2011 April 14 | timiacono.com

The Leverage on the Fed’s Balance Sheet

John Hussman’s weekly commentary had this little item in it the other day about how the Federal Reserve’s balance sheet would look if it were viewed as something other than the assets and liabilities of the central bank of the world’s only superpower, with all the attendant rights and “make-it-up-as-you-go” privileges.

As a side note, it’s probably worth noting that the Federal Reserve has already pushed its balance sheet to a point where it is leveraged 50-to-1 against its capital ($2.65 trillion / $52.6 billion in capital as reported the Fed’s consolidated balance sheet ). This is a greater leverage ratio than Bear Stearns or Fannie Mae, with similar interest rate risk but less default risk. The Fed holds roughly $1.3 trillion in Treasury debt, $937 billion in mortgage securities by Fannie and Freddie, $132 billion of direct obligations of Fannie, Freddie and the FHLB, and nearly $80 billion in TIPS and T-bills. The maturity distribution of these assets works out to an average duration of about 6 years, which implies that the Fed would lose roughly 6% in value for every 100 basis points higher in long-term interest rates. Given that the Fed only holds 2% in capital against these assets, a 35-basis point increase in long-term yields would effectively wipe out the Fed’s capital.

To avoid the potentially untidy embarrassment of being insolvent on paper, the Fed quietly made an accounting change several weeks ago that will allow any losses to be reported as a new line item – a “negative liability” to the Treasury – rather than being deducted from its capital. Now, technically, a negative liability to the Treasury would mean that the Treasury owes the Fed money, which would be, well, a fraudulent claim, and certainly not a budget item approved by Congress, but we’ve established in recent quarters that nobody cares about misleading balance sheets, Constitutional prerogative, or the rule of law as long as speculators can get a rally going, so I’ll leave it at that.

Yes, it’s tough being a bear after a 2+ year long stock market rally and being reminded from time to time that, when Fed Chief Ben Bernanke puts his head on the pillow at night, he probably giggles to himself every once in a while, “I am the invisible hand” (hat tip DC).

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Fleeting Confidence for the Party in Power

In addition to the remarkable similarity in the multi-year trend in confidence on the economy for President George W. Bush and President Barack Obama – they both start out well above two-thirds and then quickly tumble from there – the other interesting takeaway from the latest Gallup poll is this similar survey for Congress.

While controlling Congress for most of the last decade, confidence in the Democratic leadership on the economy moved steadily lower to what is probably a multi-decade low this year, whereas, confidence in the Republican leadership bottomed three years ago and is now higher than the party in power. Since the housing boom went bust, Americans favoring the economic stewardship of the Democrats was a constant, but, now they trail the Republicans, likely more evidence that governing is hard.

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Thursday Morning Links

Obama proposes $4tn cut to US deficit – Guardian
Goldman Sachs accused of misleading investors – BBC
Credit raters triggered financial crisis: panel – Reuters
In Financial Crisis, No Prosecutions of Top Figures – NY Times
Why Congress should vote no on raising the debt ceiling – Reuters
Atlas’s Rand Resists Bedding Down With Hollywood – Baum, Bloomberg
Understanding the federal deficit problem – Greenspun’s Weblog
The Real Housewives of Wall Street – Taibbi, Rolling Stone
Central banks turn net gold buyers, cut euro zone debt – Reuters
Is Goldman Sachs Too Big to Fail? – Baseline Scenario
Bankers Running Rings Around Regulators – CNBC

Oil hovers near $107 after gasoline supply drop – AP
Gold Prices Steady, U.S. Economic Data Awaited – Kitco
Battle-scarred stock bulls and gold bugs – MarketWatch
Gold exposure in commodity indexes too low – Commodity Online
John Paulson’s Complete Les Echos Interview – Zero Hedge
Gold Will Reach $1,600 in 2011 – Financial Times

Consumers may be too down on jobs – MarketWatch
Economics 101: Long Material, Short Certified Idiots – aucontrarian
Portuguese, Greek Yields Rise to Records on Debt Concerns – Bloomberg
Euro zone hit by Greek restructuring worry – Reuters
UK confidence picks up from record low – Telegraph
Foreclosure filings up 7% in March: RealtyTrac – MarketWatch
Report blame crisis partly on WaMu’s poor lending practices – Housing Wire
Fed’s exit doors close, inflationary spiral ahead – Commodity Online
Federal Reserve’s path of destruction – MarketWatch
Further Economic Weakness Means QE3 – CNBC

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