The Fed's Balance Sheet Strategy to Support Qualitative Easing: A Synopsis

“They [the Fed's financial crisis programs] all make use of the asset side of
the Federal Reserve’s balance sheet. That is, each involves the Fed’s
authorities to extend credit or purchase securities.”

Ben Bernanke, London School of Economics, January 13, 2009

The Fed's strategy is to expand Balance Sheet and to change the mix of the financial assets it holds to stimulate specific troubled markets.

As you will recall, the Fed's Balance Sheet provides the backing for the US Dollar currency among other things, and traditionally has consisted of gold, US Treasury Debt, and the explicitly guaranteed debt of agencies like Ginnie Mae.

What the Fed is doing is expanding the assets on its Balance Sheet, which is quantitative easing, but is doing it by adding specifically targeted non-traditional assets.

The Bernake Fed distinguishes its own approach from the "quantitative easing" of the Bank of Japan. It is an expansion of the central bank's balance sheet, but in the case of the Fed, with a bias. Bernanke calls it 'credit easing' while we prefer to call it 'qualitative easing.'

The Fed is deciding specifically where and to whom to apply its qualitative easing.

This is the controversial part of the program, because the Fed no longer manages the money supply and interest rates, and the general health of the banking system, but targets specific markets and companies for its monetization efforts.

In effect, one might say that the Fed has begun to assume a central planning role for the economy that decides, with specifics, who fails and who survives to succeed. What is troubling in particular is that so far the Fed has retained the perogative to do this without disclosure of the specifics even to Congress.

Bernanke divides the use of balance sheet assets into three groups:

1. lending to financial institutions,

2. providing liquidity to key credit markets, and

3. purchasing longer-term securities.

What does "Buying Longer Term Securities" mean?

In November 2008, the Federal Reserve announced plans to purchase the direct
obligations of the housing-related government-sponsored enterprises (GSEs),
specifically Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. In
principle, the extra demand for these obligations is designed to increase the
price of the securities and thereby lower rates paid for mortgages.
Additionally, the Fed outlined plans to purchase mortgage-backed securities
backed by Fannie Mae, Freddie Mac, and Ginnie Mae. These actions were designed
to improve the availability of credit for the purchase of houses, therefore
supporting the housing markets and financial markets in general.

Source: The Federal Reserve

Europe to Push Broader Regulatory Agenda at G20

This is interesting because it tees up the European agenda ahead of the G20 meeting, and helps to highlight some points of contention between Europe and the Anglo-American financiers.

The IMF subject is a reflection of Europe's decentralized status. The ECB does not possess the broad powers of the Federal Reserve Bank, and there is a difference of opinion in Europe about its future role, and the centralization of power overall.

This is highly reminiscent of the US debate between the Federalists and the Jeffersonians.

MarketWatch
Europe supports broad financial regulation
By MarketWatch
12:42 p.m. EST Feb. 22, 2009

SAN FRANCISCO (MarketWatch) -- The European leaders of the Group of 20 called Sunday for more transparency and regulation of all financial markets, products and investors, including hedge funds, according to published reports.

Heads of state and finance ministers from France, Germany, Italy, the Netherlands, Spain, the United Kingdom, the Czech Republic and Luxembourg met in Berlin to come up with a European position ahead of the G20 summit in London scheduled for April 2...

Leaders also reportedly proposed increasing to $500 billion the International Monetary Fund's financial resources for crisis management, in light of problems recapitalizing banks in Central and Eastern Europe. The IMF now has $250 billion in resources and already used $50 billion.

The call for increased IMF funding follows remarks from French Finance Minister Christine Lagarde, who said Thursday that euro-zone countries should come to the aid of any troubled member-state and avoid IMF involvement, if a bailout becomes necessary....

SP 500 Still Overvalued by 46% as Dividends Plummet at Record Pace

We have not reached a sustainable bottom yet in US equity prices despite the infomercials and chief strategist's exhortations to buy them while they are cheap on the financial news channels.

Stocks are valued based on their returns, and those returns are based on real cash flow and profits paid out to shareholders as dividends or stock buybacks to boost share prices.

For too many years US companies have essentially robbed Peter to pay Paul, servicing short term profits by offshoring US jobs, manipulating their balance sheets, and appropriating the savings of the world through the US reserve currency mechanism.

We've just about run out of track on that line, and are heading for a hard stop at a much lower level. At some point the market will perceive that the economy is improving and that the outlook for corporate profits is positive. Stocks will reflect this about six months in advance.

