 Casey Files:
What's Up, Doc?
Bud Conrad
Chief Economist, Casey Research
The
Casey Report
Nov 11, 2008
Under Bernanke's direction,
the Federal Reserve has completely rewritten its mission. Many
articles in the International Speculator and The
Casey Report have reported the strange growth in the loans
they have made and explained that Bernanke has, for a long time,
espoused unconventional actions to avert deflation and to expand
the economy. So the charts below tell that story, and it is truly
amazing.
The Federal Reserve was never
envisioned to be lender of last resort to a whole slew of investment
banks, money market mutual funds, and commercial paper issuers.
The situation is not easy to
sort out, for the simple reason that the extent of their actions
is not presented by the Fed via clear and concise data. Instead,
the data is complex and hard to analyze, partly because of the
piecemeal way the actions were taken, but also probably due to
a desire by the Fed to avoid public scrutiny and criticism.
Digging into the details of
the Fed's balance sheet reveals, however, the complete change
of composition and direction of the Fed. The most obvious change
is that they have doubled the size of their assets and liabilities.
A year ago, the Fed's assets consisted almost entirely of government
Treasuries and a little gold.
That is a clean, safe balance
sheet.
The only important liability
was the currency they issued (our paper dollars). They also had
a small reserve of deposits from all the banks. When Greenspan
wanted to give the economy a boost by lowering short-term interest
rates, he would create some money and buy Treasuries. He could
also do the reverse.
Bernanke has turned this upside
down. Initially he made focused loans to big banks. But then
the loans became bigger than the reserve deposits, leaving the
banks in total as net borrowers. The concept of a fractional
reserve no longer applies when the reserve is net negative.
To fund yet more loans, Bernanke
then sold off half of the Fed's Treasuries. And he traded Treasuries
for toxic waste of poor-quality mortgage-backed securities. And
he encumbered half of the remaining Treasuries with "off
balance sheet" swaps of about $220 billion. (Does this sound
like Enron accounting?) The balance sheet started with $800 billion
of mostly reliable assets and now has about $250 billion of unencumbered
Treasuries.
The biggest source of funding
is from the Treasury. Banks are leaving deposits in the Fed now
that the Fed is paying interest.
The important conclusion is
that the paper dollars are now issued by a far less soundly structured
Fed, an organization that is more interested in bailing out the
financial community than defending the dollar.
This chart below compares last
year's assets, which were mostly Treasuries, to this year's twice-as-large
and far more questionable mix:
The other side of the balance
sheet shows that the Fed has borrowed and taken in deposits to
fund the loans that are as big as the issuance of currency. In
effect, the Fed has doubled its footprint and doubled its responsibilities.
Mostly under the covers, they added almost $1 trillion new credit
to the financial world in about two months.
There are additional important
Fed actions not included in their balance sheet. For example,
they invented a Money Market Investor Funding Facility (MMIF)
to guarantee up to 90% of $600 billion of loans to that sector.
They do this through special-purpose vehicles established by
the private sector (PSPVs). The latest Commercial Paper Funding
Facility (CPFF) started October 27 and has issued $143 billion
so far. These are both in addition to the Asset-Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility initiated September
19. The programs are beyond keeping up with.
Nothing like this has ever
been done before by the Federal Reserve. In time, the consequences
in terms of confidence in the dollar will be bad.
-Bud Conrad
Bud Conrad is the chief economist of Casey Research,
LLC., providing fiercely independent analysis and investment
recommendations for subscribers in the U.S., Canada, and over
150 other countries around the world.
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