Comment by ergoproxy | Hacker News Reader

Comment by ergoproxy | Hacker News Reader

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I think people are missing the main point. Debt-equity swaps have been a major tool of the Federal Reserve in bailing out TBTF banks. Here's how it works:

I'm a banker. I paid $10B for MBSes in 2007. Big mistake. In 2008, their valuation fell to $0. So I do a swap with the Federal Reserve. I give Ben Bernake my portfolio of MBSes. And he gives me $10B in US Treasury Bonds he's purchased.

I never would have made a dime off my MBSes. But now, the US tax payer is on the hook for paying me $10B in principal plus interest. Meanwhile, the Fed puts "$10B" of MBSes on its books. Doesn't matter that these debts are worth zero. They get to do it...

Right now, the Fed has "$1.5T" of MBSes on their books from doing these deals. Source: http://money.cnn.com/2013/12/19/news/economy/federal-reserve...

I used to be VP of Mortgage Tax and Accounting at a Wall St. bank back in the 90s, and I try to stay up to date on this fiasco. I don't have a problem with what Chris Hedges said, just how he said it: he said it too fast, and it came out wrong. The main idea is still right.

Technically I suppose the MBS issuers are now a subsidiary of the Treasury. But I'm not sure about the 'worthless subprime debt' part. They're buying good quality MBSs in order to keep rates down and support the housing market, not to take toxic assets off the books of financial institutions.

It's important to note that the Fed is purchasing these securities at "face value"...they're not doing any kind of valuation.

Lawrence Hunter wrote an op-ed for Forbes back in 2012 saying the Fed's (at the time) "$1.3T" of MBSes were "worthless." http://www.forbes.com/sites/lawrencehunter/2012/10/29/are-fe...

My main job was pricing MBSes. The calculation is basically sum of discounted contingent cashflows. Even before the 2008 crisis, back in the mid 90s, I'd often see MBSes with a negative net income. Then I'd get frantic phone calls from upset clients, often accountants or CFOs or brokers, who couldn't understand how a valuation less than zero was even possible, and I'd have to explain how their expected expenditures were going to be greater than their revenues...

I tend to agree with Hunter and Hedges that the Fed's "$1.5T" of MBSes are mostly worthless.

That said, I also understand the reasons why the Fed is making these purchases: increase MBS prices, increase liquidity in the MBS market, and so forth. But the bigger reason still seems to me: bail out TBTF banks.

For the Fed's POV on this subject, they publish FAQs and data on their "MBS Purchase Program" several places:

http://www.federalreserve.gov/newsevents/reform_mbs.htm

http://www.newyorkfed.org/markets/ambs/ambs_faq.html

http://research.stlouisfed.org/fred2/series/WMBSEC

Thanks for taking the time to post the links. However I have some issues.

Firstly, the Fed is purchasing agency MBSs at market rates. They are pushing prices up since they are bringing demand to the market, but they are otherwise bidding competitively. The idea that these MBSs are basically worthless doesn't make sense when there is a large market for them.

Secondly a lot of the MBSs (which are all government guaranteed) are newly issued, so it can hardly be said they are helping TBTF banks decant their toxic assets leftover from the financial crisis.

Thirdly, the Fed actually eventually made a profit on the toxic debt they acquired during the bailouts. The current MBS purchase programs are far less risky. Furthermore, the US Gov has guaranteed the future cashflows of all these MBSs... so I think TBTF banks are a sidenote on this whole issue.

> the Fed is purchasing agency MBSs at market rates

In what way are they "market rates" when the Fed printed $1.5T out of thin air to purchase them? Rather, The Fed is using its market power to set the prices of MBSs.

But it's not like they started bidding on these at 10cents on the dollar and have pushed them all the way up to par. If you look at the transaction data, starting from 2009 the prices have always been round the 100 mark, give or take a percent or two. And why wouldn't they be? The Gov has guaranteed all of these!

> The Gov has guaranteed all of these!

The word "guarantee" gets tossed around a lot, but it's misleading:

Fannie and Freddie's "implicit guarantee" only means that the government will lend these GSEs funds to ensure timely payments of principal and interest to mortgagees (not MBS investors!), at rates slightly above the government's own borrowing rate, up to the "conforming loan limit" which is $417,000 in most areas. So it doesn't entirely eliminate default risk. And it doesn't reduce servicer risk or interest rate risk at all.

Only in 2013 with QE3 did The Fed start buying Ginnie Mae MBSs with an "explicit guarantee" that entirely eliminates default risk. (These securities still have issuer/servicer risk.) But The Fed is still buying non-Ginnie MBSs as well.

> the Fed actually eventually made a profit on the toxic debt they acquired during the bailouts.

The Fed made $90B in profits in 2012, but they were only able to do this by printing $85B per month in QE. In other words, they're printing profits...something you and I are not allowed to do legally. The bigger question is: If they're printing $1T/yr, why are they only making a measly $90B/yr in profits?

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