The end of an era in the financial system is near, and a new one is beginning.

You might remember the Federal Reserve bought a lot of securities during both the Great Recession and the COVID-19 pandemic as a way to stimulate the economy.

It’s been gradually letting those securities just … expire and go away.

But sometime in probably the next few months, the Fed will put that on pause. It’s going to be buying new Treasurys to replace the old ones.

At one point back in 2022, the Federal Reserve had a vast hoard of $8 trillion worth of government bonds and mortgage-backed securities it bought. It had gobbled them up to keep the financial system running, holding down interest rates, and stimulating the economy. 

“But now, the Fed doesn’t need to use that tool,” said Bill Nelson, chief economist at the Bank Policy Institute.

No pandemic, no crisis, no need. So for the past three years the Fed’s been whittling down its pile of Treasurys and what not; just letting them expire and not buying new ones.

“The Fed’s been very, they’re approaching this very cautiously,” said Ken Kuttner, an economics professor at Williams College. “They don’t want to go too far.”

They don’t want to go too far because all that buying up of securities actually has another purpose besides fighting complete economic meltdown, that’s still very important.

“It is used to sort of toggle up and down the quantity of money or liquidity in markets,” said Russell Brownback, deputy chief investment officer for global fixed income at BlackRock.  

When the Fed buys a Treasury or a security from a bank or whoever, it just kind of creates it out of nothing: “(The Fed) will print money and then go into the markets and buy assets from private sector holders,” Brownback said.

When the Fed makes up this money, it’s usually sent to what are known as reserves — these are bank accounts for banks, they keep them at the Fed. This is money banks use and lend amongst themselves when they’re in a bit of a pinch.

Maybe they have to make a loan, but they’re waiting on a deposit from someone else. Or some company is buying another company but the bank can’t move the money fast enough to cover other deposits. In other words, it’s bank money for bank problems. When there’s not enough of it, that is a very big problem.

“One example of that was September of 2019, the last time the Federal Reserve was shrinking its balance sheet,” said Seth Carpenter, chief economist at Morgan Stanley.

Reserves got to a very low level.

“And so when it came time during the day for a borrower in money markets who said, ‘Hey, I need to borrow some money,’ a lot of the banks said, ‘Well, not from me today,’” Carpenter said.

As in: Not today, I barely have enough reserves for myself.

“And some borrower gets caught short. And when borrowers get caught short, they start to get more aggressive in bidding for it,” said Carpenter. “They say, ‘I’m willing to pay more and more and more interest in order to borrow money.’ And you see money market rates start to go up dramatically.”

Interest rates within the banking system that September started to shoot up. Nobody wanted to lend; it was a big mess. The Fed had to come in and fix it by lending banks money.

This is what the Fed wants to avoid today. So it’ll have to buy some securities, just to make sure there’s enough money swishing around in the plumbing of the banking system, for the pipes to work and the banks to bank.