Fed Actions are Creating Federal Default Risk

By: Kemp Moyer | Wed, Mar 12, 2008
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On March 11th, the United States Federal Reserve announced it would lend as much as $200 billion of Treasury notes in exchange for debt including private mortgage-backed bonds (which have been crashing in value as of late) in order to try to avert a flight from the securities that were expanded to an unprecedented degree as a main component of the recent housing/credit bubble. The Fed is providing this unique shot of liquidity in hopes of stemming the relative carnage observed recently in the housing and mortgage markets. Upon announcement of the strong shot of liquidity to banks' and brokers' balance sheets, the American stock markets surged; the Dow Jones Industrial Average rose by over 400 points.

Along with previous infusions of $200 billion in other forms of Federal Reserve stimulus to the credit markets and banking system, this new form of stimulus is creating a form of stealth nationalization of credit market risk. Previously, the Fed only accepted treasury securities in exchange for cash on a short term basis. Now they are accepting lower quality securities in exchange for treasuries. Certainly, many self-interested banking institutions will line up to secure the financing options provided by the Fed.

Although these measures are being presented as acts to save the crashing credit markets in the United States, and therefore the currently credit-addicted U.S. economy, all this amounts to is a transfer of risk from the nation's private banks to the taxpayers through the acceptance of lower-quality assets onto the Federal Reserve balance sheet. The risk does not disappear from the system; it is simply passed around like a hot potato. Right now, as usual, the U.S. taxpayer is being handed a circumstance where he or she will be much more likely to be forced to foot the bill.

As a result, credit default swaps, a form of quasi-insurance on fixed income securities, now show that the debt of the United States is more at risk than the debt of its counterparts in Germany. Bloomberg reports on this new reality (http://www.bloomberg.com/apps/news?pid=20601087&sid=aVl4JGYmkX0M&refer=home). Essentially, market participants are now viewing investment in the United States as more risky than investment in comparable German securities.

To quote the Bloomberg article:

"The U.S. government is not immune from the consequences of the credit crisis," said Fabrizio Capanna, BNP's head of high-grade corporate trading in London. "Support for troubled financial institutions in the U.S. will be perceived as a weakening of U.S. sovereign credit."

Along with a crashing U.S. Dollar (Federal Reserve Note), this activity is pointing to growing global awareness of the decadence of the collective balance sheet of the United States government, as well as the burden being placed on American taxpayers.

As usual, the average U.S. citizen is being attacked to subsidize the risk that was foolishly taken on by greed-driven investors of many stripes, from bankers to investment pros to hedge fund managers to over-leveraged home buyers to mortgage lenders and pension funds. When all is said and done, the risk is transferred out of the hands of those who took it and into the collective hand of individuals who lived within their means and prudently avoided undue risk.

What is now happening is that the world is beginning to wake up to the reality that American policy makers are debasing the balance sheet of the country in order to secure the safety of a politically well-connected group. Given the unfairness, immorality and impracticality of the current situation, as well as the inherent propensity of the Federal Reserve System to encourage such behavior, the only sensible answer is to dismantle the intellectually bankrupt Federal Reserve System, end the fiat currency monopoly and move towards the sound dictates of free market credit, banking and currency issuance. The federalized cartel of such has been an unmitigated disaster.



Kemp Moyer

Author: Kemp Moyer

Kemp Moyer,

Kemp Moyer is the Editor-in-Chief and publisher of the online economic and social commentary website, Ponder This... ( www.ponderthis.net). Kemp works as a private business valuation professional in the San Francisco Bay Area, and has a background in mortgage backed security brokerage and asset and independent wealth management. Kemp can be reached at kemp34@gmail.com.

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