Tuesday, December 11, 2012

With The Federal Reserve Balance Sheet Approaching $4 Trillion How Will They Ever Unwind?

Now is the time we juxtapose (and time travel a bit).
First up, Bloomberg Dec. 11:

Fed Seen Pumping Up Assets to $4T in New Buying
The Federal Reserve will amplify record accommodation tomorrow by announcing $45 billion in monthly Treasury buying that will push its balance sheet almost to $4 trillion, according to a Bloomberg survey of economists. 

Forty-eight of 49 economists predict the Federal Open Market Committee will purchase Treasuries to bolster an existing program to buy $40 billion in mortgage bonds each month. The panel pledged in October to continue that plan until the labor market improves “substantially.”

“It’s going to be massive and open-ended in size,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York and a former New York Fed economist....MORE
And from Trust Your Instincts, Dec. 8:

Greek banks demonstrate how Fed can ultimately shrink its balance sheet
...The bigger the balance sheet, “the riskier the exit becomes,” Richmond Fed President Jeffrey Lacker said during a Nov. 20 speech in New York. “That is something we need to think carefully about.” 
Krishna Memani, director of fixed income at OppenheimerFunds Inc., said a too-rapid sale of assets risks disrupting the $5.2 trillion market for agency mortgage debt.
Tyler Durden at ZeroHedge looks at the Fed's balance sheet problem and concludes in an excellent post that it simply cannot be done.

The reason that it cannot be done is that quantitative easing has effectively destroyed the long-term US treasury bond market ... the Fed is buying these securities at a far higher price than any investors would and has effectively driven investors out of the market.
“They have to find ways of unwinding the balance sheet without dumping all of it in the marketplace,” said Memani, who oversees a bond portfolio of about $70 billion, including about $6 billion of mortgage-backed securities.
Regular readers know that your humble blogger has proposed a way for the Fed to unwind its balance sheet that doesn't require dumping all of it in the marketplace.  This past week, with their participation in the Greek sovereign debt buyback, the Greek banks demonstrated how the Fed can unwind its balance sheet.

As reported by Reuters,
Greece's five biggest banks said they would take part in the country's debt buyback which expires on Friday, putting Athens on track to meet targets set by international lenders.... 
Athens has pressured its banks, which hold an estimated 17 billion euros (13 billion pounds) out of the 63 billion in eligible bonds, to sell and they had been expected to do so since they depend on bailout funds that a successful buyback would unlock.....
Banking sources earlier said the banks had asked their boards to approve selling back as much as their entire holdings. 
"The proposals by banks to their boards were positive on the buyback offer, asking for approval to participate by up to 100 percent," said one banker, who declined to be named....
Greek banks - already battered by the country's debt crisis - have been hit further by fears that they would be forced to book losses from the buyback. 
Finance Minister Yannis Stournaras, who has told banks it was their "patriotic duty" to ensure the scheme is a success...
The Greek banks are "selling" their government bond holdings and then, because they are subject to Basel III and its liquidity provisions, turning around and buying new government bonds.

This same model can be used in the US to help the Fed unwind its balance sheet.

First, in recognition of how valuable the combination of deposit insurance and access to unlimited central bank liquidity is, the banks can "donate" their holdings of government bonds to the US Treasury....MORE