseandadditionallineitemsisfoundinAppendix1.

    3.1 Interest rate assumptions


    Toevaluatethecurrentandfuturevalueofsecurities,andthereforetheSOMAportfolio,
    assumptionsmustbemadeaboutthepathofinterestratesovertheprojectionperiod.Forthis
    analysis,werelyoninterestrateprojectionsfromtheDecember2012BlueChipforecastfor
    thefederalfundsrateandthetenyearTreasuryrate.Weusethemeanquarterlyratesfrom
    2012:Q4through2014:Q1,theannualratesfrom2014through2018,andthe5yearaverage
    ratefrom20192023.27Theassumedpathforthefederalfundsrateandtheyieldontheten
    yearTreasurynoteareshowninFigure9.Thefederalfundsrateremainsinthe0topercent
    rangeuntilthefirstquarterof2015.ThisBlueChipforecastrisesslightlyearlierthaninthe
    October2012FOMCstatementandsubsequentcommunicationsbyFederalReserveofficials;in
    otherwords,theBlueChipforecast,andthereforetheforecastusedinthispaper,isnotthe
    FOMCforecast.Afterthatpoint,therateisprojectedtoriseandstandat3.8percentin2025.
    TheyieldonthetenyearTreasurynotealsorises,fromitscurrentlowlevelof1.7percentto
    4.9percentattheendoftheprojectionperiod.Theseforecastsdonotrepresenttheviewsof

    27
    Weusethe5yearaverageinterestrateasourvaluein2024and2025.

    17

    theFederalReserveoritsstaff.Theresultsofthesimulationspresentedinthispaperwouldbe
    differentunderalternativeassumedpathsformarketinterestrates.

    Toperformtheassetvaluationsthatwillberequired,however,anentireyieldcurveisneeded.
    Asaresult,wecreateayieldcurveateachpointintimeovertheprojectionperiodusing
    historicalrelationshipsbetweenthefederalfundsrate,thetenyearTreasuryrateandselected
    intermediatetenors.Assetvaluationisneeded,forexample,toprojecttheeffectonreserves
    ofsellingMBSasenvisionedintheFOMCsexitprincipleswhenasecurityissold,reserves
    declinebythesale(market)priceofthesecurity,notbytheparvalue.Thehigherthemarket
    valueofthesecurity,themorereserveswouldbedrainedthroughthesale.Thelowerthe
    marketvalue,thereversewouldbetrue.MoredetailsareprovidedinAppendix2.

    3.2 Nearterm balance sheet assumptions


    Thissubsectionreviewsourprojectionmethodologyforselectedassetandliabilityitemsthat
    areofparticularinterest.Allelementsofthebalancesheetareprojected,butweleavethose
    oflessinteresttoAppendix1.

    3.2.1 SOMA portfolio


    TheevolutionoftheSOMAportfolioisintendedtobeconsistentwiththeFOMCstatementon
    December12,2012.Inparticular,weassume:

    (1) Thematurityextensionprogram(MEP),whichstartedinSeptember2011,iscompleted
    attheendof2012,asis$40billioninMBSpurchasespermonth;
    (2) ReinvestmentofprincipalpaymentsfromagencysecuritiesintoagencyMBScontinues
    inthenearterm,wherebynearterm,wemeantheperiodoftimebetweennowand
    thebeginningofanexitstrategyfromthecurrentaccommodativemonetarypolicy
    stance.28
    (3) Additionalpurchasesofsecuritiesareconductedin2013atapaceof$45billionper
    monthinlongertermTreasurysecuritiesand$40billionpermonthinagencyMBS.As
    thecurrentpurchaseprogramisopenendedandconditionalonmacroeconomic

    28
    TheexitstrategyandothertimingissueswillbediscussedinfurtherdetailinSection3.3.

    18

    outcomes,weusezero,$500billion,and$1trillionintotalpurchasesin2013to
    illustratethepossiblebalancesheetcontoursandincomeimplicationsoftheopen
    endedprogram.Ofnote,the$1trillionprogramisinlinewiththemedianresponsein
    theOctober2012PrimaryDealersurveyconductedbytheDesk.Thepurchasesof
    Treasurysecuritiesareassumedtobeinthematuritydistributionannouncedbythe
    DeskinconjunctionwiththeFOMCstatementonDecember12,whichhasroughlythe
    samenetdurationasinasinthematurityextensionprogram.

    GiventheinitialcompositionoftheSOMAportfolioonOctober31,2012,theportfolioevolves
    overtime.WeadjustthematuritystructureofholdingsofTreasurysecuritiesandagency
    securitiesthroughtimetoreflect(1)through(3)andthepassageoftime.Moreover,the
    forecastforfuturepurchasesimposestheassumedconstraintthatSOMAholdingsthatanyone
    CUSIPremainbelow70percentofthetotalamountoutstandinginthatCUSIP,asannouncedby
    theFederalReserveBankofNewYork.

    SimilartotheuseofBlueChipprojectionsforinterestrates,weturntopublicprojectionsfor
    theTreasurysissuanceofmarketabledebt.Weuseprojectionsofboththeamountandthe
    maturityofTreasuryissuanceinordertoprojectsecuritiesavailableforpurchasebytheFederal
    Reserve.WeuseTreasuryissuanceasofOctober2012,andfromthatpointforward,coupled
    withtheCongressionalBudgetOfficesJanuary2012projectionsfortotalTreasurydebt
    outstanding,wegeneratethelevelandmaturitystructureofmarketabledebtoutstanding.29In
    addition,weassumethattheaveragematurityofTreasurydebtoutstandingextendsfromits
    currentlevelof62monthsto70monthsby2015,roughlyconsistentwiththeTreasurysstated
    intentionsasofNovember2011andAugust2012.30Therefore,futureTreasurypurchasesare
    associatedwithcouponsthatevolveovertimereflectingprojectionsininterestrates,Treasury
    issuance,andthe70percentownershiprule.

    29
    AsofJanuary2013,thebudgetmeasuresagreedtosofaraspartoftheAmericanTaxpayerReliefActof2012
    wouldlikelynotmateriallyaffectourprojections.Othermeasuresthatcouldbeadoptedlaterinthespringof
    2013aredifficulttoforecastandbeyondthescopeofthispaper.
    30
    Refertohttp://www.treasury.gov/presscenter/pressreleases/Pages/tg1665.aspxand
    http://www.treasury.gov/presscenter/pressreleases/Pages/tg1349.aspx.

    19

    AcoupleofparticularsregardingFederalReserveaccountingandvaluationofsecuritiesshould
    benoted.Specifically,FederalReserveaccountingrecordsthesecuritiesholdingsatfacevalue
    andrecordsanyunamortizedpremiumordiscountintheotherassetscategory.
    Consequently,wemustprojectboththefacevalueoftheportfolioandtheassociated
    premiums.Toprojectpremiumsonfuturesecuritiespurchasesweneedtocalculatethe
    marketvalueofsecuritiesinthefuture.Wetakethemarketvalueforsecuritiesasthepresent
    discountedcashflowofthesesecuritiesusingthecouponratetogeneratecashflowsandthe
    yieldcurvesdescribedinSection3.1andAppendix2todiscountthesecashflows.The
    premiumisthedifferencebetweenthefacevalueandthemarketvalueofthesecurity.
    Treasurysecuritiesthatarerolledoveratauctionareassumedtobepurchasedatpar,and
    thereforehavenopremium.

    ForMBSreinvestment,weneedtoprojectthecouponofthesecuritiesthatwillbepurchased.
    ThemodelusedforthatisdescribedinAppendix2.Becausereinvestmentsareassumedto
    continueonlyinthenearterm,weassumethatpurchasesofMBStakeplaceataprice4
    percentabovefacevalue,consistentwithrecentMBSreinvestmentactivity.

    3.2.2 Liabilities and capital


    Inourmodeling,twoitemsareimportantexogenousdriversofthebalancesheetcontourFR
    notesandcapitalpaidin.Forsimplicity,weassumethatFRnotesgrowinlinewiththeBlue
    ChipforecastfornominalGDP.Capitalpaidinisassumedtogrowatitsdecadeaverageof15
    percentperyear,andsurplusisequatedtocapitalpaidin.Thisgrowthrateplaysaroleinthe
    longruntrendgrowthrateoftheSOMAportfolio.

    Reservebalances,animportantliabilityitemfortheFederalReserve,areendogenoustoour
    projectionsandingeneralcalculatedastheresidualofassetslessotherliabilitieslesscapitalin
    thebalancesheetprojections.However,weassumeaminimumlevelof$25billionissetfor
    reservebalances.Thatlevelisroughlyconsistentwiththelevelofreservebalancesobserved
    priortothefinancialcrisis.BothFRNotesandcapitalaretrendinghigherintheseprojections.
    Tomaintainreservebalancesat$25billion,weassumethattheDeskbeginstopurchase
    Treasurybills.Purchasesofbillscontinueuntilthesesecuritiescompriseonethirdofthe

    20

    FederalReservestotalTreasurysecurityholdingsasnotedabove,abouttheaverage
    proportionofTreasuryholdingspriortothecrisis.Oncethisproportionofbillsisreached,we
    assumethattheDeskbuyscouponsecuritiesinadditiontobillstomaintainanapproximate
    compositionoftheportfolioofonethirdbillsandtwothirdscouponsecurities.

    3.3 Exit strategy assumptions for the balance sheet


    Fortheneartermprojections,wenotethattheFOMCcompletedtheMEPand$40billionin
    MBSpurchasesinDecember2012,andassumetheFOMCbeginsoneofthethreepurchase
    scenarios($0,$500billion,or$1trillion)in2013.Furtheroutintheprojectionperiod,webase
    ourprojectionsonthegeneralprinciplesfortheexitstrategythattheFOMCoutlinedinthe
    minutesoftheJune2011FOMCmeeting.31TheCommitteestatedthatitintendedtotakethe
    followingstepsinthefollowingorder:

    (1) Ceasereinvestingsomeorallpaymentsofprincipalonthesecuritiesholdingsinthe
    SOMA;
    (2) Modifyforwardguidanceonthepathofthefederalfundsrateandinitiatetemporary
    reservedrainingoperationsaimedatsupportingtheimplementationofanincreasein
    thefederalfundsratewhenappropriate;
    (3) Raisethetargetfederalfundsrate;
    (4) Sellagencysecuritiesoveraperiodofthreetofiveyears;and
    (5) Oncesalesbegin,normalizethesizeofthebalancesheetovertwotothreeyears.

