Author Topic: Fed Buying Berkshire Bonds  (Read 1428 times)

bci23

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Fed Buying Berkshire Bonds
« on: July 10, 2020, 07:28:51 AM »
This is a serious question that I'm only looking for serious answers on.

Can someone explain to me the argument for why the fed buying the bonds of a company like Berkshire Hathaway helps the economy in any way? I can't think of any legit answer that could possibly justify it. I can at least see the argument (but don't agree with) for propping up the bonds of companies that need to tap the bond market for additional liquidity like Boeing or Delta but companies like Berkshire and Apple have zero liquidity concerns so what is the argument for printing money to prop up the bonds of companies like that?


wabuffo

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Re: Fed Buying Berkshire Bonds
« Reply #1 on: July 10, 2020, 07:45:51 AM »
The Fed can only buy "safe assets" because it is mandated by Congress to never take losses on its lending programs. 

The Federal Reserve has total assets of $6.9t against "equity capital" of $48b - so it is "levered" 144-to-1.  Usually the Fed only buys US Treasury debt and the MBS of Federal agencies (with implicit Fed govt credit guarantees) and thus credit risk on these assets is effectively zero.

While the US Treasury has stepped in to provide an additional "cushion" for some of the Fed's new asset programs - it is still only $114b of additional buffer and the Fed is still "levered" 43-to-1.   So even 2% losses would make the Fed "insolvent".   

This would create an unacceptable technical risk that the Fed could not cover 100% of the liabilities it has created (mostly bank reserves and currency in circulation).  It could result in a payment failing to clear in the inter-bank settlement markets that the Fed could not cover with an overdraft or discount window loan.  Rule #1 for the Fed is "never allow a payment failure to occur in the inter-bank clearing market (Fedwire)".

Of course, the Fed could get new equity from the US Treasury via Congress (which can print unlimited dollars) but it would cause a financial crisis as Congress deliberated over it.

The "dodgy" stuff must be supported by acts of Congress via the US Treasury (eg. airline loans), because it exposes the US taxpayer to potential losses.

wabuffo
« Last Edit: July 10, 2020, 07:55:51 AM by wabuffo »

boilermaker75

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Re: Fed Buying Berkshire Bonds
« Reply #2 on: July 10, 2020, 11:10:36 AM »
This is a serious question that I'm only looking for serious answers on.

Can someone explain to me the argument for why the fed buying the bonds of a company like Berkshire Hathaway helps the economy in any way? I can't think of any legit answer that could possibly justify it. I can at least see the argument (but don't agree with) for propping up the bonds of companies that need to tap the bond market for additional liquidity like Boeing or Delta but companies like Berkshire and Apple have zero liquidity concerns so what is the argument for printing money to prop up the bonds of companies like that?

To inject money into the economy.

wabuffo

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Re: Fed Buying Berkshire Bonds
« Reply #3 on: July 10, 2020, 11:21:31 AM »
To inject money into the economy.

How does trading bank reserves for a BRK bond that now sits in an account at the Fed inject money into the economy?  Bank reserves are settlement balances that remain on deposit at the Fed and never leave it.

At the margin, I suppose it removes a few bonds from the market and tightens supply/lowers yields - but I'm not sure that is a huge macroeconomic benefit.  The flip side is that the private sector has lost a liquid asset (BRK bond) and gained an illiquid one (settlement balance at the Fed).

wabuffo

boilermaker75

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Re: Fed Buying Berkshire Bonds
« Reply #4 on: July 10, 2020, 11:34:50 AM »
To inject money into the economy.

How does trading bank reserves for a BRK bond that now sits in an account at the Fed inject money into the economy?  Bank reserves are settlement balances that remain on deposit at the Fed and never leave it.

At the margin, I suppose it removes a few bonds from the market and tightens supply/lowers yields - but I'm not sure that is a huge macroeconomic benefit.  The flip side is that the private sector has lost a liquid asset (BRK bond) and gained an illiquid one (settlement balance at the Fed).

wabuffo

I misunderstood what they were doing, this was not an open market operation.

Mephistopheles

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Re: Fed Buying Berkshire Bonds
« Reply #5 on: July 10, 2020, 11:49:47 AM »

Of course, the Fed could get new equity from the US Treasury via Congress (which can print unlimited dollars) but it would cause a financial crisis as Congress deliberated over it.

Amateur question. Can't the Fed print money by simply crediting accounts of the depositing banks?

wabuffo

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Re: Fed Buying Berkshire Bonds
« Reply #6 on: July 10, 2020, 12:41:33 PM »
Can't the Fed print money by simply crediting accounts of the depositing banks?

The Fed is a lender and always requires collateral to be posted - either at the discount window or in a repo operation when it deals with a bank.  Both transactions create new settlement balances in an account at the Fed for the banking sector but only after the bank posts collateral with the Fed.

The Fed can also buy assets in the open market - Treasuries, MBS, BRK bonds - but here too, the Fed is buying these assets by creating a new settlement balance in an account at the Fed for the banking sector.

Sometimes people say, that by creating new bank reserves, the Fed indirectly increases money supply, by expanding the capacity of the banking sector to lend more.  But this isn't really true because banks have never been reserve constrained.  And they certainly are not now when they have $2.8t in reserves (over 15% of all US commercial banking assets are on deposit at the Fed!).

wabuffo
« Last Edit: July 10, 2020, 12:46:52 PM by wabuffo »

SHDL

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Re: Fed Buying Berkshire Bonds
« Reply #7 on: July 10, 2020, 03:00:11 PM »
I donít think there is a particularly good argument. Their decision to go with an index fund like approach was most likely a compromise given that they didnít have the time/resources to do fundamental analysis on each issuer and also (less importantly) they didnít want to look like they were actively picking winners and losers.

Itís also noteworthy that the Fed didnít really need to buy anything to prop up the markets. Broadcasting their intentions was enough. They probably could have gotten away with buying nothing at all.