When the crisis was in full swing last year, I kept mentioning that the goal was to offload all the bad mortgage debt from banks and the Central Banks of Foreign Governments and onto the books of the US Taxpayer, via the Fed and the Federal Reserve Bank of New York (FRBNY). I think I wrote something to the effect of “the only entity stupid enough to buy this garbage at these yields is the US Taxpayer and they are doing so because the Government has a literal gun to their collective heads.”
The Federal Reserve Bank of New York and GSE (Government-Sponsored Enterprises) Paper
In November 2008, the FRBNY set up a plan to buy lots of Mortgages issued by Freddie Mac, Fannie Mae and Ginnie Mae. The goal was simply to buy enough GSE Debt to keep prices high and by definition keep Mortgage Rates artificially low.
This would hopefully allow for a refinance wave out of Adjustable Rate Mortgages that were set to “recast” to substantially higher Interest Rates in 2009 and 2010. I think a secondary goal was to allow people to draw Equity out of their houses as they refinanced, ala 2003, where the new money would be used to increase consumption. Again, the only entity irresponsible enough to buy this junk at 50-year low yields, junk that is backed by assets at artificially high prices, is the US Government.
The program was designed to purchase $200 billion of GSE mortgages. The initial goal was to purchase old mortgages that could not find other buyers and thus provide “liquidity” to the markets – or prop up prices, depending on how jaded your view may be…
Oh yeah, and remember, the $200 billion that the FRBNY has to buy this GSE paper is not real cash, it is created by the FRBNY borrowing $20 billion from the TARP and levering it up 10 to 1. Borrowed, Levered Money buying Mortgages (which are by definition Borrowed, Levered Money), all designed to artificially prop up housing prices to levels that are otherwise impossible to sustain! Good stuff. Let’s re-nominate Bernanke!
Yesterday, the FRBNY announced that they will be focusing their purchases on newly created GSE paper. So, you have one “Government-Sponsored Entity” class (Ginnie Mae, Fannie Mae and Freddie Mac) directly selling newly created paper to another arm of the US Government, the FRBNY, that is buying the newly created paper with newly printed Dollars. That is the definition of “Debt Monetization”, I’m sorry, I mean “Quantitative Easing”…
http://www.newyorkfed.org/markets/gses_faq.html
I think the first wave of GSE paper was purchased directly from the Foreign Central Banks and was part of a deal cut last year when the US Government refused to back Freddie Mac and Fannie Mae with an “explicit guarantee” from the US Government. Now the Fed is onto simply flat out printing money and Foreign Central Banks are happily swapping their GSE paper for US Treasuries.
I told you all along that if the Government did not force the risk takers to eat the losses, then the US Taxpayer would get stuck with them. As of right now, the US Taxpayer has over $1 trillion of these mortgages directly owned by the Fed or the FRBNY. Expect this number to keep climbing.
Treasury Repurchases
The FRBNY stated early this year that it would buy $300 billion in US Treasuries. Again, the FRBNY funded this program by borrowing TARP money and levering it 10 to 1. It has bought over $277 billion so far and will have completed its purchases in another 2 weeks or so. The FRBNY announced this plan in Mid March and started buy Treasuries on March 25th.
When did the Stock Market put in its low for the year? Early March. Do you think the $300 billion in newly printed money has found its way into the Stock Market? Do you think there may be a reason why the markets hit some indigestion yesterday and have seen multiple Distribution Days (Institutional Selling) the last few weeks?
Why is the Fed Doing All of This?
The Taylor Rule
The Taylor Rule is a Nobel Prize winning economic theory that tells the Fed where it should keep Interest Rates to maximize Economic Growth and Employment and minimize long term Inflation. Per Zerohedge, the Taylor Rule currently states that the Fed should keep the Fed Funds Rate at -6.55%!
What does that mean in English?
It means that prospects on returns on loans are so bad, that the Fed would have to penalize Banks -6.55% on their deposits before these Banks would actually take risks and start to lend the money. I think that implies that Banks figure they would lose 6.55 cents on every dollar they loaned over the next 12 months. That’s bad… How are you liking those Corporate Bond accounts?
Of course it is unrealistic for a Central bank to charge Negative Interest Rates, right? The Central bank of Sweden currently has their Fed Funds Rate at -0.25%! Holy cr*p. They have to jam so much free cash into the economy, that they actually push Interest Rates negative! How bad do things have to be in Sweden? If Economics is a study of profitability at the margins, then they are telling you that the Cost of Capital has to be negative before people are willing to make a “risk free investment”.
The Bank of England thinks it’s a swell idea and may follow suit…
The Fed has chosen another avenue to fill the Economy with excess cash. Rather than make short-term rates negative, they artificially cap long term rates by buying bonds in the open market – the so called “Bernanke Put”. Sell us your clunkers and we’ll issue you newly printed dollars and Treasuries… The actual practical manifestation of this is “Quantitative Easing (QE)”.
But the Fed is running out of ammo in QE round 1 ($300 billion cited above). So they will need to either reload at the feet of the FRBNY or cut rates to negative levels. The consequences of QE2 would be a falling US Dollar and rising Gold.
Look at how Gold traded today!
Gold is the anti-Dollar, so there could be intervention by the IMF (via an announcement to sell Gold), but in my opinion, the long term path for Gold is higher as more Dollars are printed. The only way out of this debt overhang is to inflate it away, because clearly the Government does not want any investor to ever lose a penny in a bad bond or derivative investment…
Gold (GLD) broke out of a 7-month trading range today on big volume (Red Arrow). On the monthly chart, you can see that Gold is sitting near the top of a 24-month trading range. Let’s see if the buyers are ready to break Gold above $1,000 on this move.
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