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