    Theseprinciplesrepresentaroughguidetotheexitstrategy.Inparticular,atthattime,the
    Committeestatedthatispreparedtomakeadjustmentstoitsexitstrategyifnecessaryinlight
    ofeconomicandfinancialdevelopments.

    Tocompletetheprojections,however,weneedtomakeadditionalassumptions.Wetie
    changesintheSOMAportfoliotothedatethefederalfundsrisesfromitseffectivelower
    bound,which,basedontheBlueChipforecasts,weassumeisMarch2015.Weassumethat
    thereinvestmentofsecuritiesendssixmonthsbeforethisdate.Wedonotexplicitlymodelthe

    31
    MinutesoftheFederalOpenMarketCommittee,June2122,2011,availableat
    http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20110622.pdf.

    21

    useofreservedrainingtools.32Weassumethatsalesofagencysecuritiesbeginsixmonths
    afterthefederalfundsratebeginstoriseandthatthebalancesheethasreturnedtonormal
    sizeoveraboutthreeyears.Ininterpretingnormalsizewerelyonthe$25billionminimum
    levelforreservebalancesasnormal.WesummarizetheassumedexitstrategyinTable4.33

    Table4:Keyassumptionsusedinbalancesheetprojections

    $02013 $500bn2013 $1tr2013


    Assumption Purchases Purchases Purchases
    MEPTreasuryPurchases
    Amount $667 billion $667 billion $667billion
    Length 15 months 15 months 15months
    Firstmonth Oct11 Oct11 Oct11
    Lastmonth Dec12 Dec12 Dec12

    MEPTreasurySalesorRedemptions
    Amount $667 billion $667 billion $667billion
    Length 15 months 15 months 15months
    Firstmonth Oct11 Oct11 Oct11
    Lastmonth Dec12 Dec12 Dec12

    CurrentPortfolioStrategy
    Agencyreinvestments AgencyMBS AgencyMBS AgencyMBS

    2013TreasuryandMBSPurchases
    Amount N/A $500billion $1trillion
    Length N/A 6 months 12months
    Firstmonth N/A Jan13 Jan13
    Lastmonth N/A Jun13 Dec13
    MBSpurchasepace N/A $40bn/month $40bn/month
    Treasurypurchasepace N/A $45bn/month $45bn/month

    ExitStrategy
    FedFundsliftoff Mar15 Mar15 Mar15
    Redemptionsstart Sept14 Sept14 Sept14
    Agencysales
    Salesstart Sept15 Sept15 Sept15
    Salesend Aug19 Aug19 Aug19

    32
    Iftermdepositsorreverserepurchaseagreementswereusedtodrainreservespriortoraisingthefederalfunds
    rate,thecompositionofliabilitieswouldchange:Reservebalanceswouldfallastermdepositsandreverse
    repurchaseagreementsrose.Presumably,thesedrainingtoolswouldbewounddownasthebalancesheet
    returnedtoitssteadystategrowthpath,sothattheprojectedpathforSOMAholdingspresentedhereremains
    valid.
    33
    Iftheexpecteddateofthefederalfundsliftoffislaterthanassumedhere,thestartdatesfortheexitstrategy
    principleswillsimilarlybedelayedbutthecontoursoftheprojectionspresentedherewillberoughlyunchanged.

    22

    Otherlineitemsonthebalancesheetcontinueontheirprojectedpathasnotedabove.

    3.4 Income projections assumptions


    BasedonprojectionsofthesizeandcompositionoftheFederalReservesbalancesheet,a
    projectedpathforinterestrates,andsomeotherassumptions,wecancalculateanimplied
    projectionfortheFederalReservesearnings,expenses,andremittancestotheTreasury.
    Again,thedetailsofReserveBankaccountingmatter,butwewilldiscusstheprimary
    determinants,whichareinterestincome,interestexpense,capitalgainsorlosses,and
    remittancestotheTreasury.Thissectiondescribesthekeyassumptionsbehindtheincome
    projection,whileAppendix1providesadditionaldetails.

    3.4.1 SOMA interest income


    Notsurprisingly,sincetheSOMAportfolioisthelargestassetitem,itgeneratesthebulkof
    FederalReserveBankearnings.InterestincomereflectsthecouponpaymentsfromtheSOMA
    portfoliosholdingsofsecuritiesminustheamortizationofpremiumsonthoseholdings.To
    createtheprojectionsofinterestincome,therefore,wemusttracktheevolutionofthe
    portfoliofrompurchases,sales,andmaturingsecurities.Asthecompositionoftheportfolio
    evolves,thecouponontheportfolioevolves.Theamortizationofpremiumsreducesinterest
    income,sotheassumptionsaboutthepremiumsonthesecuritiespurchasedaffectthe
    calculationofinterestincome.

    FocusingonincomefromTreasurysecurities,forsimplicity,wedividetheSOMAportfolio
    holdingsintobucketsbymaturityinsteadofanalyzingeachCUSIP.Specifically,weaggregate
    CUSIPSbymonthofmaturity,treatingallsecuritiesmaturingwithinagivenmonthasasingle
    security.Basedonthesebuckets,wecalculatetheWACoftheportfolioandmultiplythatby
    theholdings.Next,wesubtractoffamortizednetpremiums.

    TheprojectionoftheSOMAportfolioandtheassociatedpremiumswerediscussedinSection
    3.2.1.AsofOctober31,2012,theWACoftheTreasuryportfolioisknown.Fortheprojection,
    weseparatepurchasesofsecuritiesfromreinvestment.Purchasesoccurinthesecondary
    marketatprojectedmarketprices.Overtime,theaveragecoupononTreasurysecuritiesinthe
    secondarymarketevolvesasexistingTreasuryissuanceagesandprojectednewissuanceis
    23

    introducedintothemarket.ThestartingpointofthecouponratesofexistingTreasury
    securitiesarefromtheTreasurysMonthlyStatementofthePublicDebtasofOctober31,2012.
    Weassumethatanypurchasesinthesecondarymarketinatargetedbuckethaveanaverage
    couponrateequivalenttotheaveragecouponofTreasurysecuritiesinthemarketwith
    remainingmaturityinthisbucket.Asaresult,wecalculatethecurrentmarketvalueofthe
    securitiestocomputetheimpliedpremium.Reinvestmentofmaturingsecurities,however,is
    doneatauction,andweassumethatnewlyauctionedsecuritiesareissuedatpar,and
    thereforehavenopremiumassociatedwiththem.Forreinvestment,weprojectfuturecoupon
    ratesonnewlyissuedTreasurysecuritiesusingaregressionbasedtermstructuremodelas
    outlinedinAppendix2.

    ForholdingsofMBS,weseparateMBSpurchasedduringthefirstlargescaleassetpurchase
    programfromNovember2008toMarch2010andthereinvestmentpolicythroughOctober
    2012,andthoseprojectedtobereinvestedandpurchasedin2013andbeyond.Thisdistinction
    isimportantbecausethecouponsonMBSpurchasedundertheassetprogramaregenerally
    higherthanthecurrentproductionMBS.TheMBScurrentlyheldontheFederalReserves
    balancesheethavecouponsthatrangefrom2.5to6.5percent.Thehighercouponsecurities
    tendtohavehigherpremiumsassociatedwiththem.MBSreinvestmentisassumedtotake
    placeincurrentcouponsecurities,whichhavebeenpurchasedatapremiumthatisassumedto
    be4percentabovefacevalue.

    3.4.2 Interest expense


    OvermuchoftheFederalReserveshistory,interestexpensehasbeenmodest.Interest
    expensederivesfrominterestbearingliabilities,inparticulartheforeignreverserepurchase
    agreementpoolandreservebalances.Overthepastdecadeorso,theforeignrepopoolhas
    averagedroughly$50billionandpaysinterestatarateconsistentwithovernightreporates.
    Asaresult,thisinterestexpenseisrelativelysmall.Asmentionedabove,priorto2008,the
    FederalReservedidnothavetheauthoritytopayinterestonreservebalances.Currently,
    althoughreservebalancesarequiteelevated,at$1.5trillion,theIOERrateis25basispointsat
    anannualrate,whichimplieslessthan$4billionpaidininterestoverthecourseofthisyear.

    24

    Interestratesareprojectedtorise,however,andweassumethattheIOERratewillbeequalto
    thefederalfundsrate.34Asaresult,interestexpensewillrise.But,intheprojections,reserve
    balancesareprojectedtodecline,sotheneteffectoninterestexpensedependscriticallyon
    thetimingoftheriseininterestratesandthedeclineinreservebalances.

    3.4.3 Capital gains or losses


    FederalReserveBankaccountingonlyrealizesgainsorlossesontheSOMAportfolioifa
    securityissold,andhistorically,theFederalReservesoldsecuritiesinfrequently.35In2011,
    MEPsalesrecordedaslightcapitalgain.Inaddition,prepaymentsonMBSresultina
    realizationofagainoralossonthatsecuritybasedontheamountoftheprepayment.36For
    theseprojections,wecalculatecapitalgains(losses)asthemarketvalueofthesecuritiesbeing
    soldminustheirparvalueandunamortizednetpremiums.Themarketvalueiscalculatedusing
    theyieldcurvesanddiscountedcashflowmethodologydescribedinAppendix2.In
    determiningtheFederalReservesincomeinagivenperiod,aftertheearningsandexpenses
    discussedabovearecalculated,capitalgains(losses)areadded.

    3.4.4 Other items, dividends, transfers to surplus, and remittances to the Treasury
    Thevariousothercomponentsthatcontributetonetincomearesmallandnotedin
    Appendix1.Twoadditionaladjustmentstonetincomearemadebeforethecalculationof
    remittancestotheTreasuryiscomplete.Asnotedabove,theFederalReserveisstatutorily
    requiredtopaydividendstomemberbanks.Inaddition,theReserveBankstransferfundstoa
    surpluscapitalaccounttoensurethatsurplusalwaysequalscapitalpaidin.Remittancestothe
    Treasuryinanyperiodarecalculatedasallremainingnetincomeaftertheseadjustments.
    RemittancestotheTreasury,however,canneverbenegative.Asnotedabove,ifthereisan
    operatinglossinsomeperiod,thennoremittanceismadeuntilearnings,throughtime,have

    34
    Thisisasimplifyingassumption.Inthefuture,dependingontheoperatingframeworkandotherfactors,the
    IOERratecouldbeabove,equal,orbelowthefederalfundsrate.
    35
    TheassetsheldbytheSOMAportfoliothataredenominatedinforeigncurrenciesarerevalueddailyand,asa
    result,canexperiencegainsandlosses.Thesechanges,however,aresmallcomparedtothesizeofthebalance
    sheetandnetincome.
    36
    Dollarrolltransactions,whichinvolvebothapurchaseandasaleofMBScanalsoresultinrealizedgainsor
    losses.

