Federal Reserve balance sheet assets trend bodes poorly for the dollar

If you find the following useful please share it or link to it. All comments are welcome. Finally, if you are an American citizen concerned about the activities of the Federal Reserve then I encourage you to support HR 1207 so that the Fed may be audited. That would be an important first step in resolving the issues presented on this page.

Now, I want to show you a graph that displays the changes in the asset portion of the Federal Reserve. And then follow that with a description of what these changes are. First, though let me make two notes.

Note on the graph itself:  It's impossible to read unless you click on it thereby opening the larger version. If possible open two pages at once, one with the graph, and the other with this page.

Note on graph's significance:  The Federal Reserve has basically doubled the monetary base since the latter part of last year. The impact of this has not yet been felt, because banks are not lending as much as they had been doing in recent times (for better or worse). Once they do start lending again, the increased monetary base will be amplified many times over. This means a much larger money supply, and that means very high prices for everyone who uses the dollar. 

There is one way the Fed could prevent this, and that would be to reduce the monetary base. To reduce the monetary base, the Fed must do the exact opposite of what it did to increase it. The Fed must reclaim loans and sell assets. Now this is why looking at the Fed's assets is so important. When you look at what the Federal Reserve has been taking in as assets, you realize it's never going to be able to get the monetary base back down again. In fact, given recent economic indicators, a spiraling debt, US trade deficits and a host of other factors, it's quite likely the Federal Reserve will continue to increase its assets in the future, thus increasing the monetary base and even more exasperating an already bad situation. All of this bodes poorly for the US dollar.

 Okay, here is the graph, based on historical figures provided by the Federal Reserve (again click on it for the big version):

Notes on each category specified it he graph:

• 1. Mortgage Backed Securities:
  These are mostly securities sold by Freddie Mac and Fannie Mae. The Federal Reserve is buying these to help prop up not only these agencies but the entire housing market. The biggest question is what will the Federal Reserve do with these mortgages? Does anyone really think the Fed will easily be able to sell these assets in the future. The housing market is still in turmoil and house prices continue to decline. Moreover, what will the Fed do if there are more and more defaults. It seems almost certain that the Fed will not be able to sell these assets for anything near what it purchased them for in real terms. To a large extent these purchases then are permanent increases in the monetary supply.
  Some links:
  • NY Fed: Agency Mortgage-Backed Securities Purchase Program
  • New York TImes: Fed to Begin Buying Mortgage-Backed Securities: "The mortgage-backed securities being purchased are considered investment grade [yeah right!] and are not the packages of loans that helped ignite the current credit market turmoil. An initial sharp rise in defaults in 2007 among subprime mortgages -- loans given to customers with poor credit history -- helped touch off the continuing credit market downturn. As defaults continued to rise, the value of securities backed by subprime mortgages plummeted and investors shied away from purchasing the risky debt."
  • TPM: Firms Hired By Fed To Manage Our Assets Won't Say How Much They're Being Paid

   

• 2. Term Auction Credit (TAF):
  Officially this program is as follows:
  "Under the Term Auction Facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized." [Source: Federal Reserve.]

  Here's what a recent FT article said about this program: "The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February. US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year. However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support. “The TAF . . . allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take . . . [this] suggests a perilous condition for America’s banking system.” [Source: Financia Times via Naked Capitalism.] 

  Just like the Fed's purchase of mortgage back securities, here too we have to ask, how will the Fed ever reduce it's holdings of these loans and get back the full amount? It seems unlikely the Fed can ever do this, so certainly a fair dose of these loans seem likely to become permanent parts of the monetary base.

• 3. Federal Agency Debt Securities:
  I cannot find any place on the internet that specifies what agencies this is, but I presume it to be Freddie Mac and Fannie Mae. See here for information on this. Perhaps these purchases might be related to the Fed's program to purchase Mortgage backed securities.

   

• 4. Foreign Bank Swaps:
  Here's one way to view a foreign bank swap: "A currency swap is a transaction where two parties exchange an agreed amount of two currencies while at the same time agreeing to unwind the currency exchange at a future date." [From The Atlanta Fed.]

