Wow, the biggest financial news story of my lifetime will probably be the bankruptcy of the Federal Reserve system. What the hell is Ben Bernanke doing? Can we get rid of these guys yet?
I already wanted to post something about the sheer stupidity of Fed actions over the last year, but this news story sums up the problem fairly well.
The Federal Reserve has been pretty much a self-sufficient entity that has brought in just enough money to cover administrative expenses. Therefore, any substantial losses--say from bad loans--cannot be absorbed. Back before the Great Depression, gold was used as collateral to protect against bad loans. In order to deal with the massive bank failures that arose in large part from interest-only mortgages, the Federal Reserve went off the gold standard and began accepting US Treasuries as collateral in the 1930's. With this type of system, the Fed could sell short-term Treasuries and recuperate losses without much problem. Short-term Treasuries have low duration and thus have a low sensitivity to interest rate changes, and make for great collateral. Perhaps even better than gold under current market conditions.
However, earlier this year the Fed introduced the Term Securities Lending Facility and the Primary Dealer Credit Facility. They are allowing non-Treasuries as collateral and if you read the article above, the Federal Reserve has gone gangbusters in trading out Treasuries for riskier assets. The Federal Reserve has little capacity to endure losses and a bailout will make the U.S. look extremely bad globally. Yes, the Federal government can bail out the Federal Reserve just like it did Fannie Mae and Freddie Mac, which weren't supposed to exist as government institutions, but the reputation of the American dollar and the American financial system sits with the Federal Reserve, not these other two. A bailout will be tragic for America's reputation.
Ben Bernanke was a Great Depression scholar and was probably chosen several years hence because even I could spot the problems back then. Still, what the hell is this man doing? Maybe people will trust me now when I say that the problems have only just begun and we really need to talk to our Oregon leadership about reigning in the Federal Reserve immediately, not when it's a day late and a dollar short.