    25

    beensufficienttocoverthatloss.Thevalueofthefutureearningsthatwillberetainedtocover
    thislossisadeferredasset.

    4 Projections
    Inthissection,webeginwiththreeoptionsfortheprojectionofthebalancesheet:no
    purchasesin2013,$500billioninpurchasesin2013;and$1trillioninpurchasesin2013.These
    baselinescenariosprovideausefulguidetohowtheFederalReservesbalancesheetmight
    evolveunderarangeofpossibleassumptions.Next,weexamineascenariowhereinterest
    ratesareuniformly100basispointshigherthaninthebaselineafterliftoff.Althoughthis
    shockparticularlytheparallelshiftisanunlikelyoutcome,wepresentittoshowtheinterest
    ratesensitivityoftheportfolio.Aswillbeshown,thecontoursoftheprojectionsintheshock
    scenarioaresimilartothoseunderbaselineassumptionsforinterestrates,butthesizeof
    capitallossesislarger,interestexpenseishigher,andremittancesarethereforelower.Finally,
    wediscussascenariowhereinterestratesare100basispointslowerthaninthebaselineafter
    liftoff.Again,thecontoursoftheprojectionsaresimilartothebaseline,withlossesand
    interestexpensesomewhatlower.Westressagainthattheseprojectionsaretheresultofthe
    underlyingassumptionsmadeaboutinterestratesandpolicydecisionsand,asaresult,arenot
    forecaststhemselves.Thepointoftheanalysishereistoestablishaframeworkforsuch
    projections,anddifferentassumptionswould,ingeneral,resultindifferentprojections.

    4.1 Baseline scenarios

    4.1.1 Balance sheet


    Figures10and11presenttheprojectionsofkeybalancesheetlineitemsunderourthree
    baselinescenarios.AsshowninthetopleftpanelofFigure10,SOMAholdingsmoveupslightly
    throughtheendof2012reflectingthe$40billionpermonthpurchasesofMBS.In2013,under
    withnofurtherpurchases(thesolidline),theportfolioremainsfairlysteadyatitsend2012
    level.37With$500billionor$1trillioninfurtherpurchases(thebluedashedandreddotted

    37
    TherearesomeagencyMBSpurchasedduring2012thatsettlein2013,causingtheSOMAportfoliotoincrease
    slightlyduring2013.

    26

    lines,respectively),theportfoliorisesthrough2013,growingat$85billionpermonth.The
    peaksizeoftheportfolioreflectsthesizeofthepurchaseprogram:withnofurtherpurchases,
    theportfolioreaches$2.75trillion,with$500billion,$3.25trillion,andwith$1trillion,$3.75
    trillion.Thelevelofreservebalancesreflecttheassetprograms,withreservebalancestopping
    outat$1.7trillion,$2.2trillionand$2.7trillioninthezero,$500billion,and$1trillionasset
    purchaseprograms,respectively.Afterpurchasesend,undertheassumptionthattheFOMC
    beginstoallowallassetholdingstorollofftheportfolioasthefirststepintheexitstrategy,
    withthetimingimpliedbytheinterestrateprojections,SOMAholdingsbegintodecline.
    NoticethatSOMATreasuryholdings,thetoprightpanel,remainconstantevenwhenrolloff
    begins.ThisfactisaresultoftheMEPreducingholdingsofshorterdatedTreasurysecuritiesto
    nearzero.MBSholdings,thebottomleftpanel,ontheotherhand,begintocontract.
    BeginninginSeptember2015,againconsistentwithourassumptionsabouttheexitstrategy,
    MBSsalesbegin,andtheseholdingsfalltozerobyAugust2019.Inthenofurtherpurchases
    scenario,thesizeofthebalancesheetisnormalizedinApril2018(32monthsaftersalesbegin),
    whileinthe$500billionand$1trillionpurchasescenarios,normalizationoccursinOctober
    2018(38months)andFebruary2019(42months),respectively.38

    ThereductioninthesizeoftheSOMAportfolio,alongwiththeprojectedgrowthofReserve
    BankcapitalandFRnotes,resultsindeclinesinthelevelofreservebalances,showninthe
    bottomrightpanelofFigure11.Asdescribedabove,weassumethatreservebalancesarenot
    allowedtofallbelow$25billion.Therefore,byearly2019inallscenarios,theseprojections
    assumethattheDeskagainstartstoreinvestmaturingTreasurysecuritiesandbegins
    purchasesofTreasurysecurities.Afterthispointintime,theSOMAportfolioexpandsinline
    withFRnotesandcapitalandreservebalancesremainconstantandunconventional
    monetarypolicyhasessentiallyunwound.

    38
    AlthoughthetimingofthenormalizationofthebalancesheetisslightlybeyondwhattheCommitteeanticipated
    intheexitprinciples,thesaleswindowweassumecouldbeshortenedandthenormalizationdatecouldfallwithin
    thewindow.Theeffectofsellingoverashortertimeperiodonincomeisambiguous:whileacceleratedsales
    wouldtendtoincreaserealizedlosses,interestexpenseshouldfallasreservesdecline.

    27

    4.1.2 Income
    Figure12showsthepathofReserveBanknetincomeunderthethreebaselinescenarios.
    BecauseofthelargesizeoftheSOMAportfolio,interestincomeiselevatedthrough2015inall
    scenarios,withthelargerportfolioshavinghigherinterestincome.AstheSOMAportfolio
    beginstocontractwiththeassumedstepsintheexitstrategy,interestincomedeclinesthrough
    mid2018.Afterreservebalancesreach$25billion,Treasurypurchasesresume,expandingthe
    portfolio,causinginterestincometorise.

    Asnotedabove,interestexpensereflectsboththelevelofthefederalfundsrateandthelevel
    ofreservebalances.ThefederalfundsrateintheBlueChipforecastbeginstorisein2015,and
    interestexpenseriseswithit.However,in2016,interestexpensebeginstomoderate,asthe
    declineinreservebalancesmorethanoffsetstheriseinthefederalfundsrate.

    Intermsofcapitalgainsorlosses,TreasurysecuritiessalesconductedundertheMEPresultina
    smallgainbecauseofthelowlevelofmarketinterestratesin2012andtherelativelyhigher
    coupononthesecuritiessold.39Duringtheexitstrategy,however,MBSsalesresultinrealized
    losses.Overthefouryearsalesperiod,September2015toAugust2019,theselossesaverage
    roughly$18billionperyearacrossallthreescenarios.Thisamountmayseemnotablebut
    shouldbecomparedtothecumulatedearningsfromthelargerportfolio.

    Onnet,remittancestotheTreasuryremainelevatedbyhistoricalstandardsthrough2015,but
    thendecline.Forthescenarioswithadditionalpurchasesin2013,remittancesfalltozerofora
    numberofyears,reflectingsomerealizedlossesassociatedwithsalesandhigherinterest
    expense,andadeferredassetisrecorded.Thelargertheprogram,thelargerthesalesand
    interestexpense,andsothelargeristhepeakdeferredasset.

    Forthe$1trillionpurchasescenario,thereisadeferredassetthatlastsforfouryearsandthat
    peaksat$40billion.Forcomparison,thesurpluscapitalaccountthatis,retainedearningsis
    aboutthesamesizeasthispeak,andtheaverageannualremittancestotheTreasuryoverthe
    projectionperiodisslightlylarger.Oncesalesarecompletedandtheportfolioreachesits

    39
    ThevastmajorityofsecuritiessoldundertheMEPwereshortdatedcoupons,notbills.

    28

    steadystategrowthpath,remittancestotheTreasuryriseslowlyastheportfolioexpandsand
    interestincomerises.Remittancesin2025arecloseto$45billion.

    Whencomparingthecumulativeremittancesgeneratedfromalternateprograms,the$1
    trillionprogram,whichresultsinthelargestdeferredasset,resultsincumulativeremittances
    thatareroughly$60billionbelowthescenariowithnofurtherpurchases,orroughly$5billion
    lessonaverageperyear.Ofcourse,theoveralleffectonthefederalgovernmentsfinancesis
    morecomplicated.Forexample,iftheseadditionalassetpurchasesprovidemeaningful
    economicstimulus,theincreaseingovernmentrevenuesfromfastereconomicgrowthcould
    morethanoffsetthereductioninremittances.Further,iftheassetpurchaseslowerinterest
    rates,theinterestexpenseofthefederalgovernmentislower.

    Asdiscussedabove,onlyrealizedgainsorlossesaffecttheFederalReservesincome.
    Nevertheless,giventhelargeSOMAportfolioandtheprojectedriseininterestrates,underthe
    baselineprojections,theportfolioisinanunrealizedlosspositionbeginningin2014.This
    unrealizedlosspositioncontinuestogrowthrough2017,butsubsequentlydiminishesasthe
    portfolioshrinksthroughredemptionsandsales.

    4.2 Higher interest rates


    PolicymakershavealsodiscussedtheinterestratesensitivityoftheSOMAportfolioandthe
    implicationsoflargeincreasesininterestratesonFederalReservenetincome.40Toexplore
    thispossibility,asshowninFigure9underthehigherinterestratescenario(thedashedline),
    thefederalfundsrateandtenyearTreasuryyieldriseatafasterpaceatliftoff,andafterone
    yearare100basispointshigherthanthebaselineratesovertheremainderoftheprojection
    period.Onecouldimagineanincreaseininflationorinflationexpectationscouldleadtosucha
    result;modelingthistypeofeconomicenvironmentisbeyondthescopeofthispaperandthe
    shockisusedsolelytodemonstrateintheinterestratesensitivityoftheportfolio.Wenote,

    40
    Forexample,theminutestotheDecember2012FOMCmeetinghighlightedthat[p]articipantsalsodiscussed
    theimplicationsofcontinuedassetpurchasesforthesizeoftheFederalReservesbalancesheet.Dependingon
    thepathforthebalancesheetandinterestrates,theFederalReservesnetincomeanditsremittancestothe
    Treasurycouldbesignificantlyaffectedduringtheperiodofpolicynormalization,availableat
    http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20121212.pdf.

