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The Fed Is Also Bankrupt

Jan. 26, 2011 (EIRNS)—This release was issued today by the Lyndon LaRouche Political Action Committee.

While printing another $600 billion and feeding the hyperinflationary new commodity speculation of many actually bankrupt financial institutions, the Federal Reserve has tried to hide its own bankruptcy with an "accounting change," as was reported last week, and dump it on the Treasury. This "minor accounting change" should be thoroughly investigated.

During the past two years' collapse the Fed has allowed banks to get paid full "value" for largely worthless mortgage-based securities (MBS) by buying the MBS itself to the tune of $1.25 trillion—beginning with $30 billion of Bear Stearns' crap in March 2008. The Fed has about $50 billion in bank capital, provided to it by the Treasury. So the Fed has now leveraged itself 23:1 on its MBS "assets" alone, and 40:1 on its total asset book, just as the Bear Stearns, Lehman Brothers, and Goldman Sachs of Wall Street did until the crash. The Wall Street Journal editorialized 9 months ago, "Although its profits are very high, still there are reasons to be concerned about the Fed's paper-thin capital position. It has a more risky portfolio than it's ever had before, including $1.25 trillion in mortgage securities that could lose market value if interest rates rise or if it has to sell them quickly." Being forced to acknowledge a 10% loss on that MBS portfolio would wipe out the Fed's big annual profits and capital combined.

On Jan. 6 the Fed changed its weekly balance sheet rules so that when those losses occur, they will be charged to the Treasury—not against the Fed's capital, as with any private bank—and become long-term debts of the Fed to the Treasury. In other words, a bailout of a bankrupt.

Just four days earlier, on Jan. 2, Fannie Mae and Freddie Mac had announced agreements with the major banks that issued huge volumes of MBS. Fannie and Freddie agreed to drop their demands that the banks buy back the fraudulent MBS junk, the pools of now-defaulted mortgages, on Fannie's and Freddie's books. They agreed to settle for less than 5% of the buybacks to which they are entitled—thus Fannie and Freddie will keep absorbing virtually all of the losses on those mortgages/MBS themselves; and the Treasury will keep bailing them out for doing so.

Just nine days before that, on Christmas Eve 2010, the Federal Reserve and Treasury quietly announced "unlimited financial support" to Fannie and Freddie for three years. This bailout was supposed to have been explicitly limited by Congress to $300 billion, in the 2008 act that put Fannie and Freddie into government conservatorship. But it has already reached nearly $200 billion, and Ben Bernanke and Timothy Geithner were indicating—in their own clandestine way—that this bailout will go much higher. The "unlimited support" means Bernanke is ready to buy and hold more toxic MBS; with the impacts of hyperinflation and higher interest rates, combined with home values continuing to fall and homeowners defaulting, those losses will get much bigger.

Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a veteran New York Fed staffer, hinted at the bankrupt-Fed threat in his research note on the "minor accounting change" of Jan. 6:

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement [of the "QEII" money-printing policy] about the possibility of Fed insolvency in a scenario where interest rates rise significantly."