Tuesday, August 25, 2009

Goldman's $4 trillion projection is wrong

From Bloomberg:
Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., said the Federal Reserve could double the size of the central bank’s balance sheet again if needed to support economic growth.

A rise in the balance sheet to $4 trillion is a “possibility,” Hatzius said in an interview on Bloomberg Radio in New York. “It is going to depend on not just what inflation does, but also on whether the economy does move back to a slower growth pace.”

This scenario is truly scary (and may also be great for Goldman because there would be that much more paper Goldman can sell to the Fed), but such a massive balance sheet buildup is increasingly unlikely. The Fed will continue it's securities purchases, but the lending facility usage will collapse, resulting in a much slower balance sheet growth. Here is the reason (from Bloomberg):
The Federal Reserve must for the first time identify the companies in its emergency lending programs after losing a Freedom of Information Act lawsuit.

Manhattan Chief U.S. District Judge Loretta Preska ruled against the central bank yesterday, rejecting the argument that loan records aren’t covered by the law because their disclosure would harm borrowers’ competitive positions.

This suit, filed by Bloomberg under the Freedom of Information Act, will force the Fed to release the names of the banking institutions who are borrowers under the various liquidity facilities. And there is nothing that banks hate more than being perceived as weak, which is what would happen upon disclosure that they had to borrow from the Fed. Institutions who are using these facilities will now simply stop, unless they absolutely need the Fed's support to survive.

An example of this is Bank of America's refusal to participate in the TALF program because it's credit card portfolio would be classified as sub-prime. TALF provides financing on sub-prime cards as well as auto, with leverage that's a bit lower than the prime equivalent. Economically BofA could and should be using the sub-prime TALF financing, but because TALF is a high profile program and the media would learn that BofA is the only large bank doing a sub-prime deal, they stayed away. From Bloomberg:

JPMorgan Chase & Co., Citigroup Inc. and American Express Co. are among issuers that sold $21 billion of card-backed debt this year through the Term Asset-Backed Securities Loan Facility, a Federal Reserve lending program to spur bond sales. Bank of America, the only major card-issuer that didn’t sell any, lacks enough quality loans in its credit-card trust to sell TALF bonds without being labeled a subprime issuer.

So Goldman's projection on the Fed's balance sheet doubling is just wrong. The securities purchasing may continue for a while (although some in the Fed are getting increasingly nervous about it), but the purchases will be offset by reductions in bank liquidity facilities.

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