Is The Fed Monetizing MBS Held By China?

Its a fair question, you know...

Lacker and Bullard may be “staking out a position rather than reflecting the current consensus on the Federal Open Market Committee,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. The FOMC “is going to be much more concerned about how they manage the phasing out of the mortgage program because the Fed is providing a substantial percentage of the investment in conforming home loan bonds.”

I think a better, and more-fair question is who has been tendering what to The Fed.

This is a key item when it comes to the bill authorizing and mandating annual, full audits.

There is every indication from the simple numbers - the amount of MBS that is held in custody for foreign central banks by The Fed .vs. the amount of Treasuries held in custody by The Fed - that in point of fact the so-called "support" is really nothing more than a sophisticated form of money-laundering.

That is, these foreign interests don't want to hold what they perceive as bonds that have a much higher risk than what they were sold.  So they cut a deal - you put together this program to "buy" MBS from "the market" and we will sell, but we will in turn hold up the Treasury market.

This, in a free and open market, might be ok.  But it is definitely not ok when done behind the curtain and claim of "stabilizing markets", when in point of fact these securities state right on the face of the prospectus that there is no government guarantee - no "full faith and credit."

In point of fact these firms were allowed to operate with 80:1 to 200:1 leverage. But this fact was not a secret, nor was it concealed from China and others - it, in fact, was clearly known to everyone in the market.

So how did that flim-flam job manage to survive for so long?  Was it simply that the housing market was booming?

No.

Everyone will dance while the music is playing, but no risk manager worth a nickel is going to allow you to buy something geared at 80:1 without some sort of assurance somewhere that there is a guarantee of value and that it will be honored.

If we are to learn anything from this sordid episode in our nation's economic history one lesson must come through: It is the presence of these "under the covers" backstops that cause asset bubbles to be blown to the degree that we saw occur, because without them nobody in their right mind ever allows a commitment of money to dodgy assets to the degree that is necessary for a bubble of the magnitude we saw in housing to occur.

Between those "side letters" (or their moral equivalents) and accounting fraud you have a recipe for disaster.  We have now seen two bubbles - The Internet and Housing - occur due almost entirely to these factors.  ENRON occurred due to the ability of the firm to run off-balance sheet deals that turned out to be an outright scam, and the housing bubble occurred due to what amounted to the same thing: massive off-balance-sheet exposures and vehicles that were effectively financed the same way (that is, sans disclosure.)

We sorely need reform - real reform.  The fact that the stock market is levitating is nothing different than ENRON levitating - fraud allows this sort of charade to go on for quite a while, but when it all comes crashing down it is catastrophic for everyone caught on the "wrong side."

America has been repeatedly fleeced - the retail investor and saver - by these frauds.  We continue to hear that you should "invest for the long haul" but in point of fact the only way you can do that and survive as an investor is when you have a reasonable belief that the fundamentals of a given company as represented in the balance sheet and statements of the firm represent reality.

Unfortunately in today's word this is simply not true anywhere, and especially in the financial sector.  We know for a fact that banks, for example, continue to be allowed to operate even after declaring a negative Tier Capital ratio in public filings, which is tantamount to a statement of insolvency.  We know that even more of these financial institutions are in fact bankrupt months (or more!) before they are shut down; Colonial, I continue to remind people, was listed as "well-capitalized" by the FDIC, yet BB&T says that the fair value of their assets is thirty-seven percent below where them marked. 

We're talking billions of dollars here folks, not a "minor accounting oversight."

If in fact The Fed is monetizing China's holdings of MBS through what amounts to an elaborate shell game, and from the public data it sure looks like they are, then we must put a stop to this immediately, punish those involved if we can find a law with an "or else" that applies, and we must add lots of teeth to the law, including criminal sanction, to prohibit this sort of thing from ever happening again.  This path is exactly how Zimbabwe blew up its economy and monetary system, and for obvious reasons we must not permit that sort of game-playing to occur here.