Fed's Vice Chairman Admits Fed Has No Exit Strategy

Federal Reserve Board Vice Chairman Donald Kohn is yapping complete nonsense about interest rates floors, the Fed's balance sheet, risk, exit strategies and other items.

Let's take a look starting with Kohn Says Deposit Rate Will Do Better Job in Future.

Federal Reserve Board Vice Chairman Donald Kohn said the central bank’s power to pay interest on banks’ deposits will do a better job of keeping the benchmark rate at the desired level as financial markets improve.

“It hasn’t been a totally effective floor,” Kohn said during an audience discussion at a conference at Princeton University in New Jersey. He is scheduled to address the event later today. “As the balance sheet shrinks and as banks become better capitalized, that will become an effective floor.”

My Comment: It hasn't been totally effective?! What kind of nonsense is that? The truth is it failed 100%. Bernanke's idea was that by paying interest on reserves the Fed could put a floor on interest rates at 2%. Bernanke's idea failed miserably and proof is the Fed Funds rate at 0%.

Congress granted the Fed’s request to immediately pay interest on banks’ reserve deposits as part of the October legislation creating the $700 billion financial-rescue fund. Fed officials hoped that would help keep the benchmark interest rate steady while the central bank flooded the banking system with cash. The authority failed to keep the main rate from declining almost to zero before the Fed officially lowered it that far.

“Interest on reserves is an important part of the exit strategy” from the Fed’s record expansion of credit on its balance sheet to combat the financial crisis, Kohn said today.

My Comment: Excuse me for asking, but by what rationale are we supposed to believe that?

Meanwhile the Fed's balance sheet is ballooning and that will without a doubt complicate the Fed's exit strategy.

That poses an additional question: Exit Strategy? What exit strategy?

Kohn Admits Fed Has No Exit Policy

Inquiring minds are reading Fed's Kohn says rates likely to stay low for some time.

The U.S. Federal Reserve is likely to keep benchmark interest rates near zero for a while in an economy that is pulling out of a steep decline and appears on course for a very gradual recovery, Fed Vice Chairman Donald Kohn said on Saturday.

"The economy is only now beginning to show signs that it might be stabilizing, and the upturn, when it begins, is likely to be gradual amid the balance sheet repair of financial intermediaries and households," Kohn told a conference at Princeton University.

My Comment: Other than via bankruptcies and foreclosures, exactly what balance sheet repair have we seen by households? And what about the fact that ranks of the unemployed are growing by 500,000 a month for months on end? Exactly what will that do to household balance sheets?

Kohn said that in spite of the fragile state of the U.S. economy and the prospect for low rates for a while, the Fed must make plain its plans to pull back its lending when a recovery begins to take hold.

"To ensure confidence in our ability to sustain price stability, we need to have a framework for managing our balance sheet when it is time to move to contain inflation pressures," he said.

My Translation: "We have no framework managing our balance sheet. We will create an exit strategy by the seat of our pants, on the fly, when the time comes. We have plenty of time because Bernanke's strategies have proven to be ineffective and the recession will be deeper and last longer than we expected."

The Fed has said it is willing to expand extensive purchases of mortgage-related and longer-term Treasury securities to support any nascent recovery.

"The preliminary evidence suggests that our program so far has worked," Kohn said referring to the commitments to buy securities to date. He said he believes they have held down long term interest rates by as much as 1 percentage point.

My Comment: The fed is holding down mortgage rates by being the lender of only resort. Ignoring all the other bloated garbage on the Fed's balance sheet, I guarantee the exit strategy from mortgage backed securities alone is going to be a nightmare.

Kohn said government spending is likely to have a more powerful effect in helping pull the economy out of recession now -- with interest rates near zero -- than it would if the Fed were still in a position to lower interest rates further.

My Comment: Excuse me for pointing out the obvious, but if interest rates were not at zero, perhaps we wound not be in a recession.

In its actions to buttress the economy through a period of crisis, the Fed has taken on some risks both from swings in interest rates as well as from the possibilities that some borrowers could default, Kohn said, adding the Fed has sought to minimize those risks.

My Comment: Excuse me once again for asking such pointed questions but exactly how have you minimized the risks?

Even specialized vehicles such as three "Maiden Lane" limited-liability companies set up at the New York Fed to hold so-called toxic assets from two firms the central bank stepped in to prevent from failure -- investment bank Bear Stearns and insurer American International Group, Inc -- may not result in losses, he said, since the Fed is holding the assets to maturity.