    29

    however,thatthisshockisbroadlyconsistentwiththetenhighestinterestrateprojections
    fromrespondentstotheBlueChipsurvey.Inotherwords,theseinterestratesareatthehigh
    endofmarketexpectations,butareseenasplausibleoutcomesbyprofessionalforecasters.In
    thebaselineinterestrateprojection,thetenyearTreasuryyieldrisesby2percentagepoints
    betweenend2014andend2016.Bycontrast,the100basispointshockimpliesthetenyear
    Treasuryyieldisincreasingby3percentagepointsoverthesetwoyears.

    Thereareacoupleofwaystoputthesizeofthisshockinperspective.Tostart,thissizeshock
    isabovethatexpectedbytherespondentstotheDecember2012BlueChipsurveywiththetop
    tenhighestinterestrateexpectations(roughly20percentofthesample),andthusisprobably
    comfortablyabovemostmarketparticipantsinterestrateprojections.Inaddition,fora
    historicalcomparison,from1978topresent,thestandarddeviationofthetwoyearchangein
    the10yearTreasuryyieldis1.6percentagepoints.Asaresult,thishigherinterestrate
    scenarioshouldbeseenasasomewhatunlikelyscenario,butnotanimplausibleone.Of
    course,totheextentthatinflationexpectationshavebecomebetteranchoredthroughtime,
    thisincreaseininterestratesmaybeevenlessprobablethanthehistoricalrecordmaysuggest.

    TheinterestrateshockdoesnotchangethebroadcontoursoftheFederalReservesbalance
    sheet,asshowninFigure13.Thehigherinterestratepathdoes,however,changetheincome
    projectionsnotably,andasaresult,leadstoadifferentpathofremittancestoTreasury.
    Broadlyspeaking,thehigherinterestratepathreducesremittancesasinterestexpenserises
    andlossesonsecuritiessalesgrow.Inthelongerrun,afterthesizeofthebalancesheet
    normalizes,thehighercouponrateonTreasurysecuritiespurchasedtokeeppacewiththe
    growthoftheFederalReservesbalancesheetactuallypushesupremittances.

    ThespecificsoftheincomeprojectionswithhigherinterestratesareshowninFigure14.
    SOMAinterestincomeremainssimilartothebaselinebecausethesecuritiesintheSOMA
    portfoliohavealreadybeenpurchasedandtheircouponsarefixed.However,interestexpense
    becomesgreateroncethefederalfundsrateliftsofffromthelowerboundbecauseofthe
    higherinterestratepath.Inaddition,becausesalesofMBSoccurwhenlongerterminterest
    ratesarehigherthaninthebaseline,realizedcapitallossesaresomewhatgreater.Overall,in

    30

    thescenariowithnoadditionalassetpurchasesin2013,thehigherinterestratescause
    remittancestotheTreasurytofalltozeroandasmalldeferredassetiscreated.Inthescenario
    with$1trillionadditionalassetpurchasesin2013,inthehigherinterestratescenario,the
    deferredassetpeaksat$125billion,substantiallyhigherthanunderthebaseline.Moreover,
    remittancestotheTreasuryarehaltedfor6years.Thisreductioninearningsinthisscenario
    reflectstheinterestrateriskthattheFederalReserveistakingonwithassetpurchases.More
    purchasestendtoleadtolargerrealizedlosses,andthelossesareevenlargerunderthehigher
    interestratescenario.Forcomparison,however,inthehigherinterestratescenario,
    cumulativeremittancesareonlyabout$45billionlowerthaninthescenariowithoutthe
    interestrateshock.Underallscenarios,remittancestotheTreasuryresumebyend2022.As
    notedabove,totheextentthatthepoliciesareeffectiveinstimulatingtheeconomy,overall
    governmentrevenueswouldbeboostedonnet,despitethesomewhathigherlossesatthe
    FederalReserve.

    Theseoutcomes,however,shouldbeviewedinalongertermcontext.Overall,averageannual
    remittancestotheTreasuryeveninthisshockscenarioremainabovetheaverageannual
    remittancesof$25billionrecordedpriortothecrisis.

    4.3 Lower interest rates


    JustasitispossibleforratestobehigherthanprojectedbytheBlueChipconsensusforecast,
    ratesmaybelowerthantheconsensusforecast.Inordertocharacterizethispossibility,Figure
    15displaysthefederalfundsand10yearTreasuryyieldundertheassumptionthattherisein
    ratesisneitherashighnorasfastasinthebaselineconsensusforecast,andinthelongrun,
    ratesare1percentagepointlowerthaninthebaseline.Possiblescenariosthatcouldproduce
    thisoutcomethroughthemediumrunincludeaslowerorweakerrecoverythancurrently
    expectedbymarketparticipants.Ratherthanrisingby200basispointsinthelongerrun,the
    10yearyieldmovesuponly100basispoints,amodestlevelcomparedtolongerrunaverages.
    Thispathisbroadlyconsistentwiththetenlowestinterestrateprojectionsfromthe
    respondentsoftheBlueChipsurvey.

    31

    AsshowninFigure16,andsimilartothehigherinterestrateshock,thelowerinterestrate
    shockdoesnotchangethebroadcontourofthebalancesheetprojection.Nevertheless,the
    incomeprojectionandthereforeremittancestotheTreasurydoesmateriallychange,asshown
    inFigure17.Ingeneral,thelowerinterestratepathmitigateslossesfromsalesofagencyMBS
    anddampensexpensefromreservebalances,boostingremittancesrelativetothebaselineto
    somedegree.Asaresult,regardlessoftheamountofpurchasesin2013,remittancestothe
    Treasurystaypositiveinallyearsoftheprojectionandnodeferredassetisrecordedonan
    annualbasis.Mirroringtheresultsinthehigherinterestratescenarios,inthelongerrun,the
    lowercouponrateonTreasurysecuritiespurchasedtokeeppacewiththeexpansionofthe
    balancesheetdepressesremittancesrelativetothebaselinecase.However,despitethelower
    remittancesattheendoftheprojectionperiod,averageannualremittancesintheprojection
    stillremainwellabovetheaverageannuallevelbeforethecrisis.

    5 Conclusion
    Inthispaper,wehaveoutlinedthemechanicsofandprojectionsfortheFederalReserves
    balancesheetandincome.Underthebaselineprojections,derivedfrompubliclyavailable
    forecastsabouttheeconomyandpublicstatementsbytheFOMC,theFederalReserves
    balancesheetissubstantiallylargerthanithadbeenhistoricallyforsomeyearsuntil
    contractinggraduallyduringtheexpectedexitperiod,andonlyreturningtoitslongrungrowth
    pathinlate2018orearly2019.Thisresult,ifitisexpectedbymarketparticipantsandwereto
    berealizedinpractice,wouldimplythatunconventionalmonetarypolicyactionswouldbe
    holdinginterestratesdown,tosomedegree,foranumberofyears.TheFederalReserves
    incomeandremittancestotheTreasuryareprojectedtoremainathistoricallyelevatedlevels
    forafewmoreyears,reflectingtherelativelyhighyieldsearnedonlongertermTreasury
    securitiesandMBS.However,remittancessubsequentlydeclineforatime.GiventheFOMCs
    statedplantosellMBSatthetimethatpolicyaccommodationisbeingremoved,somelosses
    areprojectedtoberealizedonthosesales.Moreover,theelevatedlevelofreservebalancesis
    projectedtoleadtoincreasinginterestexpenseforsometime.Takentogether,remittancesto
    Treasuryareprojectedtofalltoalowlevelortobehaltedforafewyearsandadeferredasset

    32

    willbebookedontheFederalReservesbalancesheet.Subsequently,theFederalReserves
    incomeisprojectedtoreturntoitslongertermtrendandremittancestotheTreasuryrebound.

    Todemonstratetheinterestrateriskontheportfolio,andtounderscorethefactthatthese
    projectionsarenotforecastsperse,butrather,theresultofasetofassumptions,weconsider
    howincomemayevolvewitha100basispointshockupwardsordownwardstothebaseline
    interestratepaths.Overall,higherinterestratesresultinhigherrealizedlossesonMBSsales
    andhigherinterestexpense,bothofwhichcontributetoalargerdeferredasset,allelseequal.
    Ontheotherhand,lowerinterestratesgeneratelowerrealizedlossesandlowerexpense,and
    consequently,nodeferredassetisrecorded.Inallofthesimulations,however,lookingat
    cumulativeremittancestotheTreasuryovertheperiodoftheuseofthebalancesheetasatool
    forpolicysuggeststhatFederalReserveearningsareboosted,onnet,fromtheseactions.That
    resultsuggeststhattheFederalReserveisnotimposingacostontheTreasury,butinstead,
    howeverincidentally,providingadditionalrevenues.Ofcourse,anyandalloftheresultsarea
    reflectionoftheassumptions,andnoneoftheassumptionsusedintheanalysisreflectofficial
    viewsoftheFederalReserve.Rather,theassumptionsarederivedfrompubliclyavailable
    information.

    33

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    BoardofGovernorsoftheFederalReserveSystem.1976.BankingandMonetaryStatistics,
    19141941.

    Carpenter,Seth,Ihrig,Jane,Klee,Elizabeth,Boote,Alexander,andQuinn,Daniel.2012.The
    FederalReservesBalanceSheet:APrimerandProjections,FinanceandEconomicsDiscussion
    Seriesno.201256,FederalReserveBoard,August.

    Chung,Hess,Laforte,JeanPhilippe,Reifschneider,David,andWilliams,JohnC.2011.Have
    WeUnderestimatedtheLikelihoodandSeverityofZeroLowerBoundEvents?FederalReserve
    BankofSanFranciscoWorkingPaper201101,January.

    Edwards,CherylE.1997.OpenMarketOperationsinthe1990s,FederalReserveBulletin,p.
    859874.

    FederalReserveBankofNewYork.2011.DomesticOpenMarketOperationsin2010,
    availablefordownloadat
    http://www.newyorkfed.org/markets/Domestic_OMO_2010_FINAL.pdf

    Garbade,KennethD.,Partlan,JohnC.,andSantoro,PaulJ.2004.RecentInnovationsin
    TreasuryCashManagement,CurrentIssuesinEconomicsandFinance,FederalReserveBankof
    NewYork,vol.10,no.11,November.

    Gurkayank,Refet,Sack,Brian,andWright,Jonathan.2007.TheU.S.Treasuryyieldcurve:
    1961tothepresent,JournalofMonetaryEconomics,p.22912304,November.

