How Risky is the Fed Balance Sheet?
Neena Mishra
May 02, 2009 (Zacks.com via COMTEX) --
Highlights include Fannie Mae (FNM), Freddie Mac (FRE) and AIG International Group (AIG). The simple answer to this question is, 'No one knows.' The Central Bank's balance sheet now stands at $2.2 trillion -- more than doubled since September, 2008. In all, the Fed has created 11 lending programs to combat the credit crisis, but few details of the collateral backing these loans are available. Historically, the Fed's balance sheet mainly comprised of the Treasuries, but now only about one fourth of the assets are Treasuries and the rest are securities like commercial paper, Central Bank liquidity swaps and mortgage-backed securities etc. In the recent FOMC statement, the Fed reaffirmed that it will purchase up to $1.25 trillion of agency mortgage-backed securities (MBS) and up to $200 billion of agency debt by the end of the year in order to support the mortgage lending and housing markets, and to improve the conditions in the credit markets. We agree that without the unusual methods employed by the Fed, we would have been in a much worse situation than we are in today. Mortgage rates are now at record low levels, resulting in a surge in refinancing and the credit markets -- which were virtually frozen late last year -- are functioning again. But the Fed now has an unprecedented degree of credit risk. Central Banks are not expected to assume any credit risk, but these are unusual times which require unusual actions. Most of the actions have been initiated under section 13(3) of the Federal Reserve Act, which permits it to extend credit 'in unusual and exigent circumstances' to 'individuals, partnerships and corporations that are unable to obtain adequate credit accommodations.' As Dirk Van Dijk mentioned in his recent blog, the Fed does not anticipate any credit risk in MBS purchase as 'the paper is guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE)' though 'FNM and FRE happen to be on life support from the Treasury -- to the tune of $200 billion each' After the collapse of Bear Stearns and the near-collapse of AIG International Group (AIG), the Fed had purchased $74 billion in sub-prime securities backed by assets such as home loans in Florida and California. These assets now have unrealized losses of $9.6 billion. The Central Bank holding sub-prime securities? Seems unthinkable!! But again, these are unusual events. The details of these purchases can be seen here. Also, there is high risk in the TALF program being implemented by the Fed. The Treasury was planning to expand the program from $200 billion to $1 trillion and from purchase of new auto, student and small-business loans to include commercial mortgage-backed securities and residential MBS. Further, under the Public-Private Investment Program (PPIP), TALF will be used to purchase legacy securities (the new name for toxic assets). The details can be seen here. Special Inspector General for the TARP, Neil Barofsky, also criticized the TALF for relying on the credit-rating agencies to determine if securities are safe enough for taxpayers. Going by the recent record of the rating agencies, we would totally agree with him. It was earlier reported that the Treasury Department had pledged up to $100 billion from TARP to cover losses that might arise from the TALF. In the latest details for TARP funds, it has reduced that estimate for TARP losses to $35 billion. So does the Treasury anticipate lower losses as it expands the program to include CMBS, RMBS and toxic assets, or it does not want to expand the program now in view of lukewarm response to the TALF so far? Or was the estimate reduced just because there are not enough funds remaining in TARP? With the Fed being the 'lender of last resort' and the Treasury willing to the 'guarantor of last resort,' the programs can continue for a long time, but ultimately the risks are borne by the taxpayers.
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