12/29/09 Baltimore, Maryland –
The Federal Reserve’s balance sheet has quietly ballooned back to near-record highs. The Fed announced yesterday that it’s balance sheet expanded to $2.22 trillion last week, it’s grossest level in nearly a year and just a hair from an all time high. Hmmm… if Mr. Bernanke assures us the recession is “very likely over,” then why is the Fed balance sheet in crisis mode? What are they worried about? Here’s the answer:
The Federal Reserve went from an essentially non-existent player in the mortgage backed security market a year ago to owning $904 billion of the stuff today. The “private” bank has clearly moved its aim from the financial sector to housing, loading up on MBS, debt spilling out of Fannie Mae and Freddie Mac and Treasury bonds (a handy way to suppress mortgage rates).
Coupled with the Treasury’s black check to Fannie and Freddie, we’re detecting a trend.
“The market will eventually adopt the view that Fannie Mae and Freddie Mac have been nationalized,” opines Dan Amoss of the Strategic Short Report. “Last week’s elimination of limits on Treasury’s capital infusion into Fannie and Freddie is a de facto nationalization. In other words, there’s no longer much chance of a re-privatization, but instead we’ll see a gradual transformation of these Frankensteins into new branches of government. They’ll implement the official government agenda for housing, without much regard for prudent lending.
“This will have huge consequences for the Treasury market. While the federal government will stick to its Enron-style accounting, and not officially consolidate Fannie/Freddie assets and liabilities onto the government balance sheet, the smarter foreign creditors will. These creditors will start viewing Fannie/Freddie liabilities as equal to Treasuries in terms of default risk. But this doesn’t mean that spreads on Fannie/Freddie liabilities will tighten down to Treasuries; rather, it will substantially increase the long-term default risk of Treasuries, and Treasury buyers will demand higher rates to compensate for this risk.
“In summary: the Treasury’s Christmas Eve announcement adds substantially to the case for higher Treasury yields in 2010.”
Ian Mathias
Ian Mathias is the managing editor of Agora Financial’s Income Franchise, where he writes and researches about retirement, dividend and fixed income investing. Much of his work is featured in The Daily Reckoning and Lifetime Income Report – Agora Financial’s flagship income investing advisory.
Previously, Ian managed The 5 Min. Forecast, a fun, fast-paced daily look into the future of global markets and macroeconomics. He’s also worked in public relations, where media outlets like Forbes, AP, Yahoo! and MSN Money have syndicated his writing. If he’s not at work, you’ll probably find Ian on a bicycle, racing up and down the “mountains” of Baltimore County. Ian has a BA from Loyola University in Maryland.
The Daily Reckoning is your premier source for making sense of the news Washington and Wall Street generate. Each business day, The Daily Reckoning calls on its stable of world-class writers and thinkers to show you how to get ahead.
Start your 100% FREE subscription to The Daily Reckoning today and you’ll get a free research report, “How to Survive the Fall of Social Security.” Simply enter your email address below to get your free report and join over 495,000 worldwide Daily Reckoning subscribers!
We Respect Your Privacy and We will
Never Share or Sell Your Email Address
Great article…I’m still trying to comprehend the implications of the Treasury’s blank check to Fannie/Freddie while connecting the dots to the Fed balance sheet explosion. I thought the Fed was the ultimate banker and printer of currency. So, in effect the Fed is resorting to its own off balance sheet financing (a la banks’ off balance sheet holdings of collateralized debt swaps). Is the Fed trying to hide its own insolvency or worse its bankruptcy by having Treasury do its bidding. I know the Fed can always print the money/ monetize. But, it seems like game up for their sterilization tactics if they try to obfuscate further increases in their balance sheet. I would love to hear your thoughts.
As much as I hate what the FED (and Treasury) has done since Sept. 08, what is/was the alternative?
Yes, let the banks, financial houses, homeowners (who have not been “helped” near enough) businesses just go broke; let Darwinism take it’s course……but the outcome for both scenarios is pure speculation.
We are already “monetizing” debt. Ever since the crash of ’87 the FED has been printing money 24/7…….so the question is:
Where is the “real” economy?
“Paper Enterperneurialism”?