    Ihrig,Jane,Klee,Elizabeth,Li,Canlin,Schulte,Brett,andWei,Min.2012.Expectationsabout
    theFederalReservesBalanceSheetandtheTermStructureofInterestRates,forthcoming
    FederalReserveFinanceandEconomicsDiscussionSeriespaper.

    Judson,Ruth,andPorter,Richard.1996.TheLocationofU.S.Currency:HowMuchis
    Abroad?,FederalReserveBulletin,vol.82,p.883903,October.

    34

    Meltzer,Allan.2010.AHistoryoftheFederalReserve,Volume2,19511986,Universityof
    ChicagoPress.

    Rudebusch,GlennD.2011.TheFedsInterestRateRisk,EconomicLetters,FederalReserve
    BankofSanFrancisco,April11.

    35

    Appendix 1: Overview of selected balance sheet items and


    assumptions underlying the balance sheet and income projections

    Thisappendixprovidesdetailsabouttheforecastingprocedureforeachbalancesheetitem.
    ThosenotspecificallydiscussedareheldattheirlevelasofOctober31,2012.

    6 Balance sheet
    6.1 Treasury securities

    SOMATreasuryholdingsareassumedtoevolvethroughacombinationofoutrightpurchases
    andoutrightsalesinthesecondarymarket,reinvestmentatauction,andmaturities.

    Outrightpurchasesforthe$667billionMaturityExtensionProgram(MEP)havethe
    maturitybucketsandtargetsannouncedbytheFederalReserveBankofNewYork:

    MaturityExtensionProgrampurchasedistribution
    (percent)
    Nominalcouponsecurities TIPS
    810 1020 2030
    68years years years years
    32 32 4 29 3
    Outrightpurchasesin2013aresimulatedaccordingtothematuritybucketsandtargets
    asannouncedbytheFederalReserveBankofNewYork:

    2013Treasurypurchasesdistribution(percent)
    Nominalcouponsecurities TIPS
    4.75
    44.75 5.757 710 1017 1730
    5.75
    years years years years years
    years
    11 12 16 29 2 27 3

    Securitiesassumedtobeavailableforpurchasereflectthoseoutstandingonthe
    MonthlyStatementofthePublicDebtasofOctober31,2012aswellasforecastsfor
    futureissuance.HoldingsofanyparticularCUSIParelimitedto70percentoftheCUSIP
    outstanding,consistentwiththeDeskscurrentpractice.
    ThetotalparvalueofTreasurysecuritiesoutstandingreflectstheCongressionalBudget
    Offices(CBO)projectionsfortotaldebtheldbythepublic.

    36

    TheaveragematurityofTreasurydebtextendsfromitscurrentvalueof60monthsto
    70months,consistentwithobservationsmadebytheTreasuryBorrowingAdvisory
    CommitteeinNovember2011andAugust2012.41
    Theproceedsfrommaturingsecuritiesarereinvestedatauctionatratesconsistentwith
    theBlueChipforecastforinterestrates,asdiscussedinAppendix2.Auctionsizesare
    determinedbytheamountoftotaldebtnecessarytomatchCBOprojectionsandfollow
    adistributiondeterminedbyactualauctionsthroughOctober2012.Thisdistributionis
    thenalteredasnecessarytoextendtheaveragematurityofTreasurydebt.TheCBOs
    debtprojectionsalongwiththematuritydistributionofsecuritiesauctionedinOctober
    2012aresummarizedinthetablesbelow.

    CBOdebt October2012
    Initial
    heldby Issuanceby
    Year Buckets sharesof
    thepublic bucket($
    issuance
    ($Billion) Billion)

    2010 9,019 1month 160 0.27


    2011 10,128 3month 128 0.22
    2012 11,242 6month 112 0.19
    2013 11,945 1year 25 0.04
    2014 12,401 2year 35 0.06
    2015 12,783 3year 32 0.05
    2016 13,188 5year 35 0.06
    2017 13,509 7year 29 0.05
    2018 13,801 10year 21 0.04
    2019 14,148 30year 13 0.02
    2020 14,512 Source: Wrightson,AuctionCalendar

    2021 14,872
    Source:CBO,Jan.2012TheBudgetandEconomicOutlook:FiscalYears2012to2022

    6.2 Agency securities

    Theagencysecuritiesportfolioisassumedtoevolveduetoacombinationofpurchases,
    sales,andprepayments.
    ConsistentwiththeFOMCsstatementaftertheSeptember2011FOMCmeeting,
    principalpaymentsfromSOMAagencyMBSanddebtandarereinvestedinagencyMBS.
    WeuseacurrentcouponmodeltoestimatethecoupononnewlypurchasedMBS

    41
    Refertohttp://www.treasury.gov/presscenter/pressreleases/Pages/tg1349.aspxand
    http://www.treasury.gov/presscenter/pressreleases/Pages/tg1665.aspx.

    37

    securitiesbasedontheconsensuslongrunBlueChipforecastforthe10yearTreasury
    rateand30yearfixedratemortgagerate,reviewedinAppendix2.
    PrepaymentsonsettledagencyMBSholdingsasofOctober31,2012aregeneratedby
    applyingtherealizedprepaymentrateontheSOMAholdingsofMBSfromJune2010to
    July2011(theperiodwhentherewerenonewholdingsofMBSsettlingintheSOMA
    portfolio)onmonthlyholdingsfromSeptember2012tothefederalfundsliftoff,in
    March2015.Thisprepaymentrateisnotablyfasterthanwhatwouldbepredictedusing
    thestandardPSAprepaymentmodel,likelyaresultofthehistoricallylowlevelof
    mortgagerates.Afterthefederalfundsrateliftsoff,wegraduallysmooththe
    prepaymentratebacktothelongrunPSAmodeloverafiveyearperiod.
    PrepaymentsonanticipatedfuturepurchasesofagencyMBSfollowthelongrunPSA
    modelforthelifeofthesecurity.
    Salesofagencysecuritiesbeginsixmonthsafterthefirstincreaseinthefederalfunds
    rateandlastforfouryears.ThistimingisconsistentwiththatlaidoutintheJune2011
    FOMCMinutes;however,theexacttimingismerelyillustrativeandchosensoastobe
    easilyimplementableinourprojections.
    Undertheseassumptions,andgiventhematurityscheduleforagencydebtsecurities,
    thevolumeofsalesnecessarytoreduceholdingsofthesesecuritiestozerooverthe
    fouryearperiodonlyrequiresasixmonthperiodofminimalsalesneartheendofthose
    fouryears.

    6.3 Premiums and discounts


    FederalReserveaccountingrecordsalldomesticsecuritiesholdingsatfacevalue,rather
    thanatmarketvalue.ExceptfortherolloverofmaturingTreasurysecurities,new
    purchasesofsecuritiesareconductedintheopenmarketatmarketprices.Ifasecurity
    ispurchasedformorethanitsfacevalue,thedifferencebetweenthepurchaseprice
    andthefacevaluethepremiumonthatsecurityisrecordedseparatelyasanasset
    onthebalancesheet.Likewise,ifasecurityispurchasedforlessthanitsfacevalue,the
    differencebetweenthepurchasepriceandthefacevaluethediscountonthat
    securityisrecordedasaliabilityonthebalancesheet.Reservebalancesincreaseby
    thepurchasepriceofthesecurity,thatis,thefacevalueplusthenetpremium
    (premiumsnetofdiscounts).
    Atmaturityofthesecurity,theFederalReservewillonlyreceivethefacevalue,sothe
    premiumsanddiscountsmustbeamortizedovertheremainingtermofthesecurity.
    U.S.TreasurysecuritiesandagencydebtsecuritiesheldbytheFederalReserveBanks
    areamortizedlinearlyovertheremainingtermofthesecurity.Intheaccounting
    treatmentofagencyMBSpremiums,theamortizationscheduleforMBSisbasedonan
    effectiveyieldcalculation,whichresultsinaconstantrateofreturnduringthetermof

    38

    thesecurity.Intheanalysisthatfollows,however,wesimplifythisassumptionand
    implementagencyMBSamortizationusingthepathofanticipatedpaydownsofagency
    MBS.
    Asofyearend2011,therewere$88billioninunamortizedpremiumsand$1billionin
    discountsassociatedwithholdingsofTreasurysecuritiesand$12billioninunamortized
    premiumsand$1billionindiscountsassociatedwithholdingsofagencyMBS.42Weuse
    straightlineamortizationofthesepremiumsanddiscountsovertheexpectedlifeof
    currentSOMAholdings.WederivenewpremiumsanddiscountsfromoutrightTreasury
    purchasesbyusingthedifferencebetweentheassumedcouponofthesecuritybeing
    purchasedandthecorrespondingmarketinterestrate,asgivenbytheyieldcurve
    estimatesreviewedinAppendix2.
    WeassumethatagencyMBSarepurchasedataprice4percentaboveparvalue,and
    thereforebooksomepremiumsontheseassetpurchases.Basedonthecalculationsfor
    thepurchasepricesofTreasurysecurities,weestimatethatthereareapproximately
    $60billioninpremiumsassociatedwithTreasurysecuritiespurchasesoverthecourseof
    theMaturityExtensionProgramand$24billioninpremiumsper$500billionofnew
    purchasesin2013.

    6.4 Lending
    Sinceitsinception,theFederalReservehashadtheauthoritytolendtodepository
    institutions.Priortothefinancialcrisis,however,borrowingfromtheFederalReserve
    tendedtobequitesmall,typicallylessthanacouplehundredmilliondollarsoutstanding
    perday.Duringthefinancialcrisis,lendingbytheReserveBanksgrewsignificantly,at
    onepointexceeding$1trillionoutstanding.43LendingbytheFederalReserveincreases
    reservebalances,allelseequal,becauseinlendingtoadepositoryinstitution,the
    ReserveBankdirectlycreditsthatinstitutionsreserveaccount.Asaresult,reserve
    balancesroseaslendingincreasedduringthefinancialcrisis.Theloantotheinstitution
    isthecorrespondingassetontheFederalReservesbalancesheet.
    Wemakethesimplifyingassumptionthatalldiscountwindowlendingoverthe
    projectionperiodiszero.

    42
    RefertotheCombinedFinancialStatementoftheFederalReserveSystem,availableat
    http://www.federalreserve.gov/monetarypolicy/bst_fedfinancials.htm.
    43
    Includedinthisnumberareprimary,secondaryandseasonalloans;termauctioncredit;theprimarydealerand
    otherbrokerdealercredit,creditextendedtoAIG,netportfolioholdingsofCommercialPaperFundingFacility,
    andtheoutstandingprincipalamountofloansextendedbytheFederalReserveBankofNewYorktoMaidenLane,
    MaidenLaneII,andMaidenLaneIII.

