Fed Buying Ever Riskier Assets

May 25, 2020
2 Sivan 5780

Our government is driving us into deep bankruptcy.

After the “crisis” of 2008 all sorts of debt increased. The increase is attributable to Fed “monetary policy”. Interest rates were low and it was easy to get “money” from the corporate paper market. I am very curious to know who owns all that corporate paper. I guess there is a lot in ETF’s, but that does not tell us who really owns this garbage. As a result of all that easy Fed credit we now have a “liquidity” problem (aka falling prices. Liquidity means you can buy and sell your “assets” and not disturb “market prices”). Here is the Fed’s response to this:

‘“This came two days after Powell defended the Fed’s program to buy junk bonds during his testimony before the Senate Banking Committee, which asked how purchases of junk bonds is “helping folks on Main Street.” Powell flagged that the Fed allowed for buying bonds from so-called “fallen angels” to ensure there is “no cliff” between the two lending markets (even though as we pointed out previously, a clear cliff has formed), saying “we don’t want to have a cliff there to where investment grade markets are working well, but the leveraged markets are not, non-investment grade markets are not.”
He then added that “we made a very limited, narrow set of actions to support market function in these markets, including buying ETFs, and that’s had an effect to improve market function there.”
Powell concluded by saying “we’re not buying junk bonds generally across the board at all,” which of course is correct: he is merely buying ETFs that have junk bond constituents.
And this is where the Fed’s first major test of directly manipulating and intervening in market functioning is about to take place.
While the Fed’s H.4.1 statement does not breakdown how much of the $1.8 billion in ETF holdings is allocated to investment grade and how much is junk, it is safe to say that at least $1 dollar of that amount has been allocated to purchases of Junk ETFs.
That will be a problem for Powell, because a quick scan of the holdings of both HYG and JNK reveals that these junk bonds ETFs own, among the hudnreds of other securities, several bonds from the just defaulted rental giant, Hertz.’
Here are HYG’s holdings of HTZ bonds: they amount to just over $50MM in face value across 4 bonds (out of a total of $23.3BN in holdings across just over 1,000 bonds).”

This problem is well illustrated by the Fed’s balance sheet. On 8/28/19 its “assets” were 3.8 trillion dollars and now its “assets” are 7 trillion dollars.

This the result of the Fed trying to maintain “liquidity”. It is another way of saying that Fed pets found themselves holding bags of excrement and they needed a place to unload it and the Fed is that place.

You might think the Fed is not all that smart, but that is not the case. Here is why this is YOUR problem and not the Fed’s problem:

“Is U.S. currency still backed by gold?

Federal Reserve notes are not redeemable in gold, silver, or any other commodity. Federal Reserve notes have not been redeemable in gold since January 30, 1934, when the Congress amended Section 16 of the Federal Reserve Act to read: “The said [Federal Reserve] notes shall be obligations of the United States….They shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any Federal Reserve bank.” Federal Reserve notes have not been redeemable in silver since the 1960s.

The Congress has specified that Federal Reserve Banks must hold collateral equal in value to the Federal Reserve notes that the Federal Reserve Bank puts in to circulation. This collateral is chiefly held in the form of U.S. Treasury, federal agency, and government-sponsored enterprise securities.”

If you read the above carefully, you noted that Federal Reserve notes are the obligation of the United States. As seen above, the Fed has nearly doubled its balance sheet and it is “buying” ever MOAR risky “assets” with those Federal Reserve “notes” that “we the people” back. In other words as the Fed adds to its balance sheet, the liabilities of “we the people” increase. Who do you think will pick up the tab when those “assets” tank completely? If you said, “We the people”, go to the head of the class! “We the people” are the bag holders and there is no gold in that bag!

Here is some information regarding the “bag” from the ZH article above:

“To be sure, we can only extrapolate but it is safe to say that the Fed’s holdings of both these ETFs are modest for the time being, and we assume that the bulk of ETF purchases have targeted the investment grade, LQD ETF; still the fact is that as of this moment, the Fed is a holder, via BlackRock and via HYG and JNK, of bonds which are in default, and which make the Fed a part of the Hertz post-petition equity once it emerges from bankruptcy!”

You can hear and view a brief history of the Fed here and see a hypothetical balance sheet that illustrates what is happening (2:58 – 12:50).

A very interesting thing about the Fed history is how it has gradually taken on assets of poorer and poorer quality. Up until 1932 the “currency” issued by the Fed was backed by 40% gold and 60% commercial paper. In 1932 the backing was 40% gold and 60% Treasuries. Then in 1935 the gold backing was removed and the only backing was by Treasuries. Then in 2008 the Fed added Mortgage Backed Securities into the backing mix. Now it is adding “commercial paper” back into the mix and some of that “commercial paper” is junk.

Remember, always privatize your profits and socialize your losses!

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