  From a useful article on this topic:  "In a speech last week on Policy Coordination Among Central Banks, Ben Bernanke, US Federal Reserve chairman, drew attention to the way that the Fed’s swap line with other central banks has been used to facilitate lender of last resort funding for dollar-denominated assets held outside the US. We should be thinking here about mortgage-backed securities (and their collateralised debt obligation derivatives) that are now on the balance sheets of European banks as a consequence of the collapse of the off-balance sheet structured investment vehicles where they were originally held." [Read more here, Understanding the Fed’s swap line.]

  In a sense, then, this is more loans for mortgage backed securities. I guess as the swaps are to central banks the chances of default are nil. Still though, those banks have to repay in dollars, and to do that they have to get those dollars back from those they lent them to. What do they do if those banks fail and the dollars are gone? Uh ... ask for more from the Fed? Some greater clarity on this process would be useful. Also note, that if the foreign currency gains value, and the dollar loses value, then like a currency speculator the Fed loses money on the swap agreement. This happens to currency speculators all the time, and it is certainly disconcerting to have to think about the Fed as a currency speculator, but that is the reality. The Federal Reserve is acting like a currency speculator.

  You can read more on swaps in this Financial Times article, Understanding the Fed's swap line.

   

• 5. Maiden Lane:
  This is basically bailout money for AEG and Bear Sterns. Again for emphasis, money spent on bailouts increases the monetary base and will eventually facilitate a devaluation of the dollar. It's hard to see how any of this money could ever be recovered. Below are some quotes from official sources, see the link at the end.

  There are three parts to this:

  • Part I -- "In March 2008, the Federal Reserve Bank of New York (New York Fed) and JPMorgan Chase & Co. (JPMC) entered into an arrangement related to the financing provided by the New York Fed to facilitate the merger of JPMC and the Bear Stearns Companies Inc. (Bear Stearns)." Bear Stearns Bail out.
  • Part II -- "On November 10, 2008, the Federal Reserve Board and the U.S. Treasury Department announced the restructuring of the government’s financial support to American International Group, Inc. (AIG) in order to facilitate its ability to complete its restructuring process." AIG Bailout.
  • Part III -- "On November 10, 2008, the Federal Reserve Board and the U.S. Treasury Department announced the restructuring of the government’s financial support to the American International Group, Inc. (AIG) in order to facilitate its ability to complete its restructuring process. "  It's not a mistake, text is the same. AIG Bailout. Check out my source, the New York Fed: Maiden Lane Transactions.

   

• 6. Credit Extended to AIG:
  Yet another way the Fed is helping to bailout to AIG (via money creation). This money will be retired, once the loans are paid back, if they are paid back.

   

• 7. Commercial Paper Funding Facility (CPFF):
  Here's the official description of this program, "The Federal Reserve created the Commercial Paper Funding Facility (CPFF) to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve liquidity in short-term funding markets and thereby contribute to greater availability of credit for businesses and households. Under the CPFF, the Federal Reserve Bank of New York will finance the purchase of highly rated unsecured and asset-backed commercial paper from eligible issuers via eligible primary dealers." [Source: Federal Reserve.]

  (As I understand this) this was and still is a program to "unfreeze" the markets. Large companies regularly raise money by issuing commercial paper, during last year's crisis, there was no market for this, so the Fed stepped in and made one. This basically constitutes loans to various large corporations. These loans are *not* backed by collateral. The Fed is basically acting like a commercial paper speculator, and taking on the relevant risks. I have no idea what companies the Fed is investing in, I presume this information is secret. (To anyone reading this, is that incorrect? Any information here?) So these purchases could be any company that regularly sells commercial paper ranging from Coca-Cola to IBM to GM. Oh, wait didn't GM just go bankrupt. Hm.

  Here's one article, Fed's new tool: Business loan bailout.

   

• 8. Asset-Backed Commercial Paper Money Market Facility (ABCP MMMF):
  Here's the official description, "The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility is a lending facility that provides funding to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper (ABCP) from money market mutual funds under certain conditions. The program is intended to assist money funds that hold such paper in meeting demands for redemptions by investors and to foster liquidity in the ABCP market and money markets more generally." [Source: Federal Reserve.]