    39

    6.5 TALF LLC


    AssetsheldbyTALFLLCconsistofinvestmentsofcommitmentfeescollectedbytheLLC
    andtheU.S.Treasurysinitialfunding.Inthisprojection,theLLCdoesnotpurchaseany
    assetbackedsecuritiesreceivedbytheFederalReserveBankofNewYorkinconnection
    withadecisionofaborrowernottorepayaTALFloan.
    TheassetsheldbyTALFLLCremainneartheircurrentleveloflessthan$1.0billion
    through2014beforedecliningtozerothefollowingyear.

    6.6 Maiden Lane LLC


    TheassetsheldbyMaidenLaneLLCdeclinegraduallyovertimeandfalltozerobyearly
    2015.

    6.7 Reserve balances


    Reservebalancesaretheresidualofassetslessotherliabilitieslesscapitalinthebalance
    sheetprojection.Thatsaid,aminimumlevelof$25billionissetforreservebalances,
    roughlyequivalenttothelevelofreservebalancesbeforethestartofthefinancialcrisis.
    Tomaintainreservebalancesatthislevel,firstTreasurybillsarepurchased.Purchases
    ofbillscontinueuntilthesesecuritiescompriseonethirdoftheFederalReservestotal
    Treasurysecurityholdingsabouttheaveragelevelpriortothecrisis.Oncethislevelis
    reached,theFederalReservebuysnotesandbondsinadditiontobillstomaintainan
    approximatecompositionoftheportfolioofonethirdbillsandtwothirdscoupon
    securities.Ingeneral,increasesinthelevelofFederalReserveassetsaddreserve
    balances.Bycontrast,increasesinthelevelsofliabilityitems,suchasFederalReserve
    notesincirculationorotherliabilities,orincreasesinthelevelofReserveBankcapital,
    drainreservebalances.

    6.8 Reverse repurchase agreements


    TheFederalReserveconductsreverserepurchaseagreements(reverserepos,orRRPs)
    bysellingsecuritiestocounterpartieswhosellthesecuritiesbacktotheFederalReserve
    onastatedfuturedate.Currently,thelargestportionofoutstandingreversereposis
    withforeigncentralbanksthatholddollarsintheiraccountsattheFederalReserve
    BankofNewYork.KnownastheforeignRPpool,asofendMay2012,therewasa
    littlelessthan$100billioninforeignRPpooltransactionsoutstandingontheFederal
    Reservesbalancesheet.
    InadditiontotheforeignRPpool,beforethefinancialcrisis,theFederalReserve
    occasionallyengagedinreversereposwithprimarydealerstodrainreservebalances.
    Thesetransactionsareconceptuallydistinctfromtheserviceprovidedbytheforeign

    40

    repopool;inparticular,theyareintendedtobepartofopenmarketoperationsand
    thereforepartoftheconductofmonetarypolicy.Sincelate2009,theFederalReserve
    BankofNewYorkhastakenstepstoexpandthetypesofcounterpartiesforreverse
    repostoincludeentitiesotherthanprimarydealers,inordertoprepareforthe
    potentialneedtoconductlargescalereverserepurchaseagreementtransactions.

    6.9 Currency
    FederalReservenotesincirculationareassumedtogrowatthesamerateasnominal
    GDP.WeusetheconsensusBlueChipforecastsforrealGDPgrowthandthepricelevel
    toformtheforecastfornominalGDPthrough2025.Becausethisisanannualforecast,
    weusetheannualgrowthrateastheannualizedquarterlygrowthrateforthe2ndand
    3rdquartersofeachyear,andtheninterpolategrowthratesforthe1stand4thquarters
    oftheyear.ThetablebelowsummarizestheBlueChipprojectionsfornominalGDP
    growth.
    BlueChip
    nominalGDP
    Year
    growth
    forecast
    2012 4.0%
    2013 4.2%
    2014 5.0%
    2015 5.2%
    2016 5.1%
    2017 5.1%
    2018 4.9%
    2019 4.7%
    2020 4.7%
    Source:BlueChip,December2012

    6.10 Reverse Repurchase Agreements (RRPs)


    TheFederalReserveconductsRRPswithforeignofficialaccounts,international
    accounts,andothercounterparties.ThevolumeofRRPsthatisconductedwithforeign
    officialandinternationalaccountsisassumedtostayconstantatitsmostrecentlevelof
    approximately$98billioninMay2012.Theportionthatisconductedwithothersis
    assumedtostayatzeroovertheprojectionperiod.

    41

    6.11 Other liabilities


    Priorto2008,theleveloftheTGAwasfairlyconstantnear$5billion.44Sincethattime,
    however,theTreasuryhasmaintainedessentiallyitsentirecashbalanceintheTGAand
    theTGAhasbeenvolatile,reflectingtheebbsandflowsoftheTreasuryscash
    managementasborrowingandtaxreceiptsincreasethecashbalanceandvarious
    outflowsreducethecashbalance.45
    Fortheprojections,weassumethattheTGAfollowstherecenthistoricalpatterninthe
    nearterm,andthendropsto$5billionaftertheliftoffofthefederalfundsrate.
    Thereareasetofotherliabilitiesthatwedonotdiscussindetailbecausetheyare,in
    general,eithersmallornotparticularlyrelevantforthepurposesoftheseprojections.
    MorediscussionoftheFederalReservesbalancesheetisavailableontheBoardof
    Governorswebsite.46

    6.12 Capital
    FederalReservecapitalgrows15percentperyear,inlinewiththeaveragerateofthe
    pasttenyears.

    6.13 Deferred Asset


    IntheeventthataFederalReserveBanksearningsfallshortoftheamountnecessaryto
    coveroperatingcosts,paydividends,andequatesurplustocapitalpaidin,adeferred
    assetwillberecorded.ThisdeferredassetisrecordedinlieuofreducingtheReserve
    BankscapitalandisfoundontheliabilitysideofthebalancesheetasIntereston
    FederalReservenotesduetoU.S.Treasury.Thisliabilitytakesonapositivevalue
    whenweeklycumulativeearningshavenotyetbeendistributedtotheTreasury,while
    thisliabilitytakesonanegativevaluewhenearningsfallshortoftheexpenseslisted
    above.

    7 Income

    Associatedwiththebalancesheetprojectionsareincomeitems.Thoseitemsnot
    specificallydiscussedareassumedtogeneratenoincomeorexpense.

    44
    ForadiscussionofTreasurycashmanagementduringthisperiod,refertoGarbade,PartlanandSantoro(2004).
    45
    RefertoFRBNY(2011),pages2829.
    46
    http://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm

    42

    7.1 SOMA Interest Income

    TheSOMAportfolioconsistsoffourtypesofsecurities:agencydebt,agencyMBS,
    Treasurybills,andTreasurycouponsecurities.SOMAinterestincomeisdefinedas
    holdingsmultipliedbytheirrateofreturnlessnetamortizationofpremiums.
    TheaveragecouponontheportfolioofcurrentagencyMBSholdingsisessentiallyfixed
    atitscurrentaveragecouponof4.19percentforsimplicity.Couponsonforecasted
    agencyMBSholdingsareestimatedusingthecurrentcouponmodelreviewedin
    Appendix2.Salesandprepaymentshaveacouponratereflectingtheweightedshareof
    allagencyMBSsecurities.
    TheaveragecoupononholdingsofTreasurysecurities,bycontrast,isnotfixed.The
    returnisaffectedbyredemptionsandpurchases.Threepointsarerelevant.First,we
    calculatetheaveragecouponoftheremainingstockofthesesecuritiesthroughthe
    projectionperiodusingCUSIPleveldata.Second,securitiespurchasedinthesecondary
    marketalsoaffecttheaveragecouponoftheTreasurysecuritiesholdings.Weassume
    thattheseoutrightpurchasesofsecuritieshaveacouponthatisdeterminedbya
    weightedaverageofthecouponsoneligibleTreasurysecurities.Theweightsare
    determinedbytheamountofeachsecuritythatisavailableforpurchaseafter
    accountingforselfimposedlimitsonSOMAholdings.Third,weassumethatthe
    FederalReservecontinuestorollovermaturingTreasurysecuritiesintonewsecurities
    purchasedatauctioninthesamematuritydistributionasitcurrentlyuses.Thecoupon
    forsecuritiespurchasedatauctionisdeterminedbytheinterestrateprojections.
    Asnotedabove,premiumsarelinearlyamortizedovertheexpectedlifeofthe
    securities.Inthesecalculations,aportionofthepremiumisamortizedeachyearand,
    consistentwithFederalReserveaccountingpractices,thisamortizationreducesinterest
    income.47Securitiespurchasedatadiscountaretreatedinananalogousway,and
    increaseinterestincome.

    7.2 Other interest income

    OtherinterestincomeitemsontheFederalReservesincomestatementinclude
    revenuefromdiscountwindowloansandotherloans.Mostofthetime,incomefrom
    theseitemsissmallcomparedtothatontheSOMAportfolio.However,reflectingthe
    FederalReservesactionsduringthefinancialcrisis,interestincomefromloansand
    otherassetswerenotable,althoughstillsmallerthanincomefromSOMAin2008and
    2009,comprisingbetween15and30percentoftotalinterestincome.

    47
    Ifthesecurityissold,thetotalunamortizedpremiumassociatedwiththesecurityisaccountedforinthecapital
    gain(loss)lineoftheincomestatementintheseprojections.

    43

    Incomefromotherassetsiscalculatedusingthesimpleformulaofholdingsmultiplied
    byrateofreturn.Therateofreturnfordiscountwindowborrowingisassumedtobe50
    basispointshigherthanthefederalfundsrate,consistentwiththespreadestablishedin
    February2010.TherateofreturnonTALFiscalculatedusingtheobservedrateof
    returnfromJanuary1,2011,toJune30,2011,of1.76percentatanannualrate.48Other
    assetshaveratesofreturnconsistentwiththeirownhistoricalratesofreturn.

    7.3 Interest expenses

    Twoprimarysourcesofinterestexpenseareforecastedinthismodel:interestexpense
    associatedwithreverserepurchaseagreements(RRPs)andinterestpaidonreserve
    balances.Tocalculatetheinterestexpenseonbothreversereposandreservebalances,
    thequantitiesoftheseliabilitiesfromthebalancesheetprojectionaremultipliedbythe
    projectedfederalfundsrateintheappropriatetimeperiod.