But there will be no recovery until the banking system is reformed and restructured, and the median wage begins to increase enough to support both savings and increased consumption.

Making additional debt available first as a cure is nonsensical, because the debt we have cannot be serviced and must be written off. To do so is Ponzi economics, which is what Greenspan was practicing, and why the decline has been so precipitous.

The longer we avoid making the necessary changes, the more we risk an involuntary default.


Bloomberg
Dividends Falling Most Since ’55 Means S&P 500 Still Expensive
By Michael Tsang

Feb. 23 (Bloomberg) -- The fastest reduction in U.S. dividends since 1955 is depriving investors of the only thing that gave stocks an advantage over government bonds in the last century.

U.S. equities returned 6 percent a year on average since 1900, inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG show. Take away dividends and the annual gain drops to 1.7 percent, compared with 2.1 percent for long-term Treasury bonds, according to the data. (And don't bother factoring in anything for that old-fashioned concept called 'risk' - Jesse)

A total of 288 companies cut or suspended payouts last quarter, the most since Standard & Poor’s records began 54 years ago, when Dwight D. Eisenhower was president. While the S&P 500 is trading at the lowest price relative to earnings since 1985 and all 10 Wall Street strategists tracked by Bloomberg forecast a rally this year, predictions based on dividends show shares are overvalued by as much as 46 percent.

“It’s a greater fool theory if we always buy stocks based on earnings and we never get a penny out of it, hoping for someone to buy that stock at a higher price,” said James Swanson, chief investment strategist at MFS Investment Management in Boston, which oversees $134 billion. “Dividends have been a cushion in bad times. If they go to zero it’s a disaster.” (The real disaster is that the US is running out of greater fools. - Jesse)

Twenty-five companies in the S&P 500 saved almost $17 billion by cutting or suspending outlays this year, more than all the reductions from 2003 to 2007, when the index returned 83 percent. On a per-share basis, S&P 500 companies may trim payouts 13 percent this year, the biggest drop since 1942 ...

US Considers a 40% Ownership of Citigroup, Diluting the Common Shares

Citigroup is the prime candidate for receivership.

The only reason to continue this charade, other than to inspire us with confidence in the opaque duplicity of this Administration, is to preserve the shareholders who would almost certainly be wiped out, and the bondholders who would get a high and tight haircut, in the kind of restructuring that Citigroup requires as an insolvent institution.

Larry Summers and Tim Geithner are promoting this crony capitalist approach to preserve the wealth of a few at the expense of the many.

Wall Street Journal
U.S. Eyes Large Stake in Citi
By David Enrich and Monica Langley
February 23, 2009

Taxpayers Could Own Up to 40% of Bank's Common Stock, Diluting Value of Shares

Citigroup Inc. is in talks with federal officials that could result in the U.S. government substantially expanding its ownership of the struggling bank, according to people familiar with the situation.

While the discussions could fall apart, the government could wind up holding as much as 40% of Citigroup's common stock. Bank executives hope the stake will be closer to 25%, these people said.

Any such move would give federal officials far greater influence over one of the world's largest financial institutions. Citigroup has proposed the plan to its regulators. The Obama administration hasn't indicated if it supports the plan, according to people with knowledge of the talks.

When federal officials began pumping capital into U.S. banks last October, few experts would have predicted that the government would soon be wrestling with the possibility of taking voting control of large financial institutions. The potential move at Citigroup would give the government its biggest ownership of a financial-services company since the September bailout of insurer American International Group Inc., which left taxpayers with an 80% stake.

The talks reflect a growing fear that Citigroup and other big U.S. banks could be overwhelmed by losses amid the recession and housing crisis. Last week, Citigroup's share price fell below $2 to an 18-year low. Bank executives increasingly believe that the government needs to take a larger ownership stake in the institution to stop the slide.

Under the scenario being considered, a substantial chunk of the $45 billion in preferred shares held by the government would convert into common stock, people familiar with the matter said. The government obtained those shares, equivalent to a 7.8% stake, in return for pumping capital into Citigroup.

The move wouldn't cost taxpayers additional money, but other Citigroup shareholders would see their stock diluted. A larger ownership stake by the government could fuel speculation that other troubled banks will line up for similar agreements.

Bank of America Corp. said Sunday that it isn't discussing a larger ownership stake for the government. "There are no talks right now over that issue," said Bank of America spokesman Robert Stickler. "We see no reason to do that. We believe the goal of public policy should be to attract private capital into the bank, not to discourage it...."