Wednesday, July 28, 2010

Bernanke's 2012 Surprise

New Jersey Congressman Scott Garrett of the House Financial Services Committee asks Ben Bernanke some great questions. Start preparing for 2012 my friends.!

SCOTT GARRETT: You bought over a trillion dollars of GSE debt, and to that point, under normal circumstances, on the Fed’s balance sheet what you have on there are Treasuries, or if you had anything else on there, I assume you would have a repurchase agreement for those securities on your balance sheet. Now of course around two-thirds of that are in GSE debt.

GARRETT: So right now, those are guaranteed – whether they’re sovereign debt or not, we don’t know – but they’re guaranteed by the U.S. government. But they’re only guaranteed to when? 2012, right? After that, Congress may in its wisdom make another decision, and at that point in time, you may be holding on your balance sheet – two thirds of your balance sheet – something that is not guaranteed by the Federal government. First of all, you don’t have a … do you have a repurchase agreement on those with anyone? No.
BERNANKE: I don’t know what you mean by a repurchase agreement. We own those securities.
GARRETT: You own those securities. Right. So there is no repurchase agreement outside to buy them back. You own them.
GARRETT: So after 2012, if they’re no longer guaranteed, is it fair to say that you may at that point in time actually engage in fiscal policy, because you basically are creating money at that time? And I know that you’d agree that it would be an unconstitutional role for the Fed to engage in fiscal policy – so where will you be at 2012 if they had to take a haircut on those because they’re no longer guaranteed?
BERNANKE: Well, first from the government’s perspective, I, uh, such an act would, uh, there would, the Federal Reserve would lose money which the Treasury would gain. There would be no overall change to the position of the U.S. government. Secondly, the Federal Reserve act explicitly gives.
GARRETT: How would we be gaining? How is the Treasury gaining?
BERNANKE: Well, if there’s a bad mortgage and the Treasury.. it requires $10 to make it good, if the Treasury refuses to do that then the Fed loses $10, so one way or another the government’s going to lose $10. But I would just say two things, one is that I think, uh…
GARRETT: But if you didn’t purchase them in the first place, it would just be a total – then what would have occurred? There would not have been the creation of that $10. Now that you’ve purchased them, and in essence if we don’t back them up, then you will have created that additional $10.
BERNANKE: Well, I hope that doesn’t happen, because I think it’s very important for financial stability and confidence that we, that we guarantee…
GARRETT: Let’s play out that hypothetical that it does happen.
BERNANKE: Well, then the Fed would lose money there. But let me just point out that the Federal Reserve Act, that we did not invoke any emergency or unusual powers to buy those agencies. It is explicitly in the Federal Reserve Act that we can buy Treasuries or agency securities and so we did not do anything unusual there.
GARRETT: In what status were they when you bought them? Were they in conservatorship at that point?
BERNANKE: Um, yes.
GARRETT: Is it normal practice for the Fed to buy agency securities when they’re in conservatorship? Was that ever done before?
BERNANKE: It’s never been in conservatorship before.
GARRETT: Well, there you go. So the normal practice is not what was followed here. It just seems to me that we may have gone down a different road than we’ve ever gone down in U.S. history, where the Federal Reserve has engaged in buying a security, it’s not Treasury, it’s not guaranteed by the full faith and credit of the United States for its lifetime, nor is there any repurchase agreement from any other entity that you purchased – that you have a trade with an agreement with – and that the Fed in essence could have created money if the government does not guarantee them. At least, that could be the situation we could find ourselves in 2012.

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