    7.4 Capital gain (loss)

    Inthisanalysis,capitalgains(losses)arerealizedduetoassetsales,whileunrealized
    capitalgains(losses)arecalculatedfortheportfolioasawhole.Theanalysisassumes
    thatthequantitiessoldarearepresentativeshareofthetotalholdingsunlessotherwise
    stated,andsolossesareproportionaltothetotallossposition.Realizedcapitalgains
    (losses)aredefinedtobethemarketvalueoftheassetatthetimeofthesalelessthe
    parvaluelessnetpremiumsamortizedduetosales.Unrealizedcapitalgainsare
    similarlydefinedasthemarketvalueoftheremainingholdingslessitsparvalueless
    unamortizednetpremiums.
    ThemarketvalueoftheSOMAportfolioisobtainedbyestimatingthepresent
    discountedcashflowsoftheassetsheldinSOMA.Adjustmentsaremadefor
    prepayments,purchases,andsales.Themethodologiesforderivingdiscountfactors
    andvaluingoftheportfolioaredescribedinAppendix2.

    7.5 Miscellaneous items

    Wehavemadesimplifyingassumptionsaboutotherincomeitems.Inparticular,non
    interestincomeisprimarilyfromforeignexchangetransactionsandfrompriced
    services.Duringtheheightofthefinancialcrisis,whentheleveloftheswaplines
    outstandingsurpassed$580billion,incomefromforeignexchangewascloseto$4

    48
    ThecalculationusestheaveragebalanceoftheTALFandtheinterestincomereportedintheMonthlyReporton
    CreditandLiquidityProgramsandtheBalanceSheet,October2011,p.27.

    44

    billion.Inprioryears,however,incomeonforeignexchangewasmoremuted.Priced
    servicesincome,primarilyfromcheckandotherpaymentsprocessing,wasalsoa
    traditionalsourceofincomefortheFederalReserve.Ascheckprocessingbecame
    increasinglyelectronic,incomefrompricedservicesdeclined.Asaresult,inour
    analysis,noninterestincomefromserviceincomeisingeneralsmallandsoissetto
    zeroineachyearoftheprojection.
    Wehavealsomadesimplifyingassumptionsontheremainingexpenseitems.
    Specifically,basedonrecentobservations,weassumefixedannualoperatingexpenses
    of$6billionperyear.Andfinally,consistentwiththerulesoutlinedintheFederal
    ReserveAct,dividendsareassumedtobe6percentofcapitalpaidin,andtransfersto
    surplusoccurinordertoequatesurplustocapitalpaidin.

    45

    Appendix 2: Constructing yield curves and coupons on purchased


    securities and valuation of the SOMA portfolio49

    TheprojectionsforthecouponratesonTreasurysecuritiesdependonforecastsfortheyield
    curve.Weconstructazerocouponyieldcurveusingprojectionsforthefederalfundsrateand
    theforecastforthe10yearTreasuryyield,wheretheseindependentvariablesaretakenfrom
    theadjustedDecember2012BlueChipforecastforfutureinterestrates.

    Wespecifytherelationshipbetweenayieldattenoriandtheseratesusingaregression:

    yit i 1i fft 2i (10 year )t it ,

    whereyitisthezerocouponyieldformaturityiattimet,isaconstantterm,1iistheyield
    specificcoefficientonthefederalfundsrate,2iistheyieldspecificcoefficientonthe10year
    rate,anditisanerrorterm.Weevaluatethisspecificationonhistoricaldataatthe2,3,4,5,
    10,15,20,and30yeartenors.Thehistoricaldataareyieldsconstructedfromanofftherun
    SvenssonNelsonSiegelzerocouponyieldcurve,theTreasuryyieldcurveusedinproduction
    workattheBoard.50ThesampleisdailydatafromJanuary3,1994toApril10,2010.Standard
    errorsarecalculatedusingarobustsandwichprocedure.

    TheestimatedcoefficientsandassociatedRsquaredstatisticsaredisplayedintheappendix
    tableA21.Ingeneral,theresultsareinlinewithintuitionandthesetworatescanexplain
    almostallthevariationintheotherrates.Inaddition,weperformedaseriesofrobustness
    checks.Specifically,longertermratestendedtoexhibitcointegrationwiththe10yearrate,
    butshortertermratesdidnot.Overall,theestimatedcoefficientsandresultingyieldcurves
    presentedherearebroadlysimilartothoseusingacointegratedorothertypeofspecification.

    Withtheseestimatesinhand,wethenconstructinitialyieldcurvesforeachpointintimein
    ourforecast,interpolatingvaluesfortenorsforwhichwedonotexplicitlyestimateamodel.
    WeusetheseforourprojectedcouponsonTreasurysecuritieswepurchaseovertheforecast
    period.

    49
    MuchofthemethodologydescribedinthissectionisattributabletoViktorsStebunovsandAriMorse.
    50
    Fordetails,refertoGurkaynak,SackandWright(2007).

    46

    AnadditionalestimateisneededtoforecastthecouponrateonfutureMBSpurchases.Thisis
    donebyestimatingthestatisticalrelationshipbetweentheFannieMaeMBScurrentcoupon
    rate,the10yearTreasuryrate,andthe30yearfixedratemortgagerate.Weusequarterly
    averagesofdailydatafrom1984Q4to2011Q3togenerateourparameterestimates.Weuse
    anAR(3,1,0)modeltoaccountfortheautocorrelationintheerrortermsandthecointegration
    inthetwoseries.AsisevidentfromtableA22,changesinthe10yearrateand30yearfixed
    ratemortgageratearematchedalmostonetoonewiththoseintheMBScurrentcouponrate,
    andtheautocorrelationinthedifferencedseries,whilenotstrong,isstillpersistentenoughto
    berelevantintestsforautocorrelationoftheresiduals.

    47

    TableA21:Yieldcurveregressions

    Effectiverate 10yearrate Constant

    Rsquared
    Standard Standard Standard
    Year Coefficient Tstat Coefficient Tstat Coefficient Tstat
    error error error

    2 0.536*** 0.003 155.438 0.746*** 0.007 109.305 0.018*** 0 62.483 0.971

    3 0.392*** 0.003 131.062 0.877*** 0.006 154.592 0.018*** 0 72.969 0.975

    4 0.282*** 0.002 116.573 0.945*** 0.004 211.367 0.015*** 0 80.671 0.982

    5 0.196*** 0.002 107.059 0.980*** 0.003 293.544 0.012*** 0 87.013 0.988

    7 0.071*** 0.001 87.829 1.003*** 0.001 678.057 0.006*** 0 95.999 0.997

    10 0.039*** 0 119.39 1.000*** 0.001 1420.984 0.002*** 0 59.475 0.999

    15 0.121*** 0.001 88.754 0.995*** 0.003 397.277 0.008*** 0 76.072 0.983

    20 0.149*** 0.002 64.611 1.013*** 0.004 269.745 0.010*** 0 54.576 0.953

    30 0.168*** 0.004 46.25 1.083*** 0.006 196.249 0.005*** 0 19.391 0.9

    N 4067

    Sample: 1/3/19944/10/2010

    48

    TableA22:MBScouponforecastingregression

    Dependentvariable:(FannieMae30yearcurrentcoupon)
    Std.
    Coefficient Error
    (10yearrate) 0.235 0.051
    (30yrfixedratemortgagerate) 0.858 0.059
    Constant 0.004 0.007
    ARTerm
    L1 0.254 0.109
    L2 0.07 0.111
    L3 0.242 0.121
    N=107
    Sampleperiod:1984Q4to2011Q3

    49

    Figure 1 Federal Reserves Assets and Liabilities


    3,000

    2,500

    Support for specific institutions (ML LLCs, Bear, AIG)


    2,000
    Other credit facilities (PDCF, AMLF, CPFF, TALF)

    1,500
    Central bank liquidity swaps
    Assets Agency debt and MBS holdings

    1,000
    Loans (includes term auction credit)

    Repurchase agreements
    500
    Treasury securities held outright
    $ Billions

    All other assets


    0

    Federal Reserve notes in circulation


    500

    Reverse RPs
    1,000 Capital Other Liabilities>
    U.S. Treasury accounts
    Other Deposits >
    Liabilities
    1,500
    Deposits of depository institutions

    2,000

    2,500

    3,000
    Jan 4, 2006 Jul 4, 2006 Jan 1, 2007 Jul 1, 2007 Dec 29, 2007 Jun 27, 2008 Dec 25, 2008 Jun 24, 2009 Dec 22, 2009 Jun 21, 2010 Dec 19, 2010 Jun 18, 2011 Dec 16, 2011 Jun 14, 2012 Dec 12, 2012
    Wednesdays
    Last updated December 26, 2012.

    Source: H.4.1 Statistical Release


    Figure 2 Federal Reserves Income and Expense
    90

    80

    70

    Income
    60

    Special liquidity facilities >


    50

    40 Agency debt and MBS


    $ Billions

    Central bank liquidity swaps >

    Loans (including term auction credit) >


    30

    20 Treasury securities

    10

    Foreign currency (gain/loss)


    0
    Other expenses
    Reverse RPs Interest paid on DI deposits >
    Dividends paid
    Transfers to surplus
    10

    Expense
    20
    2006 2007 2008 2009 2010 2011
    Annual

    Source: Annual Report of the Federal Reserve Board of Governors


    Figure 3 - Federal Reserve Distributions to the Figure 4 - SOMA, Capital + FR Notes,
    U.S. Treasury $Billion and Reserve Balances $Billion
    90 3000
    80
    2500
    70
    60 SOMA 2000
    Capital+Notes
    50 Reserve Balances
    1500
    40
    30 1000

    20 500
    10
    0
    0
    2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012* 1990 1993 1996 1999 2002 2005 2008 2011

    Source: Annual Report of the Federal Reserve Board of Governors; Source: H.4.1 Statistical Release
    *Preliminary unaudited estimate,
    see http://www.federalreserve.gov/newsevents/press/other/20130110a.htm

    Figure 5 - Weighted Average Maturity of SOMA Figure 6 - Weighted Average Coupon of SOMA
    Months Percent
    140 10

