We Have Not Avoided Anything

I disagree with this:

On the economic outlook for the U.S., Bullard cited recovering conditions. And with risks in the economy subsiding, “we’ve avoided this deflationary scenario that is sort of a part of what happened in Japan,” he said, referring to Japan’s so-called lost decade of the 1990s.

via Japan Press: Fed’s Bullard: Fed Assets Will Be Cut Over 5 Yrs | iMarketNews.com. (hat tip to alea for pointing this article out)

We haven’t avoided the deflation as Bullard suggests. We’ve delayed it. The Fed’s purchases of asset backed securities (specifically, mortgage-backeds) where there’s no other buyer to be found has created an air bubble in the market. We don’t know what the true value of these things are, but I can tell you one thing: they’re worth less than what the Fed paid for them.

The Fed’s job over the next 5 years is simple: find a greater fool and hope they don’t notice the massive credit risk in our national credit portfolio. From the St. Louis Fed as of 3Q ’09:

I indexed the NPL/Loans ratio to the peak of the end of the last expansion, 4Q ’07. From there, you can see the ratio now is 5 times higher than at the end of the recovery. This chart is looking at all loans, while MBS are just a subset. Then I looked at the latest Mortgage Metrics report for 3Q ’09:

Just look at the delinquency trend going across. Does it looks like credit risk is abating? It’s getting worse if you compare the ratio of seriously delinquent to the 30-59 days past due bucket. In 3Q ’08 it was almost a 1:1 ratio. It’s almost 2:1 in 5 quarters.

The securities are impaired and don’t deserve the bid the Fed probably purchased them at, which is a lot closer to par than I would’ve paid for them.

Whether Bernanke likes it or not his notion of the Fed “always getting paid back” is being put to the test. Big time.


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Filed under finance, government, macro, Markets, Monetary, Way Forward, You're kidding

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