What Does The End Of Fed's Temporary Liquidity Facilities Mean?

After the collapse of Lehman, the Fed stepped in to bail out the financial system by providing blanket guarantees on virtually all asset classes. The chaos was palpable: we now know the "thinking" behind just the $700 billion TARP component of the bailout, thanks to PIMCO's latest brain trust addition: Neel Kashkari, whose rocket science math he himself encapsulated as follows: "We have $11 trillion residential mortgages, $3 trillion commercial mortgages. Total $14 trillion. Five percent of that is $700 billion. A nice round number." The same kind of back of the envelope math dominated Bernanke's decision to provide an explicit dollar for dollar guarantee for the entire ~$8 trillion in loans in the US financial system, and then some. By some estimates the Fed guaranteed in some form or another, up to $26 trillion. And while a lot was merely backstop funding, banks were happy to take advantage of actual funding to a material degree, approximately $1.6 trillion. The bulk of these funds came from by various "temporary" liquidity programs that the Fed adopted. It is precisely the bulk of these facilities that the Fed is now ending.

And just like we saw with Citigroup last night, the Fed is ending these facilities woefully early, merely to "demonstrate" how healthy the system is. Well, it isn't, and banks will come back running as soon as the CRE roll approaches (good luck getting securitization up to $250 billion a year by 2012). So why the charade? And why the hypocrisy, when the Fed has effectively replaced the liquidity programs' direct intervention by such other programs as Quantitative Easing whose UST and MBS/Agency purchases now total over $1.2 trillion and which at their peak on March 31, will have the same notional outstanding as the liquidity facilities, when these peaked in January 2009.

The chart below demonstrates the change in time of the two key parts of the Fed's current assets: on one hand the various liquidity facilities, the bulk of which will be eliminated by February 1, and the QE "Purchase Progoram" on the other hand.

Another way of visualizing the peak and current borrowings on the plethora of bailout facilities which were initiatied with the gifting of Bear Stearns to JPM is provided in the chart below:

What has been the outcome of this bailout orgy: simple, and you can see it in widening sovereign CDS spreads every day. Essentially the Fed has transferred private market risk for public sector risk. The associated "benefits" with this transaction we all know: a collapsing dollar, surging gold, balooning deficits which will be funded only so long as America agrees to be China's vassal state, increasingly disadvantageous trading terms for America with its key trading partners, and a disappearing middle class. The charts below encapsulate the four main consequences of the Fed's decision to have US taxpayers be on the hook for the entire US financial system.

What will be the cost? Nobody knows yet, however tens of trillions of budget shortfalls over the next decade is a sovereign crisis waiting to happen. As America has no hope of every funding these shortfalls organically, it will depend on financing more and more, and in a vicious circle, even more debt will need to be raised merely to fund the ever increasing interest expense, and yes, zero interest rates can only last so long.


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