More Details (and Questions) on Fedization

Tuesday, March 25, 2008

I don't know if there is a textbook on how to create fiat money but the latest statement by the Federal Reserve New York is at least a good attempt. I allow myself to fill in some of the gaps, trying to explain what really happens and who will make the most money. If your guess is the Fed, you have just won a free subscription to this blog.
In an effort to explain the Fedization of Bear Stearns the Fed NY put out another release in order to clarify such details as the actual cost of financing to JP Morgan after earlier agency reports had said the $29 billion entry on the asset side of the Fed's ledger was done at the discount rate.
From the Fed NY press release:
The Federal Reserve Bank of New York has agreed to lend $29 billion in connection with the acquisition of Bear Stearns by JPMorgan Chase & Co.
With a few strokes at the computer the Fed will create $29 billion out of thin air and wire it to JPM.
The loan will be against a portfolio of $30 billion in assets of Bear Stearns, based on the value of the portfolio as marked to market by Bear Stearns on March 14, 2008.
The Fed NY refuses to answer the most interesting question: What is in that portfolio and what is its value today?
JPMC has agreed to provide $1 billion in funding in the form of a note that will be subordinated to the Federal Reserve note. The JPMC note will be the first to absorb losses, if any, on the liquidation of the portfolio of assets.
Am I correct with the interpretation that JPM's risk is now limited to $1 billion and the Fed will eat the rest of these "if any" losses that may/will arise in the liquidation of these assets?
The FRBNY loan and the JPMC subordinated note will be made to a Delaware limited liability company (“LLC”) established for the purpose of holding the Bear Stearns assets. Using a single entity (the LLC) will ease administration of the portfolio and will remove constraints on the money manager that might arise from retaining the assets on the books of Bear Stearns.
The biggest constraint could be the ability to find a market price that will not kill the entire structure of this bailout.
The loan from the FRBNY and the subordinated note from JPMC will each be for a term of 10 years, renewable by the FRBNY.
As long as the music plays the Fed will collect interest on $29 billion it created with its electronic printing press. What a handsome return for a couple of man-hours at the computer. To quote Fed chairman Ben Bernanke from his infamous speech given in November 2002, "the US government has a technology, called a printing press - or, today, its electronic equivalent - that allows it to produce as many US dollars as it wishes at essentially no cost."
The rate due on the loan from the FRBNY is the primary credit rate, which currently is 3.25 percent and fluctuates with the discount rate. The rate on the subordinated note from JPMC is the primary credit rate plus 475 basis points (currently, a total of 8 percent).
Money For Nothing - But No Mention Of The Chicks
This fiat money game sure is fun for the Fed.
3.25% p.a. on $29 billion is a cool $942.5 million. Multiply by 10 years and add the $29 billion principal and you arrive at a hot $38.425 billion, provided it all works out as planned. On top of that come another $800 million interest and $1 billion in principal from the JPM note.
In this case Fedization is such a good business that the Fed is very likely to take more ailing gamblers onto its breast. I mean, $40.225 billion for basically no costs, who could withstand?
To muffle my Fed-rage I can easily resort to the dire outlook that maybe this rescue works for a while; but there are certainly a few more technically bankrupt financial entities out there.
Blackrock Financial Management Inc has been retained by the FRBNY to manage and liquidate the assets.
Another hand pilfering the corpse of Bear Stearns.
The Federal Reserve loan is being provided under the authority granted by section 13(3) of the Federal Reserve Act. The Board authorized the FRBNY to enter into this loan and made the findings required by section 13(3) at a meeting on Sunday, March 16, 2008.
I remember having seen some questions as to the legality of this Fedization earlier this day.
Repayment of the loans will begin on the second anniversary of the loan, unless the Reserve Bank determines to begin payments earlier. Payments from the liquidation of the assets in the LLC will be made in the following order (each category must be fully paid before proceeding to the next lower category):
  1. to pay the necessary operating expenses of the LLC incurred in managing and liquidating the assets as of the repayment date;
  2. to repay the entire $29 billion principal due to the FRBNY;
  3. to pay all interest due to the FRBNY on its loan;
  4. to repay the entire $1 billion subordinated note due to JPMC;
  5. to pay all interest due to JPMC on its subordinated note;
  6. to pay any other non-operating expenses of the LLC, if any.
Any remaining funds resulting from the liquidation of the assets will be paid to the FRBNY.

Doesn't sound as if the Fed would expect the $29 billion portfolio to rise by just one dollar.
Is the Fed already preparing for a bailout/takeover of General Motors? First payment after 2 years sounds like a car dealer desperate to move his declining inventory. But in the case of the Fed the inventory consists mostly of Federal Reserve Notes, wrongly called US dollars. I take this as another sign that their product is going out of fashion much faster than most people think.

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