Centralverse Q&A, Round II
Two great questions on today’s round of Centralverse Q&A: What are the requirements for becoming a Fed governor? How will the Fed’s balance sheet change? If you have questions you’d like answered on the podcast send them in. As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com.
Introduction
I am Alexander Bagehot and you’re listening to The Bankster Podcast, the only podcast dedicated to the fascinating and ever more consequential world of central banking.
These are exciting times here in the Centralverse. Just about every week there is a new announcement or rumored announcement about a change in leadership or a change in monetary policy action. This week was no exception and I’m going to be discussing two questions on today’s episode. Now for those of you that caught the first episode in the Centralverse Q&A series you’ll remember that we approach each question in three phases: a bit background information about why it’s interesting this week, the short answer, and finally the long answer. So now that we’re all on the same page let’s dive into Centralverse Q&A, Round II.
Question #1
What are the requirements for becoming a Fed governor?
Background #1
Last week, the Wall Street Journal reported that Randal Quarles is claiming Colorado as his home. He lives in Utah and the private investment fund he runs is based in Utah. However, and now quoting from the article, “[Quarles] lived in Colorado from the age of 7 months through second grade...After that, [Quarles] returned to Colorado for a material portion of every summer to stay with his grandparents…[oh, and he also spends many a Christmas in Colorado, his spokesman added].” So why on earth would the prospective future Federal Reserve Governor make such gymnastic like positioning to claim Colorado? Well, because he has to.
Short Answer #1
The Federal Reserve Act specifies that no two members of the Board of Governors can come from the same Federal Reserve District and that they should represent different sectors of the economy. Utah is in the 12th District, which already has a Governor - Janet Yellen, who claims San Francisco. The 10th District, of which Colorado is a part, does not currently have a Governor. Lucky for Quarles that’s where he went to 1st grade.
Long Answer #1
The Federal Reserve Act lists just two prerequisites for the position of Governor. To quote from Section 10 of the Act itself, “In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.” So, as a whole, the 7 governors need to represent (a) different sectors of the economy and (b) different geographical locations of the country. That specific call out for the geographical representation is very specific. And that’s why Quarles has had to do such gymnastics to claim Colorado as the answer to the otherwise simple question, “Where are you from?”
I’ll send a link of the Wall Street Journal article in the show notes of this episode. Which by the way I haven’t sent out for the past few episodes. My apologies! Going forward, instead of receiving the show notes a few days later - I will be sending them out on the same morning that I release the podcast. You can sign up to receive the show notes directly in your email inbox by going to my website www.thebanksterpodcast.com. Anyways, the article tells some fun stories about how some current and past governors have claimed their answers to the question, “Where are you from?” The article also hints at the story of the initial amendment that was written into the 1913 Act that added the line about no two governors from the same area.
To end this long answer I will say just one more thing about the prerequisites of becoming a Governor. The Federal Reserve Act specifies that, like many other high ranking governmental positions, the US President will nominate the individual and the Senate will confirm him or her.
Question #2
How will the Fed’s balance sheet change?
Background #2
During the Financial Crisis of 2007-2009 the Fed, in an effort to encourage growth back into the economy, dramatically increased the size of the balance sheet from under $1T to $4.5T. At the June FOMC meeting of this year, the Fed announced that “soon” they would begin decreasing the size of that balance sheet. At the September FOMC meeting, held just last week, they announced that the “soon” would be October. So how will they do this? I have a short and a long answer for you.
The only other piece of background information you need to know before I share those answers with you is what the balance sheet is made of. The majority of the $4.5T are either Government bonds or Mortgage Backed Securities. Both of these assets receive payments every month. They are basically loans. Loans from the government and loans from home owners. Owning $4.5T worth of these loans means that some of them end every month (like when you finish paying off your mortgage and no longer have to send the bank money every month). In order to maintain the $4.5T the Fed has to replace the ones that are paid off. They do this to the tune of billions and billions of dollars every month - replacing the old ones with new ones. Ok, now we’re ready for the answers to the question, “How will the Fed decrease the balance sheet?”
Short Answer #1
The Fed will decrease the size of the balance sheet by slowly not replacing all of the loans that are paid off. Every few months they’ll let a bigger portion of the loans go unreplaced. Important to note that they won’t actively sell off the loans. Just let them expire. Now onto the fun, wonky details.
Long Answer #1
The actual portion and speed of the decrease in the size of the balance sheet is actually different for the two types of loans that I mentioned in the background section a minute ago. For the government debt, known as Treasury securities, the Fed will allow $6B to roll off from the balance sheet for the first three months. Then they’ll allow an additional $6B (for a total of $12B) to roll off for the following three months. This pattern of $6B increase every quarter will continue for one year where it will hit $30B. At that point $30B worth of Treasury Securities will be paid off every month without being replaced.
Do you remember what the other type of debt the Fed holds was? Yep, Mortgage Backed Securities. So with these the Fed plans to be a little bit more cautious and move at a slower pace - $4B will roll off for each of the first three months. Then $8B for the following three months, etc. etc.. until the 12th month when the steady state will be $20B. When will this end you might be asking yourself? Well, the Fed’s official statement in wonderful Centralversease worthy only of the Long Answer section says, “The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve's securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.” In other words, to use a phrase loved by Central Bankers, “We’ll see”.
Conclusion
And that concludes the second round of Centralverse Q&A. If you have questions you’d like answered on the podcast send them in. As always, I can be reached for comments, feedback, or questions on twitter or via my website www.thebanksterpodcast.com.
Today’s episode was written, edited, and produced by me, Alexander Bagehot. Thanks to all of you for listening, and I’ll see you next time on The Bankster Podcast!
