If the United States ever decides to create a Sovereign Fund (SWF), the behavior of the Federal Reserve during the Great Recession and the Covid-19 pandemic can serve as a model. By buying government-guaranteed securities and bonds of private companies known as fallen angels, the behavior of the Federal Reserve mimicked the behavior of a sovereign wealth fund.

Before the creation of the Federal Reserve in 1913, the US economy was considerably more unstable. The United States would regularly alternate cycles of expansion and depression. Lack of reliable credit has held back growth in many sectors, especially agriculture. While there had been several attempts to create a national bank in the United States, it took the bank run of 1907 to finally convince Congress to pass legislation creating the Federal Reserve Bank in 1913.

While the Federal Reserve was making money from its open market operations, it was not until the onset of the Great Recession that the Fed increased its economic activity to support the U.S. economy, which as a as a by-product, generated more wealth for the federal government.

During the Great Recession of 2008-2009, the Fed launched an operation known as quantitative easing. At the start of the 2008-09 global financial crisis, the Fed’s balance sheet stood at $ 2.2 trillion. At the height of the financial crisis, the Fed’s balance sheet soared to $ 4.5 trillion. As the financial crisis eases, the Fed reduced its balance sheet to $ 3.8 trillion until the pension crisis threatened to freeze credit markets in the United States in September 2019.

Due to the freezing of overnight credit markets, the Fed intervened in the private market to ensure liquidity in the private commercial repo market. A buyout market is a form of short-term borrowing for traders in government securities. For example, a repo broker will sell government securities to investors. The repo broker will then redeem (hence the term repo) typically within twenty-four to forty-eight hours at a slightly higher price. Whoever sells the repo essentially borrows money to meet cash reserves, and when he redeems the security, he pays a small interest (which is why he is buying it back at a slightly higher rate) so that he can use it. the title as collateral. The person who buys the security essentially lends money to the repo seller and receives their commission when the repo seller buys the security back. The implied interest rate is called the repo rate. When the time came for the repo market to start on September 16, 2019, however, there was a dramatic shortage of liquidity as the interbank market had dried up.

Money market funds began to take advantage of the liquidity shortage and imposed interest rates of up to ten percent instead of the normal two percent rate. The banks appealed to the Fed, and after an initial hesitation, the Fed responded forcefully by injecting $ 53 billion in liquidity into the market and an additional $ 75 billion the next day to prevent the credit markets from freezing. This led to a $ 400 billion increase in Fed intervention in four months. Central bankers increasingly believe that quantitative easing or the emergency injection of liquidity to stabilize the repo market is becoming a permanent feature of the international money market.

Since the initial injection of liquidity into the money supply, the Fed’s balance sheet has grown from $ 3.8 trillion in August 2019 to $ 4.2 trillion in 2019. A secondary benefit is that the Fed is earning money. money by adopting this type of behavior and at the end of the US fiscal year, the profits are deposited into the US Treasury.

Faced with the unprecedented financial emergency caused by the Covid-19 virus, the Federal Reserve entered uncharted waters and began buying commercial bonds and paper on the open market. By purchasing these commercial bonds, investment grade Class A bonds and recently lapsed angel investors, the Fed will be entitled to the interest payments these bonds pay, and has opened up a new source of revenue for the Treasury. In 2019 and 2020, the Fed deposited $ 54.9 billion and $ 88.5 billion, respectively, with the US Treasury Department.

By receiving direct interest payments from these bonds, the Fed now meets all the technical conditions to be classified as a sovereign wealth fund. With the expansion of Fed activity in the wake of Covid-19, the Fed’s current balance sheet stands at $ 7.9 trillion.

The Fed has announced that it will start selling corporate bonds, valued at $ 13.77 billion. Instead of selling these corporate bonds into the market immediately, the Fed will hold these bonds until they mature, ensuring that there will be a profit on the purchase of these bonds. The proceeds from the sale of these corporate bonds will be deposited in the US Treasury, less the initial cost of the bonds.

With the Federal Reserve acting as a sovereign wealth fund, the US government should consider taking the next step in providing a source of income for the American people by creating an investment board within the Fed. Instead of depositing Federal Reserve profits in the US Treasury, the money should be invested in corporate bonds, securities as well as real estate. This board would buy stocks not only in the United States, but would also take stakes in foreign companies that offer a good return on investment. Profits from this advice would then reinvest the funds to grow the fund even more, and since the Fed is autonomous in its financial operations, there would be no choice of investment instruments due to political pressure.

Richard E. Caroll is a retired economist and has appeared in Real Clear Defense, International Policy Digest, and Foreign Policy News.

Image: Reuters.


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