Home Feds In A Box – Unwinding May Not Be So Easy

Feds In A Box – Unwinding May Not Be So Easy

user profile picture Chris Martenson Sep 10, 2009
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One of the key questions is, “Can the Fed ever unwind all of the positions it has taken on from failed banks and Wall Street firms?”

This is an important question, because if the answer is “No, at least not precisely when they wish to do it,” then it raises the risk that all that hot money will prove immune to efforts to recall it and it will whiz around creating all sorts of monetary trouble.

Now that the Fed has declared that the recession has ended and green shoots are everywhere, the next obvious part of this journey will have to be the unwinding of the massive amounts of stimulus and thin-air money that has been injected into the system.

Certainly after watching the risk-money out-chasing junker stocks well up off their lows, we can surmise that the speculative animal juices are flowing again and that the Fed might want to consider taking away the punchbowl.

Instead, today the Fed bought another $18.8 billion net ($32.4 billion gross) in agency mortgage-backed securities, which represents the exchange of thin-air money for GSE MBS paper.

So far, all that we know about is that the Fed is talking about how to take the punchbowl away but that bankers are warning the Fed to “go slow.”

Fed Tries to Prepare Markets for End of Securities Purchases

Sept. 3 (Bloomberg) — The Federal Reserve is trying to prepare investors for an end to its housing-debt purchases, while keeping interest rates near zero, reflecting an economy pulling out of a recession with little momentum.

Federal Open Market Committee members discussed extending the end date of the agency and mortgage-backed bond programs, minutes of the group’s Aug. 11-12 meeting showed yesterday. The move would be aimed at avoiding disruptions in housing credit at a time when recovery prospects are clouded by rising unemployment and slowing wage gains, analysts said.

While the economy is projected to expand this quarter, central bankers had “particular” concern about the job market, signaling that the FOMC may need to see a peak in the unemployment rate before it begins withdrawing monetary stimulus. Some policy makers saw dangers of “substantial” declines in the inflation rate, yesterday’s report showed.

“They need to see labor markets improve and inflation stabilize, and not fall, before they even have a serious discussion about increasing interest rates,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York and former member of the Fed’s research staff.

Central bankers extended their $300 billion U.S. Treasury securities purchase program by a month in August and continue buying up to $1.25 trillion in agency mortgage-backed securities and $200 billion in the debt of agencies including Fannie Mae and Freddie Mac.

A number of policy makers judged that a “tapering of agency debt and MBS purchases could be helpful,” the Fed minutes said. Officials postponed a decision on extending the initiative, which is scheduled to end in December.

An extension would be “an attempt to make quantitative easing potentially less disruptive when it ends,” Feroli said.

Central bank officials have indicated differences on when to begin withdrawing the monetary stimulus.

What all the above means is that we are still quite a ways away from seeing the end of the Fed “thin-air” rescue programs. 

And I have a prediction:  It’s going to be a lot harder than anybody thinks.  Every effort to withdraw the money will be met with dire warnings from bankers that the “stability of the financial system is at stake,” and other such nonsense, meant to disguise the bankers loss of access to risk-free money.

Okay, this is not really a prediction anymore, because we already have our first example of just how rapidly government officials will cave in response to banker demands.

The example comes to us from efforts to end a relatively modest program of debt guarantees where, for a minor fee, the FDIC guaranteed bank debt up to 125% of its face value.  (Try getting that sort of guaranteed insurance for your business debt).

Given that banks are allegedly on their way to health and some are reporting tidy profits, one would think this program could easily sunset on time.  Not so fast, says the American Bankers Association:

FDIC Proposes Six-Month Extension for Debt Guarantees

Sept. 9 (Bloomberg) — The Federal Deposit Insurance Corp. proposed a six-month, emergency-only extension to its debt guarantee program as regulators move to wean companies from federal aid approved at the height of last year’s credit crisis.

Bankers have pressed the FDIC to spell out how it will end the program, which Federal Reserve Chairman Ben S. Bernanke has said was instrumental in keeping markets stable during the worst of the 2008 financial crisis. The program is part of the Temporary Liquidity Guarantee Program; a portion for business checking accounts was extended in August for six months.

“The point here is to allow for an orderly transition out of a government-backed system,” said Robert Strand, a senior economist at the American Bankers Association in Washington, in a telephone interview yesterday. The ABA had asked the FDIC to “worry about the cutoff points and the suddenness” of ending the guarantees, to make sure closing down the program doesn’t roil markets, he said.

The lessons here are clear:

  • At every step of the way, bankers are going to resist the loss of their free money.
  • The banker’s tactics will be to toss out dire warnings of “roiled markets” and “destabilizing the system” and other such veiled threats that translate into, “When our industry is unhappy, you’re unhappy.”
  • The removal of stimulus, when it does begin, will be exceedingly gradual and delicate.

For my part, I have serious doubts that all of the “assets” purchased by the Fed can ever be completely unwound.  Either the counterparties no longer exist, or if they do, some will decline (read: refuse) to buy the assets back, because doing so would bankrupt them (due to the fact that the assets are worth a lot less than the price the Fed bought them for).

Adding to this story are the immense borrowing needs of the federal government over the next year.  How can the government possibly find enough cash to borrow if the Fed is busy withdrawing cash from the markets?

No, it would seem that the Fed’s thin-air money program (called “quantitative easing” in fancy parlance) is going to be with us for a while.

Unwinding is not going to be easy.