Long-Term Capital Management used massive leverage to generate profits in government bonds (before blowing up and nearly bringing the world’s financial markets with it). Is this not exactly what quantitative easing is?
Josh Brown wrote a piece for The Daily Beast today on “The Insanely Profitable Federal Reserve.” They sent nearly $80 billion to the Treasury last year which is truly a massive number. However, if the Fed were to report unrealized losses on the assets in their portfolio I’m certain this entire profit would be wiped out and then some.
The Fed started 2013 with $1.6 trillion of long-term treasuries and $900 billion of mortgage-backed securities. During the year the 10-year Treasury bond lost roughly 7.5% of its value and MBS lost roughly 2%. This means they lost about $150 billion on these positions.
But the Fed also bought $85 billion per month more of these securities during the course of the year. MBS rallied some to finish the year but the 10-Year Treasury (I’m using this as a proxy for their average duration) closed the year on its lows, meaning every purchase they made during 2013 was underwater. In all, they probably lost more than $150 billion, or roughly twice what they remitted to the Treasury.
They will say, ‘don’t worry, we intend to hold all these securities to maturity when we’ll recover all of our principal.’ It’s not that simple. The Fed now owns over 40% of the long-term Treasury market as well as over 40% of the entire MBS market. This is why they simply MUST taper or the Fed will eventually own both markets entirely. It also makes it nearly impossible for the Fed to sell without crushing those markets, sending rates soaring and undoing all the work QE did in the first place.
Still, as Richard Fisher posits today, the Fed may be forced to sell and at a loss. Unlike LTCM, though, this wouldn’t force them into insolvency because the Fed can print money. That’s the difference. Still, I’m not convinced there wouldn’t be consequences… and neither is Fisher, which is why he is voting to end QE ASAP.