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Fed Policy: Underwrite Mortgages to Underwrite the Treasury

Interest-Rates / US Debt Mar 23, 2011 - 04:26 AM GMT

By: Dr_Jeff_Lewis


In a little known program to which few have been paying attention, the US Treasury is attempting to unwind positions it inherited from a very expensive bailout of government-sponsored entities Fannie Mae and Freddie Mac. 

The Treasury department has as much as $143 billion in securities to sell to investors, with the first sale starting at $10 billion in the month of March.  These asset sales, though not for immediate digestion by the Federal Reserve, must be purchased with investment dollars from private investors.   The Fed, after all, is still focused primarily on Treasury yields themselves and will remain steadfast in purchasing Treasuries before presumably beginning new talks about QE3.

For the Fed, inflation is almost a necessity.  As most investors have realized, the bulk of the portfolio of loans owned by both Fannie and Freddie are toxic, and due to the regulatory environment that permitted Fannie and Freddie to buy most anything with exposure to the risk of loss, the US Treasury sits on copious amounts of underperforming assets at a time when millions of people, still out of work, have to make the decision between paying their mortgage or putting food on the table.

However, for the millions of others who are employed, the decision to hold onto their house is a noble one.  Many buyers, now underwater, see some 15-30 years of repayments in which they will not only pay nearly double the cost of the home in interest, but in which they will also have paid more in principle than the current market value of their home.

The Fed’s Double Task

The Federal Reserve, knowing full well that inflation exists in items excluded from the core CPI—food and oil—wants to see inflation in real estate prices.  In doing so, it must continue to bid down the cost of money and ensure at the same time that homeowners feel confident to buy their own home.

Without activity in the retail space for single-family homes, the Treasury will accumulate even more losses, which again must be afforded by the Federal Reserve.  An unlimited credit line from the US Treasury means that while Fannie and Freddie may have long gone bankrupt, the printing presses of the American central bank can keep their dying models alive enough to extract what little is left - all at the cost of the US dollar.

The total cost for bailout, which now stands at just over one-quarter of a trillion dollars, is not at all absolute.  In fact, the eventual sale of all assets purchased in 2009 will require not only an improving job market, but an improving real estate market, as well as a decline in borrowing from the US Treasury.  With all these elements of a normally free market intertwined, there is only one solution: the Fed has to keep the dollar down.

Gold and silver are in a unique position to continue their rallies as these assets hit the market.  MBS debt and US Treasury debt, though not the same institutionally, still pull from the same amount of risk capital that circulates throughout the economy.  Unless this capital is made up by private investors, the Fed will absolutely have to continue indirect monetization of the two failed GSEs.  This comes at a time when the Fed’s firepower leftover from QE2 is being rapidly exhausted, and a QE3 program would be necessitated in order to liquidate Treasury assets without draining the fixed-income market.

If the Treasury continues on its fundraising campaign, QE3 is not only anticipated, but assured.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


23 Mar 11, 13:09
How Weaker Dollar and Inflation Improve the Repayment Prospects?

It doesn't make any sense to me , yet folks like you repeat the myth as a mantra. Why don't you show how a falling dollar and price basket inflation (Iassuem that's the inflation to which you refer) will make repayments of GSE backed conforming mortgages more of a sure this - especially when those that owe the money on those mortgages are not seeing their incomes go up in nominal terms. The floor is yours.

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