The big picture: Looks like the Chinese have "called our loans" and lent money back to "Fed-Hedge"

[HamdenRice]

I'm semi-joking because there used to be so many posts asking, "what if the Chinese call our loans," and a lot of us would respond that if they were talking about t-bills, those loans cannot be called, but only sold.

Nevertheless, if you step back and look at the big picture, the underling problem is that the international global pool of savings has lost confidence in dollar denominated debt instruments that are sold by US banks. The most important of these debt instruments are mortgage backed securities.

I was thinking about this version of the "big picture" after listening, once again, to This American Life's excellent report on the global pool of savings. At the start of the crisis, TAL explained, there were $70 trillion in global savings -- almost double the world's gross product -- sitting around in banks around the world, desperately seeking somewhere to be invested. This did not include investments in equities or direct investment; it only included "fixed income" investments, which means investment in debt and deposits in banks.

The global pool of savings has doubled over the last few years. That is not, surprisingly, because of financial shenanigans. It was primarily because of the rapid increase in wealth of previously poor countries, especially China and India, and their fantastical savings rates.

Before the crisis, the only feasible place for foreign investors to put this money was in mbs. That led to excessive money available for mortgages, which led to asset inflation, which led to the bubble, which led to foreclosures, which led to defaulting mbs -- and the entire base of the financial pyramid collapsed.

The most shocking and somewhat economically perverse outcome is that the global pool of savings may have lost confidence in dollar denominated private debt, but has developed an insatiable appetite for dollar denominated federal debt.

Trillions have been dumped out of mbs. Trillions are being pumped into treasury securities.

It may be a wash.

The result is basically socialized banking. The Fed and Treasury have replaced Citi and BoA as the world's banks. Trillions sucked out of banks and deposited with the Fed and Treasury.

The solution?

The Fed and Treasury simply turn around and lend it to the places that the banks had been lending it -- to the banks to get their balance sheets in order (TARP), to the commercial paper markets (Fed commercial paper facility), and now to homeowers (Obama's foreclosure program), and even to car buyers, student borrowers and credit card holders (the proposed asset backed security program).

The Fed and Treasury are effectively the world's bank. They are making enormous amounts of liquidity available.

The Fed and Treasury can borrow fantastic amounts and increase liquidity without a threat of inflation or the collapse of the dollar for several reasons.

There is no threat of inflation because the Fed and Treasury are not creating a net increasing in liquidity. They are not "printing dollars." They are replacing dollars that have been withdrawn from the private financial system and re-routed to them -- the same dollars being withdrawn from the private banking system being re-routed through the new developing public banking system.

There is no threat of devaluation, because the Treasury is not "spending" most of that money; it is mostly investing it. That means that global investors look at the Fed and Treasury and don't see an institution that is borrowing recklessly to spend, but borrowing and matching most of that borrowing with investments in debt of others -- debt that pays higher interest than the Fed and Treasury themselves have to pay. The Fed and Treasury are actually in a highly profitable position.

The Fed-Treasury is borrowing at very low rates and lending at higher rates. Fed-Treasury has become a "hedged" commercial bank. Let's call it Fed-Hedge.

The Fed and Treasury: the first socialist hedge fund in economic history.

[rosesaylavee]

1. Interesting.

I can almost get my head around that scenario. Most of this is so confusing to me that most explanations given are understandable at first reading but if someone were to ask me to repeat it - no way. This makes sense and I thank you for that. Let's see if I can repeat it later. :P

[westerebus]

2. Fresh paint.

The billions spent buying MBS will not be recovered. At best 60% given the current haircut in the American market. The world market is looking worse. Add the broad losses across the stock markets around the world and you have a considerable loss of (invested) savings.

The FED really has little option given its' charter to protect the American Banking industry from collapse. Investing Treasury held dollars of global investors including US investors to prop up US banks will not lessen the need to re-inflate market capitalization by banks or non banks. The FED is a real equal opportunity lender.

It should put US banks in better shape coming out of this mess. Provided the Treasury doesn't write the losses on to their balance sheet and cover the cost with more borrowing. Borrowing in the sense of printing more dollars, monetizing the debt. Which is why, I think, they keep Volker near by.

The system is as rotten as the people who have manipulated it. A gallon of paint covers a million sins, as my sainted grandfather would say.