BlackRock Inc, the firm that is managing those vehicles, has told the central bank those holdings are likely to eventually turn a profit, Kohn added.

My Comment: Oh Really? How much did you pay Blackrock to say that?

Let's take a look at Maiden Lane and other assets...

Bloomberg is reporting Bear, AIG Dumped $74 Billion in Subprime, CDOs on Fed

April 24 (Bloomberg) -- The Federal Reserve took on more than $74 billion in subprime mortgages, depreciating commercial leases and other assets after Bear Stearns Cos. and American International Group Inc. collapsed.

In its biggest disclosure of the securities accepted to stabilize capital markets, the Fed said yesterday it had unrealized losses of $9.6 billion on the assets as of Dec. 31. The bonds, swaps and notes were taken in from Bear Stearns, once the fifth-biggest Wall Street firm by capitalization, and AIG, which had been the world’s largest insurer.

The losses on securities backed by assets such as home loans in Florida and California signal that U.S. taxpayers may be forced to reimburse the central bank through the Troubled Asset Relief Program, according to Christopher Whalen, managing director of Torrance, California-based Institutional Risk Analytics.

“The numbers basically confirm that Treasury is going to have to take some TARP money and reimburse the Fed,” said Whalen, whose financial-services research company analyzes banks for investors. “It is essentially up to the Treasury to get the Fed out of this.”

My Comment: Whalen hits the heart of Kohn's plan. The only way the Fed will not suffer losses is if taxpayers will bail out the Fed.

The central bank lent $2 trillion to financial institutions and hasn’t disclosed information about most of the collateral backing those loans.

The Fed report follows requests from lawmakers to identify the collateral and a lawsuit by Bloomberg News. Fed Chairman Ben S. Bernanke pledged to expand disclosure, assigning Vice Chairman Donald Kohn to lead the effort.

My Comment: Kohn leading the effort to expand the disclosure sure is a comforting thought. I am sure the truth will come out now.

The central bank has refused to name the borrowers, the amounts of loans or the assets banks put up as collateral under most of its programs, arguing that doing so might set off a run by depositors and unsettle shareholders.

My Comment: So no one has any idea what the assets the Fed is holding, yet we are supposed to believe there will not be losses, yet the only way there won't be losses is if the Treasury via the TARP (taxpayers) bail out the Fed.

Maiden Lane I is a $25.7 billion portfolio of Bear Stearns securities related to commercial and residential mortgages. JPMorgan refused to buy them when it acquired Bear Stearns to avert the firm’s bankruptcy.

The Fed’s losses included writing down the value of commercial-mortgage holdings by 28 percent to $5.6 billion and residential loans by 38 percent to $937 million as of Dec. 31, the central bank said. Properties in California and Florida accounted for 45 percent of outstanding principal of the residential mortgages.

Maiden Lane II contains almost $11 billion of outstanding subprime mortgage-backed securities from the AIG transaction that the Fed said lost $180 million so far. The fund also contains $6.2 billion of Alt/A adjustable-rate mortgage-backed securities that the report said has $936 million of unrealized losses. The Fed values $11.4 billion of assets in Maiden Lane II with mathematical modeling, the same methods used by banks and AIG itself.

About 19 percent of the mortgage-backed securities are rated speculative grade, or BB+ at Standard & Poor’s, according to the Fed. About 40 percent are given the top rating of AAA.

Maiden Lane III has lost $2.6 billion after being created Oct. 31 to buy collateralized debt obligations from AIG counterparties, according to the Fed. CDOs in this unit include three parts of a high-grade asset-backed security known as TRIAX 2006-2A, totaling about $3.2 billion. Maiden Lane III also has two parts of a commercial mortgage-backed CDO called MAX 2007-1 A-1 with a face value totaling $7.5 billion. The fair value of those two is less than half that much, or $3.3 billion, according to the central bank.

A third of the amount outstanding in the Maiden Lane III CDOs are speculative grade, or deemed by ratings companies as having a greater chance of default. Another 27 percent are rated AA+ to AA-, the second-highest tier of S&P’s scale, the Fed said in its report. All but $155 million of the $26.8 billion in CDOs are classified as Level 3 assets, or those valued with mathematical models instead of market prices.

Ridiculous Statements by Kohn and Blackrock

It is ridiculous for Kohn and Blackrock to suggest there may be a profit on Bear Stearns and AIG assets held by the Fed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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