Treasuries for Trash

The little-known story of $1.5 trillion in new Federal Reserve loans...

IT'S NO SECRET that the Federal Reserve plays a big role in American inflation, writes Ian Mathias for The Rude Awakening.

   It sets the country's benchmark lending rates, it prints money, and even a hint of rising inflation expectations from Ben Bernanke – the Fed's chief – can put the Dollar in the doghouse.

   But starting late last year, Bernanke and his brood created a whole new way to devalue the greenback...one that has resulted in the printing, borrowing, and trading of over $1.5 trillion.

   Flash back to December 2007. The credit crisis was about to swing into full force. US banks had recently issued a slew of dreadful earnings reports, and even worse losses and bigger write-downs seemed imminent. Banks needed cash to cover these losses – straight away – and they needed to cover those losses as cheaply as possible.

   Enter the Fed and its new Term Auction Facility. In a TAF, the Fed offers banks billions in 28- or 35-day loans at a rate below the Fed's published lending rates. And in the first such auction, on 17th December 2007, banks received $20 billion in cheap loans from the Fed. It held another TAF a few days later...lending them another $20 billion.

   The "success" of the TAF was instantly evident. Banks were asking for more than the Fed was willing to lend, and each auction appeared to provide temporary relief for financial stocks, too. It worked so well the Fed decided to keep on holding TAF auctions indefinitely. And as the credit crunch worsened, it even started offering more money, up to $75 billion at each auction.

   There's been a TAF every other week since December. So to date, TAF auctions have resulted in the printing and lending of $810 billion to financials fighting to remain solvent – not exactly "prime" borrowers.

Trash-for-Treasuries

   The Bear Stearns crisis hit full force in March, bringing home to the Fed that investment banks were on the hook too.

   Billions and billions of mortgage-backed securities so clouded their books that not a soul on Wall Street was willing to buy them. Thus, the TSLF was born.

   In a Term Security Lending Facility, investment banks trade illiquid asset-backed securities for US Treasuries. In other words, the Fed willingly exchanges the debt of the United States, the global embodiment of a "sure thing" security, for subprime trash.

   Like the TAFs, the TSLFs have been a big hit. So now, you see, between the TAFs and the TSLFs, the Fed has placed a $1.5 trillion bet on the fate of financials. True, there's a chance all the loans will be paid back. Maybe those toxic mortgage securities will one day return to full valuation. But they might not. And it'll be as if the Fed printed money just to throw it away.

   From the geo-economic point of view, these auctions slay the Dollar. The Federal Reserve – the central bank of the United States – is running the presses 24/7, lending extra cheap cash to companies in genuine danger of going under.

   Even worse, Bernanke and company are implicitly calling bundles of subprime loans and US Treasury notes one and the same. If you were managing China's holdings of US Treasury notes – worth some $500 billion – how would you feel about your US I.O.U.s today?

   If you were a currency trader, would this prompt a buy or a sell the Dollar?

   But here's the real kicker: No one is talking about the TAFs and the TSLFs.  No "expert" commentary, no subtle hints of the rife moral hazard of it all...not even a tally of exactly how much the Fed has given away to date. When the combined efforts of the TAFs and TSLFs crossed the $1 trillion mark, there wasn't even a peep from any major media outlet. Just business as usual.

   Every newspaper in the country blasted headlines of the Fed's $30 billion bailout of Bear Stearns. But this slow and steady trillion-dollar bailout of the financial community at large is back-page news at best. And it'll stay that way until we start to make some noise.

   So tell your friends. Because if we don't keep the Fed in check, who will? The Street...?

   And if you haven't started already, we propose more Gold Buying in the very near future. It's the one store of value the Fed can't keep handing out like candy. There's no TAF or TSLF for Gold.

   Bless you, Comex and the London Gold Fix.