Typography

One of this blog's most recurrently popular posts is a 2012 ditty entitled the Idiot's Guide to the Federal Reserve Interdistrict Settlement Account . The Interdistrict Settlement Account, or ISA, is a highly esoteric "plumbing" mechanism that lies at the centre of the Federal Reserve System. After a century of being ignored, it suddenly became a popular topic for discussion in late 2011 and 2012 as the breakup of the euro became a real possibility. Groping for a fix, European analysts turned to the world's other large monetary union, the U.S. Federal Reserve System, to see how it coped with the sorts of monetary problems that Europe was then experiencing. Here's a short explanation of the ISA. Consider that there is no such thing as a unified Federal Reserve dollar. Rather, both the paper dollars that you hold in your wallet and the electronic reserves that a private bank holds in its vaults are the liability of one of twelve distinct Federal Reserve district...

Most people don't realize that the central banks of Belgium, Japan, Greece, Switzerland, and South Africa are all publicly-traded. In times past, central clearinghouses were typically privately-owned while the issuance of bank-notes was the domain of competing banks. The fact that a few central banks still retain traces of their former private nature is a good reminder that centralized banking isn't necessarily the domain of the public sector. The Swiss National Bank , for instance, was founded in 1907 to take upon itself the issuance of national bank notes, hitherto provided by private banks. According to Hübscher and Kuhn ( pdf ), efforts to establish a wholly government-owned central bank were defeated in an 1897 national referendum. Opponents of the plan drew up an alternative proposal for a privately owned bank the structure of which would, according to Bordo, "not allow for state socialism or the public control of credit policy." One fifth of the new bank's ...

Mutilated Bank of Thailand baht notes A couple of years ago Mike Sproul and I worked on a short project. Mike wanted to know what portion of outstanding central bank notes are actually held by the public and what percentage has been lost, destroyed in fires and foods, buried, and misplaced. The implications are that if a large percentage of notes have been destroyed over the years, then the central bank holds significant "free" assets in its vaults for which a corresponding liability no longer exists. If you're interested in what backs "money", then this amount is important. This is a similar concept to the idea of a "breakage". Businesses that sell gift cards, which are really just liabilities of the issuer, would prefer if those cards were lost and never redeemed. After all, the issuer will no longer be on the hook for anything and can book a pure profit. Gift card liabilities that are never redeemed are called breakage . The loyalty point industry a...

Bankers clear and settle with each other at a clearing house Perry Mehrling had in interesting comment about how to settle the Eurosystem's Target2 imbalance problem. If there were Eurobills, balances could be settled periodically by transfer of assets, just as is done in the Federal Reserve System. More precisely, if there were a System Open Market Account at the ECB, in which all of the national central banks held shares, settlement could be made by transfer of shares. Perry is talking about adapting the structure of the Fed's Interdistrict Settlement Account to Europe. To understand the ISA, check out my Idiot's Guide to the Federal Reserve Interdistrict Settlement Account . In short, the 12 regional Reserve banks run up debts and credits to each other over the course of the year due to changes in payments flows. These debts and credits are settled each year by transferring securities that have been bought in open market operations from debtor Reserves banks to credit...

Last year and earlier this year, debate concerning the Target2 mechanism in Europe and its growing imbalances shed some light on the equivalent institution in the US, the Interdistrict Settlement Account (ISA). The argument has been made to import the ISA structure into Europe, in particular, the yearly settling of accounts between district Reserve banks. If the ECB were to operate this way, the idea goes, then there would be some sort of quid pro quo on Target2 imbalances - European national central banks (NCBs) would not be able to accumulate debts to each other ad infinitum. The observation was made that contrary to what one might expect, the ISA at the time did not seem to be balancing. Thus the idea that adoption of the Fed model would impose "firm limits" on intra-Eurosystem credit is invalid, since the Fed doesn't seem to always impose settlement on district Reserve banks. This April, though, the ISA seems to have been settled, as the charts below will illustrate....

Paul Krugman compares Greece to Argentina. Devaluation in Argentina surely helped, and so would it in Greece. But there's a problem. See my comment: The comparison to Argentina is a poor one. Argentina's central bank was a fully-operational currency issuer when it lifted its peg, and the peso already circulated along with dollars. Greece's central bank is currently in-operational as a currency issuer; drachmas simply don't exist. Should the Bank of Greece try to relaunch itself, will its drachma liabilities be voluntarily accepted as mediums of exchange? Probably not, for the same reason its bonds are worthless. Like the Greek government, the BoG simply has no credit. Compounding this is the fact that already-existing euros circulate in paper form, and the fact that so many Greeks have accounts in German banks they can use for payments. Given this broad array of payments choices, the free drachma will be stillborn. Nor can drachmas be forced into circulation. A country...

