The Federal Reserve Becomes the 'Buyer of Last Resort'

The Federal Reserve is pursuing a pernicious policy that is insidiously debasing the dollar. This policy has generally been met with indifference, if it has even been noticed at all.

The Federal Reserve is debasing the dollar by purchasing inferior assets of poor quality. These assets are mortgage-backed securities issued by federal agencies like the insolvent, and for all practical purposes bankrupt, Fannie Mae.

These are assets neither the banks nor private investors want. If there was a legitimate, real-world demand for these assets, the Federal Reserve would not need to buy them. But it is. Thus, instead of acting in its historical role as the “lender of last resort,” the Federal Reserve has on its own expanded its mandate to become the “buyer of last resort.”

By purchasing mortgage-backed securities, the Federal Reserve is debasing the dollar. Just how pervasive – and therefore serious – this debasement has become is apparent from the following chart prepared by BusinessInsider:

The Wall Street Bailout Continues

According to its latest report, the Federal Reserve now owns over $1 trillion of mortgage-backed securities, which is 45.6% of all assets on its balance sheet. One year ago mortgage-backed securities were only 0.6% of the Federal Reserve’s total assets!

The Federal Reserve is very highly leveraged, much more than most banks. It is carrying $2.15 trillion of debt on $52.8 billion of capital, giving it a leverage of 40.8-times more debt than capital. The Federal Reserve’s mortgage-backed securities alone, represent 19-times its capital, meaning that if the true value of these assets is 5.3% less than their book value, the Federal Reserve’s capital is wiped out, effectively making it another insolvent institution.

Given that Fannie Mae is itself insolvent and most other mortgage generating federal agencies are not far from perilously sliding down to that same dire financial condition, it is reasonable to assume that the true value of these mortgage-backed securities is less than 94.7% of their book values. Therefore, on a strict accounting basis, the Federal Reserve is probably insolvent.

That said, the Fed could always remedy its “insolvency” by creating more dollar bills for itself. And, in fact, the Fed is already in the process of doing this exact thing. How else could its assets have mushroomed from $800 billion last year to more than $2 trillion currently?

We call this “inflation.”