Today’s report examines the latest Fed balance sheet data and surprise, surprise, the Fed had a little shrinkage problem this week. The cuts were particularly large in those programs that most directly impact the markets. If this were to continue, the market would take another hit. For the Fed to contract its balance sheet the week before Christmas is odd, to say the least. But if every participant in the financial system is intent upon paying down or writing off debt, then there’s not much that the Fed can do to reverse that.
The Fed faces an especially huge problem created by the FCBs ongoing dumping of up to $60 billion in GSE paper each month. The PDs have joined the fray, also dumping GSE paper hand over fist over the past several months. Add to that the fact that the GSEs have a reported $300 billion in notes and bonds coming due early in the new year that they must roll over, and the Fed finds itself faced with the threat of systemic collapse.
The Fed announced on November 25 that it would begin buying up $600 billion in GSE and MBS paper. They began buying the GSE paper in early December. In spite of that, over the past couple of days, GSE spreads to Treasuries began creeping up again. Just this evening, December 30, the Fed announced that it would begin buying direct GSE issued MBS paper in January. The Fed intends to acquire ALL of this paper by the end of the first half of 2009. The purchases will be made through Primary Dealers, who may participate as principles. The Fed says that because the paper is backed by Fannie, Freddie, Ginnie, and Fartie, and because it intends to engage in a buy and hold strategy, its risks are minimal. I kid you not. That’s really what they said.
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