A snappy little 41 page working paper by the former Philadelphia Fed President, March 10, 2022:
Page 13
...Thus, early in the financial crisis the stage was set for a much more active role for the Fed in credit allocation and thus, a more active involvement in fiscal policy.
The Financial Crisis Stage Two: More Credit Policy and Balance Sheet Expansion. In September to December 2008, following the failure of Lehman Bros. on September 15, the Fed invested $85 billion in the rescue of AIG using the Board’s powers under Section 13(3). Over the course of the fall of 2008, the Board also created, again using Section13(3), an alphabet soup of lending programs in an effort to support the broader real economy by investing in private sector securities.25 It included programs to make loans to private investors to purchase asset-backed securities, commercial paper, and to support money market funds, for example. These programs would not be sterilized and thus would involve balance sheet expansion, an action impacting monetary policy.
It is important to recognize that these programs took time to establish and could have been implemented directly by the Treasury. Fundamentally, the new programs shifted credit risks from private entities to the taxpayer without explicit congressional approval. As such, they represented off-budget spending by the Fed. Even in fast-moving crises, where it may be desirable to have the Fed act with alacrity, the programs (including the lending to rescue Bear Stearns and AIG) could have been shifted over to the Treasury after a few months in exchange for government securities. This would have required legislation, but it would have meant Congress was responsible for the oversight and accountability of these taxpayer financed investments. I suggested just such an action in the FOMC meeting in December 2008 and publicly14 in Plosser (2009a). 26
I will discuss this strategy more below as it is key part of my “New Accord” recommendations to clarify and constrain the use of Fed credit policies in an emergency.
Another significant step was taken in November 2008 when the Board announced it would purchase $500 billion in agency MBS and $100 billion of agency debt beginning in January 2009. 27 This was an entirely new and significant step into credit allocation. As discussed previously, the Fed had essentially operated with a “Treasuries-only” portfolio since the 1951 Accord. Because the agency MBS purchases also expanded the balance sheet, it was also an important monetary policy action, although this was not emphasized by the Board of Governors at the time.28 In the announcement, for example, the Fed said, “This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.” 29 Chair Bernanke (2009) spoke specifically on this issue, saying that the Fed was using its powers to engage in “credit easing.” As he explained, the tools “.... make use of the asset side of the Federal Reserve’s balance sheet. That is, each involves the Fed’s authorities to extend credit or purchase securities.” The actions were clearly stated in terms of the Fed’s intention to allocate credit to the housing sector relative to other sectors of the economy. The alternative, of course, would be to buy Treasuries.
Footnote #28 is interesting:
28 There is an important underlying issue that has not received much public attention. The announcement of MBS purchases in November was made by the Board of Governors (BOG) not the FOMC. In fact, there seems to be no FOMC document or record of prior approval by the FOMC. Consequently, the BOG appears to have made an announcement of a major expansion of the Fed’s balance sheet without the explicit approval of the FOMC, which is the body responsible for monetary policy. While the expansion was approved by the FOMC at its December 2008 meeting, it was accompanied by significant discussion scattered throughout the meeting (see Board of Governors (2008b, pp. 16-103, 166-167). The commentary on pages 30-35 by Jeffrey Lacker (president of the Richmond Fed) concerning governance and the roles and responsibilities of the BOG and the FOMC regarding monetary policy and the size of the balance sheet is particularly relevant. Outside of commitments by the chair to work cooperatively with the FOMC in the future on such matters, I was unable to find subsequent documentation that these governance issues have been discussed or further clarified.In March 2009, the FOMC announced it would increase the intended agency MBS purchases by $750 billion and agency debt by $100 billion. The announcement also indicated the intention to purchase $300 billion in longer-term Treasury securities. Purchases of agency MBS continued until the spring of 2010. At that point, the financial markets’ functioning had mostly normalized, and the economy was beginning to slowly recover. The Fed, however, continued to purchase long-term Treasuries and lengthen the maturity of its portfolio. By the summer of 2012, Fed was dissatisfied with the pace of the recovery and wanted to apply more monetary stimulus, so the rationale for MBS purchases was modified “to support a stronger economic recovery and help ensure inflation, over time, is most consistent with its dual mandate.” 30 Purchases continued through the end of 2014.31 By December 2014, the Fed’s portfolio of agency MBS had grown to $1.74 trillion, accounting for almost 40 percent of Fed assets. 32....
....MUCH MORE (41 page PDF)
Part of the "much more", page 19:
Managing a Large Balance Sheet and the Potential for Abuse.
Unsterilized credit policy initiatives, including the large volume of agency MBS purchases, contributed to unprecedented growth in bank reserves and hence the Fed’s balance sheet. The Fed has never seriously considered reducing the balance sheet sufficiently to enable a return to its precrisis operating regime, commonly referred to as a “corridor system.” In this prior regime, the Fed adjusted the volume of bank reserves up and down to ensure that the fed funds rate (the rate that banks trade reserves among themselves) remained close to its target set by the FOMC. Most major central banks used this regime prior to the financial crisis.
Once bank reserves became large, this framework could not be used, as modest changes in bank reserves would have no impact on the effective fed funds rate.44 As long as the fed funds target is effectively zero, this is not a major issue. It becomes a significant issue when the Fed wishes to raise the fed funds target above zero. How can it do that when the banking system is flooded with reserves? Goodfriend (2002) suggested that paying interest on reserves (IOR) would be a way to raise rates even if a large volume of reserves existed in the banking system.45 46 The IOR acts as a floor on short-term rates under which banks have no incentive to lend. Thus, raising the IOR would encourage other rates to increase without shrinking reserves. In central bank parlance this is called a “floor system.” The essential policy instrument in this regime is the interest rate paid on reserves. 47
In theory, this allows the Fed to manage the interest rate and bank reserves separately. The danger of this approach is that it increases the temptation to use the Fed’s balance sheet for other purposes. The Fed was forced into this arrangement by its QE policies, but the Fed has now explicitly adopted the floor system as an operating regime, although they had to give it another name. So it became the “ample reserve” regime.48 The Fed has been vague as to how it will decide on the size of the balance sheet and what factors might motivate changes in the volume of purchases up or down.
A series of official statements by the FOMC on policy normalization began in 2014.49 None anticipated outright sales of securities. Most who opposed sales argued that simply allowing runoffs of maturing securities would be sufficient to gradually shrink the balance sheet. 50 Others were concerned that the balance sheet may need to fall faster and sales may be necessary. The fact that runoffs are likely to be slower for the MBS portfolio (especially as interest rates rise) means that the role of credit policy as measured by the share of MBS would likely rise over time....
All of which leads up to:
Balance Sheet Responses to the Pandemic and Shutdowns
