Saturday, February 27, 2010

Fed's Balance Sheet

This post follows my earlier post, largely due to a couple of comments that my friend made. I was wrong as I was looking at the wrong line-item - and what I am about to mention has been mentioned earlier by a lot of bloggers. This post is about the expansion of the Fed's balance sheet. Only when one sees the numbers, does one realize the magnitude of this event.

Please follow this link for all historical data.

Disclaimer: This post is written by a person who understands very little about Fed's accounting practices but understands something nonetheless.

Jan 7 - 2010 (in millions)
Securities held outright for week ended Jan 6 2010 : $1,844,953 up by $1,349,570 from week ended Jan 7 2009; which is a 270% increase.
Mortgage backed Securities are at $908.5 B, which did not even have an entry for the week ended Jan 7 2009. Treasury holdings are at $776.6 B, up from $476 B for the same period.

Feb 25 - 2010 (in millions)
Securities held outright for week ended Feb 24 2010:
MBS - $1,032,735
Treasuries - $776,557

So, this just shows how the Fed's balance sheet has ballooned.
Now, does this imply that inflation is around the corner?
Not necessarily.
The Fed can monetize the debt or other assets and later, sell the securities and, in effect, reduce the money supply (I think I am wording this correctly :| ). I am sure that they must have done this in the past; but what stands out this time is the fact that we may be on the brink of a systemic change.
Unemployment, sovereign debt crises, a developed America, an enormous fiscal deficit that is projected to hit $1.4 T by the end of this year, a volatile foreign exchange market, increasing commodity prices, drastic climate changes, pockets of growth outside the US and an increasing need to issue more debt.
After the recession at the beginning of this decade, the ample liquidity in global markets could have allowed the Fed to offload Treasuries. Will they be able to offload them now?
A larger question is that related to MBSs and this relates to my previous post about $8 T of MBS exposure. I believe that the $1 T mentioned under the Fed's holdings is the same as that accounted for under FHLBs. The issues related to MBSs are beyond my scope of understanding.
Reg. the Treasuries, this is my belief: The Fed will continue purchases of Treasuries through the secondary market after the primary dealers buy them through auctions. Bryan Marsal had spoken about the phase of 'extend, pretend and extend'; and this is what will happen. The failure of a Treasury auction will be postponed as far as possible, yields will move up and we will extend, pretend and extend till we hit a systemic breaking point.

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