Saturday, January 24, 2009
The credit-worthiness of the Fed is not looking too good.
Here's the crux of the problem: In an effort to fix the current crisis, the Federal Reserve is massively expanding its balance sheet while seriously diluting the quality of the assets on that balance sheet. . . . On Jan. 14, 2009, the Fed's balance sheet showed $2.1 trillion in assets. That supported $881 billion in currency in circulation. . . . That $2.1 trillion was a huge increase from the $868 billion on the Fed's balance sheet on Jan. 16, 2008. At $813 billion, the cash in circulation a year ago wasn't a whole lot less than what's in circulation now. As everybody from then-Treasury Secretary Hank Paulson to a newly inaugurated President Barack Obama has kept telling us, banks aren't lending. They're hoarding currency by keeping it on deposit with Federal Reserve banks. . . . The Fed is due to report on the value of those assets sometime in the next week. It could report huge declines in the value of that paper, since AAA-rated securities backed by commercial mortgages fell 11% in the fourth quarter and A-rated securities fell almost 50%. That would raise questions about the size of the liability the U.S. taxpayer will eventually face from the Fed's efforts to support the financial system, and I'd expect to hear howls of protest from Congress and taxpayers if it turns out that these assets that the Fed accepted as collateral are now worth much less than their original values. Shouldn't the Fed have given the price of these assets a bigger haircut when it accepted them as collateral in order to protect taxpayers? . . . It's a question that will resonate loud and clear in Congress as the Obama administration thinks about buying up bad assets from banks in order to rescue the financial system. The sticking point in setting up such a program using what's called an aggregator bank has been what price the government should pay for these illiquid assets without reliable market prices. A big loss for the Fed certainly wouldn't make Congress more interested in throwing more taxpayer money down a rathole. Nor should it. . . . There's also a good chance that the Fed will cook the books by fudging the value of its assets. That's what private-sector bankers have done throughout the crisis. . . . As politically attractive as that course may be, though, it, too, has its long-term costs. If the discrepancy is too blatant, the decline in balance sheet values too small, then the Federal Reserve will have squandered a little more of what ultimately is its most valuable asset in ending this financial debacle: its credibility. And once credibility is lost, it's awfully hard to regain.
WELCOME Instapundit readers. Check out the video from 2007 below the fold.