The Federal Reserve System, America's private central bank, has a problem. Actually, make that two related problems:
- Its massively bloated balance sheet shows assets worth $4.5 trillion, and…
- In the bank's new era of "transparency," unwinding that balance sheet will disrupt markets.
The Fed has painted itself into a dangerous corner, and the smartest way to get out of it is probably what it's least likely to do.
How Fed Transparency Became a Market Necessity
Historically, Fed officials didn't speak much about prospects for the economy or markets, or about their policy decisions. In fact, they didn't speak much about why they do what they do even when they were conducting open market operations.
As recently as 1987, in his testimony to Congress, then Fed Chair Alan Greenspan explained, "Since I've become a central banker, I've learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said."
That all changed with the 2008 financial crisis.
With markets in free fall, two major investment banks wiped out, and the biggest banks in America essentially insolvent, the Federal Reserve took unprecedented action.
The Fed was providing unlimited liquidity to faltering banks – including foreign banks – and agreed to let both Morgan Stanley and Goldman Sachs, two giant investment banks, become commercial banks to get access to the Fed's discount window and liquidity lines. All the while, critics in Congress who blamed the Fed for creating the subprime crisis and then bailing out their bank constituents demanded transparency out of the nation's private central bank.
The cries of "Audit the Fed!" over the Fed's hand in abetting the crisis with its artificially low rates and bailing out of bad actor banks wafted through Congress. Pretty soon, Fed officials (starting with Fed Chair Ben Bernanke) began a course of greater transparency.
They had to.
Telegraphing low interest rates for the foreseeable future and announcing regularly scheduled "large-scale asset purchases," the Fed's reference to what the rest of the world calls quantitative easing, was the Fed's way of calming markets and letting them know it wasn't going to stop backstopping big banks, the bond market, or equities markets.
Fed transparency had become a market necessity.
But now, expected and demanded transparency is going to backfire on the Fed. It will disrupt the very same markets the Fed had used "announced transparency" to backstop and push higher and higher.
The underlying problem is the $4.5 trillion of "assets" on the Fed's so-called balance sheet.
Those assets are U.S. Treasury bills, notes and bonds of various maturities and mortgage-backed securities… Presumably, all government-backed "agency" securities.
Fed officials have been testing the waters about moves to unwind their balance sheet since the last Federal Reserve Open Market Committee (FOMC) meeting. Recently released meeting minutes revealed th…
About the Author
Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.