In a stroke of ingenuity, banks are packaging anything they can find to get cash from the Fed. Admittedly this is a broad statement, but Lehman for one recently pooled $2.8B of its unsold buyout debt into the Freedom CLO, which it in turn punted to the Fed for loans (though it was required to keep 25% on its own balance sheet). This raises questions as to whether there is any hope of preserving the Fed’s balance sheet. As it takes on more collateral of questionable worth, some are starting to worry that the Fed will run out of T-bills. What options does the Fed have in the unlikely even that it does run out? Yves Smith has a good compilation of options from various sources. All of them are quite unconventional, but the Fed has shown itself to be fairly comfortable with innovative policy. Some of the more interesting options (of questionable legality) include the Fed issuing short-term paper, paying interest on bank reserves, or reversing the TSLF by providing Fed guaranteed MBS to banks.Federal Reserve options aside, I’ve been wondering, how does this all end? Housing prices show no sign of slowing their decline, MBS and similarly backed junk seems destined to keep declining in value (though such “sure bets” are admittedly a dangerous assertion). It seems that this credit crisis will proceed well through 2008 and possibly into 2009. That is unless drastic action is taken in the form of outright purchases of MBS by a branch of the federal government or some incredibly creative stop on housing prices, though I am not advocating either.
I’m interested in hearing people’s thoughts on both the issue of Fed options in the event it runs out of T-Bills (if it even can) as well as the notion of “how this all ends”.
(Graphic from Alea).
Posts
3 comments:
I think that the Fed's balance sheet is like tax code in the sense that no one really understands it. Extremely smart people dissect it and find "loopholes" in which to exploit. With the newly granted power from the government, this problem is likely to become worse before it becomes better. I think, in the end, transparency and written rules of practice will end this whole mess. We need the smart people determining the rules of the game, not exploiting them.
It is impossible for the Fed to run out of T-Bills because they can just print currency in order to finance any debt, but with that being said if they continue to issue t-bills than this could have an inflationary effect on the economy which would be incredibly untimely right now considering the current market conditions
You are certainly right that new currency can be printed to finance any debt. The question is whether anyone would be ready to do that, as you pointed out, given the current macro conditions. It's also worth nothing that as much as we'd like to think the Fed is independent, political pressures exist which further raises issues about the availability of the money printing option.
Post a Comment