  This program is very similar to the CPFF program above. Think about the typical risks associated with investing in commercial paper? Well, how about loaning money with commercial paper as the collateral? But wait, commercial paper doesn't have collateral so ... so this is a loan twice removed with out any collateral to begin with. Again, this is highly speculative investing. How can the Fed's job be engage in such speculation? After all the value of the dollar rests on the actions of the Federal Reserve.

  Here's one article: What do Fed policy and the commercial paper market have in common?

   

• 9. Primary Dealer Credit Facility
  Here's what an official source says, "The Primary Dealer Credit Facility (PDCF) is an overnight loan facility that will provide funding to primary dealers in exchange for any tri-party-eligible collateral and is intended to foster the functioning of financial markets more generally." [Source: New York Fed.]

  Here's what one intelligent commentator said, "The Fed opened the window to broker dealers. This is a shocker, a sign of the Fed's desperation. Recall that one of the reasons the Fed was able to assure us it wasn't taking too much risk in its Term Auction Facility was that it said the institutions involved were sound. It doesn't supervise broker-dealer and cannot make any such assurances. This is simply extraordinary...[continues at source]" [Source: Naked Capitalism.] Enough said.

   

• 10. Term Asset-Backed Securities Loan Facility (TALF):
  Here's the official source, "The Federal Reserve created the Term Asset-Backed Securities Loan Facility (TALF), to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities (ABS) collateralized by auto loans, student loans, credit card loans, equipment loans, floorplan loans, insurance premium finance loans, loans guaranteed by the Small Business Administration, residential mortgage servicing advances or commercial mortgage loans." [Source: New York Fed.]

  Okay, basically the Fed is creating money to buy up student loans and credit card debt. This program still seems in its infancy, but it will be interesting to watch. I mean, good grief, they're buying credit card debt. I mean, we're really getting ridiculous now aren't we?

   

• 11. Other Loans:
  Other loans ...

   

• 12. Repurchase Agreements:
  Here's the official description, "Among the tools used by the Federal Reserve System to achieve its monetary policy objectives is the temporary addition or subtraction of reserve balances via repurchase and reverse repurchase agreements in the open market. These operations have a short-term, self-reversing effect on bank reserves." [Source: New York Fed.]

   

• 13. US Treasury Securities:
  These securities represent government debt. In this case the Federal Reserve has bought up part of the governments debt by creating money (as is the case with all Fed purchases). Although this practice is taken for granted as standard procedure by most mainstream economists, it's policy is dubious. After all it amounts to *printing* money to pay for US government debt. Can the Federal Reserve really do this in an unbiased manner? Does the US have the right to do this considering the US currency has taken on the role of a world reserve currency?

  As I understand it, the Fed stated in March it would buy up $300 billion in long term Treasuries. I don't know how much (if any) of this has already been done. Here's an article, Fed to buy $300 billion in long-term Treasurys.

  You can find information on the specific types of securities at Treasury Direct: Treasury Securities & Programs.

  Note that any time the Federal Reserve buys these types of securities, the value of the currency (the US dollar) is decreased. This also means the value of the bond's nominal value is also decreased. Currently some of the biggest investors in these types of securities are in foreign countries. (To be amazed follow this link: Major Foreign Holders of Treasury Securities.) If at some point these foreign holders decided America's foreign debt were becoming unpayable or that the value of the dollar were being debased, they could decide to unload this debt. This would, of course, be catastrophic for the dollar. Sadly for Americans, a large part of their fate rests in the hands of foreign investors in China, Japan, and the Middles East, among other places.

   

• 14. Treasury Currency Outstanding:
  "Treasury currency outstanding consists of coins, silver certificates and U.S. notes originally issued by the Treasury, and other currency originally issued by commercial banks and by Federal Reserve Banks before July 1929 but for which the Treasury has redemption responsibility." [Source: Miscellaneous Factors Affecting Bank Reserves.]

   

• 15. Drawing Right Certificate Account:
  Perhaps this has something to do with SDRs. I don't know. But it's not a major factor, so will not investigate.

   

• 16. Gold:
  Real money. Read What Has the Government Done to Our Money?

   

• 17. Other assets:
  Other assets ... 

Again if you are an American concerned about what actions the Fed is taking, then I encourage you support HR 1207, a bill to audit the Fed. Also, I would encourage to check out the following sites:

• LewRockwell.com
• Mises.org
• Campaign for Liberty

All comments are welcome!