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The Fed Is Tightening! Really!

Don't look now, but the Federal Reserve has already started to tighten monetary policy. When it's in an expansive mode, the central bank increases the size of its balance sheet, buying or accepting assets in exchange for cash. When it's in a less expansive mode, it reduces the size of its balance sheet — sometimes by selling assets, and sometimes by simply not redeploying cash that comes into its coffers. In other words, it can tighten without raising interest rates. And that's precisely what happened last week.

Every Thursday afternoon, the Fed gives us insight into its holdings by publishing a report on "Factors Affecting Reserves." Here's the most recent release, and here is last week's release.

In the release, the first table (table 1) shows the factors affecting reserves — all the different stuff the Fed has on its balance sheet. Table 8 provides the total assets of the Federal Reserve System. And if you look at Table 8, it clearly shows that the Fed's total assets on Wednesday July 20 were $2,875,211,000,000* down $6.793 billion from the July 13 total.

The reason for the decline is that several components of the Fed's balance sheet are in run-off mode. In other words, if the Fed simply stands pat on asset purchases, or rolls maturing treasuries into new treasuries, its balance sheet will shrink. Consider the huge pile of mortgage-backed securities (MBS) the Fed purchased as part of its first quantitative easing initiative in 2009 and 2010. As this data set shows, the Fed's holding's of MBS peaked a year ago at $1.12453 trillion. And they have steadily shrinking ever since, as people pay off mortgages or refinance. In the most recent week, the Fed's holdings of MBS fell $4.67 billion to $904 billion.

In addition, several crisis-era Fed initiatives that had the effect of expanding its balance sheet are tapering off. The TALF (Term Asset-Backed Securities Loan Facility), established to help the asset-backed securities market, shrinks with each passing week. The balance of such loans outstanding stands as $12.422 billion, off $24 billion in the past year. Then there are the Maiden Lane vehicles, which were set up to remove junky assets from the balance sheet of Bear, Stearns (Maiden Lane I) and AIG (Maiden Lane II and III) In each instance, the Fed lent money to the vehicle to buy the assets. The loans are paid down as the securities they bought mature or throw off interest income. Last week, Maiden Lane's assets fell by $3.14 billion, as it paid off about $3.2 billion of its loan, while Maiden Lane III's assets fell about $840 million, as it paid off a similar amount of its outstanding loan balance. All three are likely to be moneymakers for the Fed, and hence for Treasury. Taken together, the TALF and three Maiden Lanes represent about $68 billion on the Fed's balance sheet that is melting away.

Of course, a few billion on a balance sheet of $2.9 trillion isn't an awful lot. But it shows that beyond the rhetoric, and for all its talk of accommodation, the Fed's do-nothing position is now to have its balance sheet shrink.

Daniel Gross is economics editor at Yahoo! Finance

Email him at grossdaniel11@yahoo.com; follow him on Twitter @grossdm

*the original article incorrectly stated this sum as $2,875,210,000.