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The Fed's Hidden Agenda

Is a Secret Bank Bailout Coming?

Written by Geoffrey Pike
Posted February 21, 2014

I've heard a few stories about people worried about the condition of the banks.

I've heard other stories alluding to a future bank bailout.

Some people fear what happened in Cyprus is coming to the U.S. They fear their money is not safe in the banks.

And they're right to worry about the money they have in the bank... but not because of a coming confiscation in the style of Cyprus.

Truth is, there is little need to worry about the government coming in and directly confiscating funds from your U.S. bank account. You do have to worry, however, about the government and the Fed working to destroy the value of the money that is in your bank account.

You also likely don't need to worry about your bank going bankrupt as long as you are within the FDIC limit (currently $250,000). It is not that the FDIC has the money to bail out the major banks; it's that the Federal Reserve can do it by creating money out of thin air.

I also don't think you have to worry about another bank bailout in the fashion of 2008. There is rarely an economic issue where there is so much agreement amongst the American people, but in 2008, 90% or more of the American voting population was adamantly opposed to the bank bailouts. The government and Fed almost had a revolution on their hands.

They are not going to let that happen again. Instead, the Fed has been quietly bailing out the banks for almost a year and a half now with few cries of opposition. Why risk causing a revolt when they can do it this way?

The Hidden Agenda of QE3

In September 2012, the Fed announced a new buying program. It was the third round of quantitative easing, or QE3 for short. The Fed had already gone through two previous rounds of quantitative easing starting in late 2008.

Quantitative easing is just another term for money creation. The Fed simply buys assets with new money created out of thin air. We use the term "money printing," but most of the new money is actually in the form of digits.

Prior to 2008, the Fed would buy government debt. It would typically buy shorter-term U.S. Treasuries, but it could also buy longer-term debt. It wasn't until the fall of 2008 that the Fed started a policy of buying other assets aside from government bonds.

QE3 actually came about in two steps.

The first one, in September 2012, announced that the Fed would buy $40 billion per month in mortgage-backed securities, or MBS. It wasn't until December 2012, three months later, that the Fed upped the ante and announced it would buy $45 billion in new U.S. government debt each month. This was in addition to the $40 billion per month in MBS.

So the Fed was buying $85 billion in assets through most of 2013, essentially creating $85 billion per month out of thin air. It was just back in December of 2013 that the Fed finally announced the beginning of its taper. It is still buying assets (inflating the money supply), but at a slower pace.

When the buying program was first announced for the MBS, the Fed and the media touted it as a plan to help housing. They reasoned it would lower interest rates and help boost a struggling housing market that had recently come off of a major bust.

While housing across the country has certainly recovered a bit (although not to the all-time highs in most areas), we can't be sure how much QE3 has affected mortgage rates. The rates were already very low when the Fed began buying MBS.

But I believe the main purpose of QE3 was not as stated. Instead, I believe the main purpose — at least for the portion of buying MBS — was to bail out the banks and make them more solvent.

Interestingly, I have seen very little commentary pointing this out, even among many websites devoted to criticizing the Fed. In this sense, the Fed's plan has worked brilliantly (though not for us). It has been able to bail out the banks without having any backlash like it experienced back in 2008.

Buying Toxic Assets

For almost a year and a half, we have been hearing about the Fed buying mortgage-backed securities (MBS). But we are never really told exactly what they are buying and how much they are actually worth.

So what is this $40 billion "worth" of MBS per month really worth? Our best guess is that these are so-called toxic assets. They are non-performing or under-performing loans.

When the housing bubble burst around 2007, most new (and even not so new) homeowners who had mortgages were underwater. Their mortgages were bigger than the values of their houses. In many cases, people simply could not afford the payments. They had miscalculated their ability to pay.

Ironically, most of the distortion took place because of the Fed and its policy of loose money and artificially low interest rates.

As a result, many mortgages held by the banks and government agencies quickly lost value because so many people stopped paying their mortgages.

If the Fed buys $40 billion of MBS in a month, is it really paying the current market value, or is it paying what they were originally worth? My guess is the latter.

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This is a pure bailout of the banks, plain and simple. They are buying $40 billion each month in assets that aren't really worth $40 billion because many of the mortgages are in default. Pooled together, they are worth something, as some people will continue to pay or try to resume paying.

Imagine a company buys a stock for $100 per share, and then the value falls to $40 per share. Then the Fed comes along and says, "We are going to buy your shares from you at the original price of $100 per share."

In this scenario, the company would be getting bailed out to the tune of $60 for every share bought up by the Fed.

It doesn't matter what the asset was originally worth. It matters what it is worth today. In the case of MBS, the Fed is buying assets that are worth far less than what it is paying for them. It's buying these assets with money created out of thin air.

If you were a bank that had a bunch of mortgages worth a total of $5 billion that originally cost you $20 billion, then you would probably be more than happy for the Fed to come along and buy them up at the original value of $20 billion.

You can push your losses off to the Fed, which is really pushing your losses off on anyone who uses U.S. dollars.

Crazy?

This may sound crazy, but in some ways I prefer the Fed secretly bailing out the banks to it buying U.S. government debt.

At least the money going to the banks is helping to make them solvent, so it isn't a complete waste.

It is bad that we see big bonuses for banking executives that would otherwise be out of business if it weren't for the bailouts. It is bad that the bailouts create moral hazard and encourage more risk-taking in the future. And it is bad that the whole thing is inflationary.

But at least the bank bailouts are going to where you keep your money. The only bigger revolt by the American people than an open bailout would be bank failures without a bailout where the FDIC does not make good on its promises.

Meanwhile, the other part of QE3 — the Fed's buying of government debt — is terrible. It allows the government to run massive deficits at lower interest rates, preventing spending cuts and making things far more painful in the future. The government's spending severely misallocates resources and will only lead to a major correction at some point in time.

Regardless of your thoughts on the subject, you probably don't have to worry about major bank failures right now. Small banks will be absorbed by the bigger banks if they fail, and bigger banks are being taken care of right now. Even with the so-called tapering, the Fed is still currently buying $30 billion per month in MBS.

If you keep your money in an FDIC-insured bank account, it will probably be safe — at least in terms of any direct confiscation. But if you really want to keep it safe, you will probably need to put some of it in hard assets to protect yourself against continued inflation.

Until next time,

Geoffrey Pike for Wealth Daily

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