Looking back at 2008, everyone now recognizes that the problem was too much leverage. But how much leverage was too much leverage?
Prior to the crisis, leverage ratios had reached critical levels. Bear Stearns was leveraged a whopping $42 in debt for every $1 in equity just prior to collapse.
So if 42:1 leverage was a big deal… how are we supposed to feel about the Federal Reserve whose leverage is almost double that? Today, The New York Times, asks with a profound lack of alarm: “Can the Fed go down the tubes, in the same way that Bear Stearns, Lehman Brothers and Merrill Lynch did”?
In the midst of the Federal Reserve’s creative but controversial quantitative easing program — the five-year plan of buying billions of dollars in debt securities each month and forcing down interest rates to historically low levels — the central bank’s balance sheet has ballooned to nearly $4.3 trillion in assets from $800 billion, leaving one large unanswered question hanging over the marketplace: What does the Fed intend to do with all those bonds?
Can the Fed’s equity capital of $56 billion — yes, the Fed is leveraged 77 to 1 — be wiped out? A mere 1.3 percent change in the value of those $4.3 trillion in bonds would theoretically wipe out the Fed’s equity. Can the Fed go down the tubes, in the same way that Bear Stearns, Lehman Brothers and Merrill Lynch did?
To be clear: The Federal Reserve cannot possibly exit from the corner it has painted itself into. All proposals to the contrary are simply not credible, have no basis in history and involve far too much hand waving and wonkish postulating to be a part of any rational set of predictions.
Let’s be clear: Financial policy in the USA is currently being set by radicals.
These are not conservatives. These are not even responsible adults. These are radical theorists who are testing historically unprecedented policies which have no basis in reality, and for which the supporting evidence has yet to materialize. In fact, the evidence of their outright failure continues to flood in on a daily basis.
Furthermore, every one of their policy initiatives has failed thus far, and required an equal or greater round of “QE” to stave off the implosion that must naturally follow.
Which brings us to today: Now the Federal Reserve is leveraged 77:1 (or nearly twice the level of Bear Stearns). And they’re really not even trying to pretend there’s an exit plan, because they already know it will fail.
The entire rationale behind a private Federal Reserve system is to prevent excessive debt/leverage from building up in the system. And yet under the radical and historically-unprecedented policies of Mr. Bernanke, the Federal Reserve is now leveraged a whopping 77:1 and lacks any trace of an exit plan. The road we’re on isn’t just “one way” that empires collapse. This is the typical way.
It is time to replace the radicals in the Federal Reserve with responsible adults who recognize that banks must be allowed to fail, and that those who take on systemically dangerous amounts of leverage must be tried, found guilty and jailed.