Treasury Bonds Used in an Interesting Manner

"Opinion"

09/03/2010

Paul Munnis


Quick: “Who is the biggest buyer of U.S. Treasury Bonds?”

If you answered the Chinese – you are wrong. It is the U.S. Federal Reserve.

How come?

When Fannie Mae and Freddie Mac defaulted the Fed obtained all of their mortgages as assets. Each month the mortgage portfolio shrinks as people make payments on their mortgages.

Thus as the Fed assets shrink they need to replace them with another asset of equal value. So they buy U.S. Treasury Notes which pays the Fed (you and me) interest.

It’s odd when we buy Treasuries which gives the U.S. Government money to work with we do it in order to cover the government’s deficit spending.

The U.S. Treasury Department then pays interest to the Fed; the Fed uses the money to keep its assets sheet strong. That makes the deficit seem not so daunting.

All the while taxpayers are getting paid interest earned on the T-Bonds. The money earned and returned goes to pay off the national debt.

Seems a bit convoluted, what?

At this moment in history this is a part of what keeps the wheels of the American economy turning. In effect a money machine has been crafted by the Fed. And they have turned the Fanny Mae and Freddie Mac mortgages into assets that are earning money for us. They have gone from losses to becoming cash cows.

At some point the mortgage portfolio gets too lean as more is paid down so then what happens?

The Feds must either acquire more mortgages or it just keep T-Notes as assets.

Nobody knows yet what the Fed will actually do.

Could the Fed become the manager of mortgages for the U.S. and could this be the next step in restructuring American debt underwriting? It could happen as the Fed could just become Fannie Mae and Freddie Mac instead of institutionalizing them as quasi public corporations once again. They would loan money to banks, banks would write the mortgages then sell them to the Fed. The Fed would earn a profit from the mortgage interest and use it to pay down the national debt.

In the meantime the Fed continues to buy Treasury assets and it keeps the Fed’s portfolio balanced. It also assures a basic demand for Bonds for each issuance. It puts the Fed in a position to take up the slack in the Bond market should the Chinese ever decide to sell off U.S. Treasuries. At the same time it holds down Bond interest rates for there is a sure buyer for the U.S. Bonds.

Boehner may want to fire Geithner and Bernanke just because they are too damn smart for the Republican Party to manage.