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So, the Fed is in the mortage business?
By stephen | March 12, 2008
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For an introduction, I want to start with this article:
It appears that Ms. Spears is having some financial problems. Here are some paragraphs from the article that may be of interest:
What little light has been shed on Ms. Spears’s finances came last May, when part of an income statement surfaced in her divorce case. It put her average monthly earnings at more than $730,000, mainly from royalties, but said she earned only $13,000 a month from investments. (Her spending, including $102,000 a month for entertainment, gifts and vacation and $16,000 for clothes, was more eye-catching.)
The nature of her investments might be unclear as well. Accountants are trying to learn whether her money was moved into overly risky investment vehicles, whether any business deals need to be undone and whether her assets were outright looted. (Her father filed a report of grand theft, according to The Los Angeles Times, asserting that paintings, jewelry and other valuables had been stripped from her Beverly Hills home).
Apparently, Britney has some shaky assets on her balance sheets. Well, don’t worry Britney. You’re not the only one.
In an announcement that has sent produced a large and varied reaction, the FED has announced that they will attempt to bail out banks by letting them use mortgage-backed securities as collateral for loans. This move is unprecedented in the Fed’s history. For the first time, they are entering the mortgage business. Since its inception, the Fed has used open market operations (the buying and selling of treasury bonds) to expand or contract the monetary policy. A good detailed discussion is here, at interfluidity. Simplistically, the Fed’s balance sheet looks like:
Assets - Liabilities
bonds - US currency
When they want to inject liquidity into the market, they buy bonds, paying for them with cash that enters circulation. On the contrary, to contract the money supply, they sell bonds, receiving cash for the sale, and that cash is taken out of the economy. Clearly, their ability to carry out monetary policy depends on the solvency of the bond market. If that market seizes, then they can’t implement monetary policy.
What makes this move by the Fed so remarkable is that they are putting mortgage-backed securities on their assets. The risk of these securities will therefore be absorbed by the currency, most likely through inflation. Bonds, which are relatively stable assets, compared to ill-maintained houses with bankrupt owners, provide the backing for the currency. This allows some of the risks of inflation to be absorbed. By making the currency more risky, it can drive up expected inflation. The risk comes from several sources
- the value of the collateral - the mortgage-backed securities - is very volatile.
- the market for these securities may not be solvent, meaning that if the fed wanted to sell these assets, there may not be buyers
If the fed loses its contract the money supply, this will lead to an inflationary spiral. Additionally, this action, even if it has no immediate negative consequences, it makes people question their expectations of the Fed’s actions. Adding risky assets to the backing of our currency will cause people to divert capital into more stable currencies, such at the Euro, pound, or Real. I had joked with my econ professor that perhaps the day would come that if I couldn’t pay for my car, I could sell it to the Fed. I suppose anything is possible.
Topics: General |
[…] Econ Steve: So, the Fed is in the Mortage Business? - “I had joked with my econ professor that perhaps the day would come that if I couldn’t pay for my car, I could sell it to the Fed. I suppose anything is possible.“ […]
Posted by: Jeff Barr’s Blog » Links for Wednesday, March 12, 2008 on March 12th, 2008 at 4:23 pm