Why Is The Fed Happy Buying All Those Mortgages? Because You’re Guaranteeing Them!

Courtesy of John Carney at Clusterstock/Business Insider

Despite the huge and unprecedented rise in the Federal Reserve’s exposure to mortgage backed securities, the Fed says that it is unlikely to face any losses because it is only buying securities backed by Fannie Mae, Freddie Mac and Ginnie Mae.

This is meant to reassure policy makers and the public that the Fed is prudently protecting its balance sheet against losses. Protection against losses at the Fed is important to the public for three reasons.

Fed profits are an important source of revenue for the US Treasury. Any shortfall in that revenue will force the Treasury to borrow more or raise taxes.

Losses at the Fed could hurt its flexibility when it comes to policy decisions. Despite all appearances, the Fed does not have unlimited flexibility to manipulate interest rates without triggering inflation. If the Fed is facing serious balance sheet losses, it will be more difficult to continue low interest rates to combat a recession.

The prestige of the United States is on the line here. A faltering Fed will sap confidence around the world in the US, making it harder for both private and public institutions to raise capital in both debt and equity markets.

In short, the American people are hugely exposed to any losses at the Fed.

Which is what makes it so bizarre that we’re meant to be reassured by the fact that the Fed’s exposure to mortgage securities is limited by taxpayer guarantees from Fannie, Freddie and Ginnie. It’s taxpayer losses all the way down.

To make the situation even more mind boggling, we’ll add a further twist. The massive borrowing of the US government is supported, in part, by the Federal Reserve buying Treasuries. That is, the Fed is funding the very same government it is relying on to fund any losses from mortgage securities.

Look at it this way. Deep losses in the Fed’s mortgage portfolio would trigger payments from the Treasury backed mortgage insurers, which would have to be funded by the issuance of debt, some of which would have to be bought by the Fed to keep the borrowing costs down.

Don’t you feel safer already?