Sunday, April 19, 2009

What Is The Fed Up To? (Part II): Assets

The above graph tracks the outright holdings of the Fed, please click to expand. Outright holdings refer to the securities that the Fed has purchased outside of repurchase (liquidity) transactions.

On 11/25/08 , The Fed announced that they would purchase outright mortgage backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. The actual purchases were to start in January and continue through 2009. On March 18, the Fed announced that it intended to purchase up to $1.25 trillion of these securities.

The first thing that hits me is the fact that they announced their intentions over a month before they came into the market to buy. This provided plenty of lead time for dealers to bid the price of the securities higher, knowing that they had a buyer locked in. Any wonder why fixed income trading revenue was so sky-high for all of the banks that have reported earnings so far?

It is clear that the Fed has no intention of fixing the problem of over-leverage. The debt is just being consolidated on the books of the Fed. The truth is, these are not the riskiest assets to hold (they have enough exposure to those in the Maiden Lane LLCs). Ginnie Mae is explicitly backed by the Federal government. Fannie's & Freddie's backing is not as strong, but the government has made it clear that they are willing to pledge the taxpayer's dollar if need be. So, on a credit risk basis, these securities are not that different from Treasury debt.

The problem boils down to the following: if there is debt outstanding, someone has to pay for the principal and interest payments. If there are defaults on this paper, you and I pay for it. Meanwhile, the parties who should have been left holding the bag, get off the hook. The debt should pay nothing and the buyers should take the loss. This business of printing money to bail out profit making institutions must stop.

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