Is Treasury's TARP Debt Already Monetized?

Where does all the TARP money show up? TARP, of course, stands for the Troubled Asset Relief Program that became law on October 3, 2008, a program aimed at providing support for the banking system. The program was initially intended to provide liquidity-help for the troubled assets that were on the balance sheets of banks but it soon morphed into a program to support troubled banks in their capital needs as funds were made available to purchase senior preferred stock and warrants from commercial banks and other troubled financial institutions.

The first $350 billion of funds was authorized to be released on October 3, 2008 and Congress approved the release of the next $350 billion on January 15, 2009. Part of the concern with the program was that the government deficit would have to increase by $700 billion in order to create the funds. Concerns arose about how the Treasury Department would finance these payments?

One quick answer was “let the Federal Reserve monetize the debt?”

What if the Federal Reserve has already monetized the debt related to TARP? If this is the case, then two questions that have been puzzling me have answers to them. The first question relates to the increase in excess reserves in the banking system. The second question relates to the concern about how the Federal Reserve will reverse out all of the reserves that it pumped into the banking system last fall. Let’s look at both in turn.

Federal Reserve Bank Credit has increased by $1.2 trillion since just before the financial meltdown in September 2008. What has increased the most in the banking system? Excess reserves in the commercial banking system have risen by about $800 billion. Excess reserves in the WHOLE banking system had run about $2 billion before September 2008. Something unprecedented obviously took place!

In terms of policy making the creation of TARP and the response of the Federal Reserve are closely tied together. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?: http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.) As mentioned above, the first round of TARP was released in October. But, the Federal Reserve could not wait. It began pumping reserves into the banking system in the latter part of September increasing Reserve Bank Credit outstanding from about $890 billion on September 10, 2008 to $1.5 trillion on October 8, $1.9 trillion on October 29, and $2.2 trillion on November 19.

In all this action, what happened to reserve balances at the Federal Reserve? They went from around $8 billion on September 10, to $175 billion, to $420 billion, to $624 billion, respectively, on the same dates as above. Excess reserves in the banking system averaged $2 billion in August, $60 billion in September, $268 billion in October, $559 billion in November, and $767 billion in December.

Excess reserves in the banking system averaged $844 billion in May and are averaging around $800 in June. Clearly a lot of money!

The question is “Why are the banks sitting on such large amounts of basically idle cash?”

My response is that they are sitting on this cash because it is connected with the receipt of TARP monies and the banks are hoping, as some of the larger and stronger institutions have done, to repay the funds as soon as possible.

Let’s look a little closer at the data. I am using information from the H.8 release put out by the Federal Reserve System on assets and liabilities of all commercial banks in the United States. Year-over-year, through May 2009, total assets in the banking system increased by 9.7% or about $1.1 trillion. Cash assets in the banking system increased a whopping $731 billion or at a year-over-year rate of 236%. This is comparable to the year-over-year increase in excess reserves observed on the H.3 release of the Federal Reserve providing data on bank reserves.

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