What the Fed's Really Doing, Who They're Bailing Out, and What's Next

Desperate times require desperate measures - that sums up what the Fed's been doing and why.

But markets haven't fully priced in their rescue and recovery programs for what they really are: an admission that "this time is different," and it's too late to stop what's going to happen next.

Here's what the Fed's doing, in layman's terms, what it says about where things are, and what's next.

How the Fed Got Us Here

The Federal Reserve System is America's private central bank. Yes, it's private; no, it's not a branch of government, and it doesn't have any magic powers, unless printing unlimited sums of money to throw at any and every economic and market problem it can is a magic power.

Sometimes it is. This time is different.

There's no need today for a long history lesson about how the Fed came into being. All that's important is why Congress passed the Federal Reserve Act of 1913.

They bought into the whole magic beans fairy tale...


Trillions of dollars of Fed “stimulus” can’t stop COVID-19 from devastating markets and economies – but it can sure make things worse. Find out how:

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Trillions of dollars of Fed “stimulus” can’t stop COVID-19 from devastating markets and economies – but it can sure make things worse. Find out how:

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After the Panic of 1908, when the nation's largest banks almost imploded from over-leveraging themselves in pursuit of profits, and J.P. Morgan had to singlehandedly bail them out, the banks decided they needed to create a central bank with the power to print their own money to hand out to themselves next time they faced insolvency.

Congress bought into the Act for one single reason. If they were to give ownership of the nation's money supply to a private central bank, which they did (the Fed owns our money - read that on top of any bill in your wallet; it says "Federal Reserve Note"), then the Fed could print as much money as Congress needed them to, to buy Treasury-issued debt. That way Congress could run deficits, issue debt to pay for all their spending to win votes, and feather their beds.

With a complicit central bank, they wouldn't have to tax to spend; their issuance of Treasury debt to pay for their spending could be bought by the new central bank with their own money, as much of it as needed. A Faustian bargain for sure, but the bargain was struck, nonetheless.

Now, again, we find the country's banks in need of rescuing, the country's capital markets in need of rescuing, the government in need of rescuing, and the whole economy in need of rescuing.

The Fed to the rescue.

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Things are so bad at America's too-big-to-fail banks that the Fed has had to pull out its 2008 playbook.

It's not that the banks are insolvent; they aren't - though if the economy sinks the way it's headed, they will be.

Banks are desperate for "liquidity." They need grease to keep their wheels turning, to be able to finance their loan books as loans sour, and need "reserves" at the ready if depositors want their money back.

So, the first thing the Fed did was inject hundreds of billions of dollars into the fed funds or "repo" market, where banks with excess reserves lend to each other overnight.

Then the Fed opened up it's "Discount Window," the direct lending window where desperate banks have to go to borrow directly from the Fed with their tails between their legs because no one in the fed funds market will "repo" with them, because no one believes they'll get their collateral back on the short-term loans they'd make them.

In other words, insane amounts of money being injected into the fed funds market isn't enough.

Then the Fed announced it was ramping up QE4, the quantitative easing program designed to pump even more money into banks.

Why? Because the banks need the money. That's the bottom line. Be afraid.

Then the Fed had to promise to spread its magic dust on money market funds. It set up a lending facility to give money to money market funds to give to depositors of those "cash" accounts who are exiting them to the tune of tens of billions of dollars every day.

Money market funds (which investors think are safe, but they are not anymore - well, they are because the Fed's rescuing them) invest depositors' money in commercial paper, the short-term loans corporations need to fund payrolls, inventories, and cash flow needs.

Since corporations are facing an existential threat - technically known as bankruptcy - if they don't have any sales, revenues, or way to pay back even their commercial paper loans, the Fed is buying commercial paper from money market funds, and in some cases from companies directly.

It's that bad.

Then the Fed offered to backstop muni mutual funds and muni money market funds. That's because investors dumping municipal bond funds means the debts, the bonds issued by municipal entities, by local governments and taxing authorities held in those funds, are being dumped to meet redemptions and their prices are going down, rendering them prone to downgrades and more selling.

Now the Fed's willing to accept corporate bonds and bond ETFs as collateral for loans.

They're doing that because they don't want investors dumping bonds and investors dumping ETFs with underlying bonds in them, to force the prices of those bonds down as dealers try and sell them.

It's that bad out there.

The Fed's using its "urgent and exigent" powers to do whatever it takes to rescue banks, corporations, and investors from the suddenly stuck economy, which has ground to a halt, preventing sales, revenues, cash flow, and trust from greasing the wheels that move America forward.

We saw this movie, but on not this big a screen, in the 2008 Financial Crisis, at the height of the crisis.

The Fed was desperately doing everything it could, which wasn't enough, and the Treasury floated the idea of a TARP, Troubled Asset Relief Program, which would require $700 billion from Congress, and be used to buy up stuck assets.

TARP was eventually passed and markets shot higher. Then reality sunk in as the coming recession looked inevitable. Capital markets, after jumping for joy, collapsed to make lower lows, until late March 2009, when they finally bottomed out.

That's what happening here, only this time the Fed's magic dust has lost its magic, as investors smell the fear and panic in successive rescue programs being rolled out, without limit, even before the bad news hits home.

We're headed for another drop in stocks, down to test their lows and support levels. That's because this time is different.

There's going to be a bottom, and a recovery, for sure. It's just a matter of when.

In the meantime, click here to check out my coronavirus roadmap to learn how to navigate each of the potential pathways the virus could take markets down. You don't want to miss it...

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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