1. Paul Vangilder The Federal Reserve

2. H ISTORY Created on December 23, 1913 in response to a century of banking panics Lender of Last Resort Dual Mandate – Maximum Employment – Price Stability Recently assumed increased regulatory duties

3. S TRUCTURE 13 Regional Fed Banks Headquartered in DC New York Fed Largest and most influential bank Conducts open market operations Vault holds 216 million troy ounces of gold

4. M ONETARY P OLICY 3 Main Tools – Reserve Requirement Proportion of demand deposits a bank must hold on reserve at Fed Lower Reserve Requirement: Stimulative – Allows banks to make more loans Raise Reserve Requirement – Banks forced to keep more on reserve at Fed – Leads to less loans – Discount Window Short-term, secured lending facility that banks can borrow from Raise Rate-Contractionary Policy Lower Rate-Stimulative – Open Market Operations

5. O PEN M ARKET O PERATIONS FOMC Committee determines Open Market Operations – Chairman Ben Bernanke and 9 other Members – Eight meetings per year – Announcements on policy highly anticipated by Wall Street Fed Buys short-term government bonds – Stimulative – Lowers interest rates – Increases money supply Fed Sells short-term government bonds – Contractionary – Raises interest rates – Decreases money supply MSU Student Investment Association5

6. O PEN M ARKET O PERATIONS Fed Funds Rate – Overnight lending between banks – Currently 0-0.25%, intended to “stimulate” economy Recently Announced it will be 0% through 2014 – Buy short-term bonds to lower rate Increases liquidity in banking system – Sells short-term bonds to raise Fed Funds rate Decreases liquidity Large Scale Asset Purchases (QE) beginning 2008 – Fed buys long-term government bonds as opposed to just short-term

7. H ISTORICAL F ED F UNDS R ATE

8. Q UANTITATIVE E ASING QE1 November 2008 to Spring 2010 – Fed Purchased: $125 Billion in Agency Debt (Fannie/Freddie and Treasuries) $1.25 Trillion in Mortgage Backed Securities (MBS) Objective: Stimulate the economy, lower interest rates, and fight deflation Shadow Objectives – Support solvency of the banking system – Devalue the dollar to boost exports – Drove stock market rally from March ‘09 to April ‘10

9. QE2 Summer 2010 – S&P 500 down 10% – GDP Growth Sub 2% – Fears of “Deflation” resurface Bernanke informally announces QE2 at August 2010 Jackson Hole Speech QE2 Formally begins November 2010 – To last through June 2011 – Fed purchased 4-6 billion in US Treasury securities per day – $600 Billion in total – 100% monetization of debt issuance from the Treasury

11. QE’ S EFFECT ON M ARKETS S&P 500 rises from 666 to over 1200 during QE1 S&P 500 rises to multi year highs of 1,363 during QE2 Inflation Rises – Oil up to $135/barrel in April 2011 – Gold Reaches all-time highs – Tremendous pressure on emerging market inflation

12. F ED B ALANCE S HEET VS S&P 500

13. O PERATION T WIST Shift Duration of Fed’s Treasury portfolio – Fed will sell $400 Billion in 0-3 Treasuries – Buy $400 Billion in 6-30 Treasuries – Designed to lower long-term interest rates

14. “B ERNANKE P UT ” Put Option – Contract that insures an investor against loss Derived from “Greenspan Put” – Fed Chairman 1986-2006 – Met every distress in financial markets with lower interest rates and more liquidity QE provides temporary relief to structural economic problems – Pattern: Economic problems resurface shortly after QE ends Seen in Summer 2010 and August-September 2011

15. F ED AND V OLATILITY August 2011 Fed Meeting-No QE3 Dow down 200 points immediately Rallied over 600 points to finish up over 4%

16. QE3? Key metrics to watch to provide political will for QE3 – S&P 500~sub 1100 – WTI Crude oil~sub $80 – EUR/USD continues to fall Dollar strength not good for short-term exports Structure of QE3 – Bill Gross: $600 Billion of MBS Purchases – Others: Nominal GDP Targeting