Here we go again: Is the Federal Reserve solvent?

Posted Sep 18th 2008 10:10AM by Peter Cohan
Filed under: Amer Intl Group (AIG), Lehman Br Holdings (LEH)

The New York Times reports that the Federal Reserve has less reserves. Specifically, a year ago it had $800 billion in reserves and that number is down 63% to $300 billion. The other $500 billion is "encumbered" -- that's a nice way of saying that instead of being invested in "safe" Treasury bills, the Fed owns the assets of American International Group (NYSE: AIG), $29 billion worth of grubby former Bear Stearns collateralized debt obligations (CDOs) and the like through a little something it calls "Maiden Lane LLC", and tens of billions worth of the same from Lehman Brothers Holdings Inc. (NYSE: LEH) and other banks.

I raised the question of Fed solvency in July. Whether it was solvent then, it is less so now. But is there a limit to how much money the Fed can create to fund itself? With demand for Treasury Bills skyrocketing (albeit at interest rock bottom interest rates of 0.14% for the 1-month bill), it looks like now would be a great time for the Fed to replenish its coffers by issuing a trillion dollars worth to shore up its balance sheet. If it can indeed do that, the downside is that these low rates will pay it very little income.

And assuming that the Fed does not want to be in the business of owning half a trillion worth of encumbered assets, it will eventually need to get rid of them. And in so doing, it could find itself in competition with the ever- dwindling portion of the investment banking and insurance industry which the government does not own. How so? Because the Fed will be competing to get the best price for the assets it is trying to sell.

Will it use its power to put those publicly traded companies in a pickle? Or will it forgo the advantage to the taxpayer so its competitors can profit? Beats me.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns AIG shares and has no financial interest in the other securities mentioned.

Tags: aig, american international group, AmericanInternationalGroup, ben bernancke, ben bernanke, BenBernancke, BenBernanke, federal reserve board, FederalReserveBoard, inthenews, leh, lehman brothers, LehmanBrothers, The Fed, TheFed

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Reader Comments (Page 1 of 1)

9-18-2008 @ 1:35PM

sally higgins said...

Whether or not AIG 's holding company will survive depends on who is elected th new President of the U.S. If Obama wins we will definitely have a deep depression. When he raises all those taxes, the ultra rich will take their money outside the country and invest it overseas or stick it in an overseas account to avoid paying taxes. The future of our economic future is in the voters hands.

9-18-2008 @ 5:10PM

Bob said...

Sally, your right. I'm not ultra rich but am ready to retire, own 4 small business' that puts me in the top 1% income wise. I'm already having meetings with like minded people about what to do, O'Bama or not. The dollar is doomed, cash needs to be put somewhere safe. Hidden if you will. There's no legal way and no safe place to preserve it. If O'bama does get elected you will see a drastic change in tax income and a panic by those with money. I just want out and am desperately searching for a place to go. My friends and I will figure it out.

10-03-2008 @ 9:45PM

Bob Del Castillo said...

If you don't call 9 a trillion dollar deficit created under the present administration a tax on US citizens, you need a reality check. I don't know if Obama will cure all our ills but I know voting for someone who supported the present administration's economic packages, over 95% of the time is not the answer.
I'd also like to know what makes you think the ultra rich are even interested in the average US citizen. They have one business goal. Separate us from our money.
Bob

9-19-2008 @ 12:11AM

F. AbdelWahab said...

Of course, we are all worried about our money both the so-called rich and the
middle class, along with the poor. We certainly would be stupid to vote for someone who has already proven they were aligned with an ill-thinking party. Why put them back in the same Driver's seat? O'Bama has shown that his thinking was right on target too many times. He has the right, intelligence and temperament to lead us sensibly. I believe this will not be an overnight affair for anyone, no matter who. Anyway, a new broom sweeps clean!!

9-19-2008 @ 5:01AM

Dan Barnett said...

O'Bama? When did he become Irish?

9-19-2008 @ 12:59PM

contrariansite said...

The Fed has blown through 18% of its reserves just covering IndyMac...what about the 1000 that are on the "watchlist"?

9-19-2008 @ 6:16PM

miketreeboy said...

Hey: our elected officials have no control over the Federal Reserve Banking Corp. It is privately owned and only does it's own will. If you do not believe this , look it up for yourself.

9-19-2008 @ 10:25PM

iftoo said...

Hey Sally. The rich can do what they want, but guess what? The overseas markets are just as depressed if not more... That money's not going anywhere except maybe to china...