MBS Op-Ed: Q&A with the Readers
I must say the blog has been bustling with activity recently. You guys have been communicating tremendously with us after almost every post. Each comment adds perspective and furthers the discussion. Thank you all for your participation!
On that note after perusing today's posts for commendable comments I noticed a seemingly informed statement made by one reader. Here is the comment:
This comment is exciting and makes us proud....
The Fed is balancing our $14.264 trillion economy on a crisis filled tightrope. Total US Federal Debt is in $10.667 trillion and growing. CLICK ON ME TO GO TO FEDERAL DEBT SITE . Based on dollar GDP predictions (BEA REPORT) US Federal Debt is now 75% of GDP (Public Debt is $6.363trillion or 45% of GDP). This statistic draws historical comparisons to the post-Great Depression era.
Naturally this is alarming not only for consumers but for our leaders on Capitol Hill as well. In the current contractionary economic environment, as unemployment rates worsen, US Tax Revenues will lessen. Government bailouts have bred more bailouts and protectionism has taken over. All while TARPs and Stimulus Packages are planned to jump start economic activity. Government spending is on a record pace.
Here lies the problem in very simple terms...government income is less than government expenses...we are operating by deficit spending. This cannot continue or the budget deficit will grow at an increasingly faster rate and eventually the US Economy will spiral into a depression. So US financial leaders had to take control ... and they did.
The Fed is now supporting financial markets by artificially manipulating borrowing costs of all kinds. They are purchasing Treasuries (bills notes bonds and TIPs), commercial paper, Agency Debt (FN and FRE bonds), MBS, ABS....they are participating in reciprocal currency arrangements, repo agreements, term credit auctions, liquidity facilities, bailouts, swaps and special drawing rights accounts...
Furthermore the Fed is even considering the purchase of longer term Treasury securities which would essentially give the Fed complete control over the yield curve and most other fixed income markets. Participating in money and capital markets is in line with the Fed's primary objectives. FED FAQ. In the process of doing so the Fed has also manipulated borrowing costs in a such a way that they have essentially granted themselves the opportunity to take advantage of "positive carry".
The basic premise behind the carry trade: you borrow $100 at 5.00% from your local bank. You reinvest that $100 in a bond that pays 6.00%.
Cost to borrow $100 at 5.005 = $5.00
Income from Bond investment at 6.00%: $6.00
Net out/carry trade profit: +$1.00
Of course this example makes several assumptions, but the trading strategy is clear nonetheless. $1 positive carry.
Plain and Simple: To save the US Economy from pending doom, the Fed has resorted to playing the banking game on the grandest of scales. When dealing with debt on a macroeconomic level, every basis point interest paid or received makes a difference...which leads me to:
If the Fed's goal is "to promote the resumption of sustainable economic growth and to preserve price stability" ...
Why are they buying 5.50% MBS???Why wouldn't they purchase 4.0s and 4.5s all the time?
I posted this question last Friday and have gotten some great responses, but not enough. I will post my answer tomorrow afternoon. I look forward to reading your responses until then...