Michiel Bijlsma and Jasper Lukkezen have a very good article on the Bruegel blog that deals with the question: why is there no Target2 debate in the US? On a purely technical note, they bring up an interesting point that Interdistrict Settlement imbalances can arise not just from capital outflows from one district to another, but from the daily redistribution of SOMA assets bought on behalf of the other Reserve banks by the New York Fed. I hadn’t previously considered this mechanism and consider it to be a good addition to understanding the debate. More controversially, they maintain that ISA imbalances primarily arise from SOMA redistribution and that regional capital flows contribute fewer imbalances. Perhaps, but that’s an empirical question. Continuing on a purely technical note, Bijlsma and Lukkezen note that when the FRBNY purchases from a counterpart with a depository account at one of the FRBs, this particular FRB then credits the counterpart’s depository account, which incre...

Perry Mehrling wrote an interesting post called Why did the ECB LTROs help? He visits the comparison of the Federal Reserve Interdistrict Settlement Account and the ECB Target2 settlement mechanism . I have also found this comparison in a number of other publications, see the list at bottom. Here is the comment I left at the Money View blog. My reading of the Euro-system rules is that deficit national central banks (NCBs) never have to settle with surplus NCBs. These intra-system balances can grow ad infinitum. Thus, deficit NCBs don't have to worry about owning acceptable assets for settlement, since there is no ultimate day of reckoning. The result is that survival constraints for Eurosystem NCBs are far looser than the survival constraints faced by regional Federal Reserve banks, which must settle each year. In the old days this settlement was conducted by transfers of gold certificates amongst regional Federal Reserve banks. After 1975 the settlement medium was switched to secu...

Tyler Cowen posts again on the theory that banks are using the ECB's new and broader facilities for arbitrage by buying risky sovereign debt, thereby driving interest rates down. There is another explanation for the fall in rates, see my comment below: The new ECB collateral rules dramatically increase the quantity of assets that banks can submit to the ECB in order to get ECB clearing balances. Bank loans are now allowed, so are lower quality ABS. This means that it is less likely that the national governments will have to guarantee local bank debt. This was a real problem in Greece and Ireland, for instance, for the local banks had run out of assets to submit to the ECB. Instead, banks were creating debts amongst each other and having the government guarantee these debts, before submitting them to the ECB as collateral. Since private non-marketable debt can now be submitted to the ECB, governments will no longer be required to covertly bail out their banks by guaranteeing intra-...

Tyler Cowen has another post on the ECB financing sovereign governments via loans... It is finally being recognized that the eurozone made a major policy breakthrough : My thoughts: I don’t think the key here is arbitrage and government monetary financing. It’s about a slow bank run that has been enveloping Southern Europe for a few years now. The mechanism which governs intra-Euro payments requires Greek/Italian etc banks to “solve” for the bank run by submitting collateral to their national central bank in return for settlement balances. Much of this is done overnight or on a weekly basis. By establishing 3 year operations, the ECB is telling the banks and the rest of the world that they will continue to meet the demands of anyone running on the Southern European banks for the next 3 years. That sort of commitment to the system might be large enough to stop the bank run. It’s similiar to how, in the old days, banks suffering bank runs would often bring out all their cash and gold fro...

Two comments on The Money View. One on Perry Mehrling's The IMF and the Collateral Crunch and the other on Daniel H. Neilson's Is there an ECB? Neilson links to the erroneous Tornell/Westerman piece. My comments on this are in a previous post . In short, Karl Whelan's Worse than Sinn clarifies the issue. Sterilization by the Bundesbank is not happening.  Merhling and me discuss the nature of the transactions conducted between borrowing NCBs and the lending ECB. Perry, I can't find any explicit reference to whether intra-Eurosystem credits are collateralized or not. But I still think not. Collateral is posted by a borrower to a lender to protect the lender should the borrower default. Then the lender can collect the collateral instead. But ECB losses are dealt with in a specific way. See bottom of http://www.ecb.int/ecb/orga/capital/html/index.en.html In short, if the ECB suffers a loss on a loan to an NCB then that loss is allocated to all NCBs according to the ECB...

Commented at FT Alphaville on How Germany is paying for the Eurozone crisis anyway : There are some good bits in the VOXeu article, although I have a few quibbles. "“that the Bundesbank will soon exhaust the stock of securities that it can sell to fund further loans to the Eurosystem.”" The Bundesbank doesn’t need to fund its loan to the ECB by selling off assets. Effectively, German banks are deserting the PIIGS banks in droves. Reserves are flowing from the accounts of PIIGS banks at their domestic PIIGS NCBs to the German reserve accounts at the Bundesbank . Thus the Bundesbank’s reserve accounts (a liability to its domestic banking system) are rising even as its credit to the ECB (an asset on its balance sheet) rises. This is more or less automatic. So in order to balance a rapidly increasing credit item to the ECB, the Bundesbank doesn’t need a declining quantity of assets to act as the balancing mechanism; increasing reserves held at the Bundesbank will do the trick. Th...