    120
    8
    100
    6
    80

    60 4
    40
    2
    20

    0 0
    1980 1984 1988 1992 1996 2000 2004 2008 2012 1980 1984 1988 1992 1996 2000 2004 2008 2012
    Note. Includes only nominal Treasury securities; Note. Includes only nominal Treasury securities;
    Source: Federal Reserve Bank of New York Source: Federal Reserve Bank of New York

    Figure 7 - Interest Income Figure 8 - Selected Treasury Receipts


    $Billion $Billion
    100 2000
    Fed Earnings
    Social Security
    Total Interest Income 80 Individual Income Taxes
    SOMA Interest Income 1500
    Corporate Income Taxes

    60
    1000

    40
    500
    20

    0
    0
    1980 1985 1990 1995 2000 2005 2010 1996 1999 2002 2005 2008 2011
    Source: Annual Report of the Federal Reserve Board of Governors Source: United States Treasury Bulletin
    Figure 9 - Interest Rates*

    Federal Funds Rate


    percent
    7
    Quarterly

    Baseline
    Higher Rates 5

    2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

    10 year Treasury Rate


    percent
    7
    Quarterly

    Baseline
    Higher Rates
    5

    1
    2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
    * Baseline interest rate paths are the consensus December 2012 Blue Chip forecast, other interest rate paths are authors calculations
    Figure 10 - Selected Assets Projections

    SOMA Holdings SOMA Treasury Holdings


    Billions of dollars Billions of dollars
    5000 4000
    Monthly Monthly
    No Purchases in 2013 No Purchases in 2013
    $500bn Purchases 4500 $500bn Purchases
    $1trn Purchases 3500
    $1trn Purchases
    4000
    3000
    3500

    2500
    3000

    2500 2000

    2000
    1500

    1500
    1000
    1000

    500
    500

    0 0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    SOMA Agency MBS Holdings SOMA Agency Debt Holdings


    Billions of dollars Billions of dollars
    2000 600
    Monthly Monthly
    No Purchases in 2013
    No Purchases in 2013 1800 $500bn Purchases
    $500bn Purchases $1trn Purchases
    $1trn Purchases 500
    1600

    1400 400

    1200
    300
    1000

    800 200

    600

    100
    400

    200
    0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    Source: Authors Projections


    Figure 11 - Selected Liabilities Projections

    FR Notes Treasury General Account


    Billions of dollars Billions of dollars
    2200 240
    Monthly Monthly
    No Purchases in 2013 2000 No Purchases in 2013 220
    $500bn Purchases $500bn Purchases
    $1trn Purchases $1trn Purchases 200
    1800
    180
    1600
    160
    1400
    140
    1200
    120
    1000
    100
    800
    80

    600 60

    400 40

    200 20

    0 0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    Capital Paid In Reserve Balances


    Billions of dollars Billions of dollars
    220 3500
    Monthly Monthly
    No Purchases in 2013 No Purchases in 2013
    $500bn Purchases 200 $500bn Purchases
    $1trn Purchases $1trn Purchases
    3000
    180

    160
    2500
    140

    120 2000

    100
    1500
    80

    60
    1000

    40

    20 500

    0
    0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    Source: Authors Projections


    Figure 12 - Income Projections

    SOMA Interest Income Interest Expense


    Billions of dollars Billions of dollars
    120 120
    Annual Annual
    100 No Purchases in 2013 100
    $500bn Purchases
    $1trn Purchases
    80 80

    60 60

    40 40
    No Purchases in 2013
    $500bn Purchases 20 20
    $1trn Purchases

    0 0

    2011 2015 2019 2023 2011 2015 2019 2023

    Realized Capital Losses Remittances to Treasury


    Billions of dollars Billions of dollars
    120 120
    Annual Annual
    No Purchases in 2013 100
    No Purchases in 2013 100
    $500bn Purchases $500bn Purchases
    $1trn Purchases 80 $1trn Purchases
    80
    60
    60
    40

    20 40

    0 20
    -20
    0

    2011 2015 2019 2023 2011 2015 2019 2023

    Deferred Asset Unrealized Gains/Losses


    Billions of dollars Billions of dollars
    160 325
    End of year End of year
    No Purchases in 2013 140 No Purchases in 2013 250
    $500bn Purchases $500bn Purchases
    $1trn Purchases 120 $1trn Purchases 175

    100 100

    80 25
    -50
    60
    -125
    40
    -200
    20
    -275
    0
    -350
    2011 2015 2019 2023 2011 2015 2019 2023

    Source: Authors Projections


    Figure 13 - Selected Balance Sheet Items with Higher Interest Rates

    SOMA Holdings SOMA Treasury Holdings


    Billions of dollars Billions of dollars
    5000 4000
    Monthly Monthly
    No Purchases in 2013 No Purchases in 2013
    Higher IR No Purchases 4500 Higher IR No Purchases
    Higher IR $500bn Purchases 3500
    Higher IR $500bn Purchases
    Higher IR $1trn Purchases Higher IR $1trn Purchases
    4000
    3000
    3500

    2500
    3000

    2500 2000

    2000
    1500

    1500
    1000
    1000

    500
    500

    0 0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    SOMA Agency MBS Holdings Reserve Balances


    Billions of dollars Billions of dollars
    2000 3500
    Monthly Monthly
    No Purchases in 2013
    No Purchases in 2013 1800 Higher IR No Purchases
    Higher IR No Purchases Higher IR $500bn Purchases
    Higher IR $1trn Purchases 3000
    Higher IR $500bn Purchases
    Higher IR $1trn Purchases 1600

    1400 2500

    1200
    2000
    1000

    800 1500

    600
    1000
    400

    200 500

    0
    0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    Source: Authors Projections


    Figure 14 - Income Projections with Higher Interest Rates

    SOMA Interest Income Interest Expense


    Billions of dollars Billions of dollars
    120 120
    Annual Annual
    100 No Purchases in 2013 100
    Higher IR No Purchases
    Higher IR $500bn Purchases
    80 Higher IR $1trn Purchases 80

    60 60

    40 40
    No Purchases in 2013
    Higher IR No Purchases 20 20
    Higher IR $500bn Purchases
    Higher IR $1trn Purchases
    0 0

    2011 2015 2019 2023 2011 2015 2019 2023

    Realized Capital Losses Remittances to Treasury


    Billions of dollars Billions of dollars
    120 120
    Annual Annual No Purchases in 2013
    No Purchases in 2013 100 Higher IR No Purchases 100
    Higher IR No Purchases Higher IR $500bn Purchases
    Higher IR $500bn Purchases 80 Higher IR $1trn Purchases
    Higher IR $1trn Purchases 80
    60
    60
    40

    20 40

    0 20
    -20
    0

    2011 2015 2019 2023 2011 2015 2019 2023

    Deferred Asset Unrealized Gains/Losses


    Billions of dollars Billions of dollars
    160 325
    End of year End of year
    No Purchases in 2013 140 No Purchases in 2013 250
    Higher IR No Purchases Higher IR No Purchases
    Higher IR $500bn Purchases Higher IR $500bn Purchases 175
    Higher IR $1trn Purchases 120
    Higher IR $1trn Purchases 100
    100
    25
    80
    -50
    60
    -125
    40 -200
    20 -275

    0 -350

    2011 2015 2019 2023 2011 2015 2019 2023

    Source: Authors Projections


    Figure 15 - Interest Rates*

    Federal Funds Rate


    percent
    7
    Quarterly

    Baseline
    Lower Rates 5

    2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

    10 year Treasury Rate


    percent
    7
    Quarterly

    Baseline
    Lower Rates
    5

    1
    2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
    * Baseline interest rate paths are the consensus December 2012 Blue Chip forecast, other interest rate paths are authors calculations
    Figure 16 - Selected Balance Sheet Items with Lower Interest Rates

    SOMA Holdings SOMA Treasury Holdings


    Billions of dollars Billions of dollars
    5000 4000
    Monthly Monthly
    No Purchases in 2013 No Purchases in 2013
    Lower IR No Purchases 4500 Lower IR No Purchases
    Lower IR $500bn Purchases 3500
    Lower IR $500bn Purchases
    Lower IR $1trn Purchases Lower IR $1trn Purchases
    4000
    3000
    3500

    2500
    3000

    2500 2000

    2000
    1500

    1500
    1000
    1000

    500
    500

    0 0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    SOMA Agency MBS Holdings Reserve Balances


    Billions of dollars Billions of dollars
    2000 3500
    Monthly Monthly
    No Purchases in 2013
    No Purchases in 2013 1800 Lower IR No Purchases
    Lower IR No Purchases Lower IR $500bn Purchases
    Lower IR $1trn Purchases 3000
    Lower IR $500bn Purchases
    Lower IR $1trn Purchases 1600

    1400 2500

    1200
    2000
    1000

    800 1500

    600
    1000
    400

    200 500

    0
    0

    2007 2011 2015 2019 2023 2007 2011 2015 2019 2023

    Source: Authors Projections


    Figure 17 - Income Projections with Lower Interest Rates

    SOMA Interest Income Interest Expense


    Billions of dollars Billions of dollars
    120 120
    Annual Annual
    100 No Purchases in 2013 100
    Lower IR No Purchases
    Lower IR $500bn Purchases
    80 Lower IR $1trn Purchases 80

    60 60

    40 40
    No Purchases in 2013
    Lower IR No Purchases 20 20
    Lower IR $500bn Purchases
    Lower IR $1trn Purchases
    0 0

    2011 2015 2019 2023 2011 2015 2019 2023

    Realized Capital Losses Remittances to Treasury


    Billions of dollars Billions of dollars
    120 120
    Annual Annual No Purchases in 2013
    No Purchases in 2013 100 Lower IR No Purchases 100
    Lower IR No Purchases Lower IR $500bn Purchases
    Lower IR $500bn Purchases 80 Lower IR $1trn Purchases
    Lower IR $1trn Purchases 80
    60
    60
    40

    20 40

    0 20
    -20
    0

    2011 2015 2019 2023 2011 2015 2019 2023

    Deferred Asset Unrealized Gains/Losses


    Billions of dollars Billions of dollars
    160 325
    End of year End of year
    No Purchases in 2013 140 No Purchases in 2013 250
    Lower IR No Purchases Lower IR No Purchases
    Lower IR $500bn Purchases Lower IR $500bn Purchases 175
    Lower IR $1trn Purchases 120
    Lower IR $1trn Purchases 100
    100
    25
    80
    -50
    60
    -125
    40 -200
    20 -275

    0 -350

    2011 2015 2019 2023 2011 2015 2019 2023

    Source: Authors Projections

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