The Merits of HR 1207 (Audit the Fed)

A blast-out email I received this morning from Rep. Alan Grayson (D-Fl) confirmed that HR 1207 - the "Audit the Fed" bill - has gained significant traction in the House of Representatives, having gained over 290 co-sponsors. In anticipation of tomorrow morning's debate concerning HR 1207, to be heard before the House Financial Services Committee, I'd like to briefly share the fundamental reasoning which underlies my support of this bill.

First and foremost, I am a pragmatic libertarian; i.e. I understand that certain externalities are bound to occur when the universe of private transactions are allowed to take place in complete absence of regulation. In other words, I agree with preventing one man from polluting his own land (private property) if that pollution can flow down the river to another man's property. Similarly, I am of the opinion that the global financial system has grown sufficiently complex to warrant the existence of the Federal Reserve. True, the founders of this nation did not establish anything resembling a central bank. However, these men could never have envisioned the current scenario, whereby the dollar serves as the world's reserve currency, let alone that a financial instrument such as a "collateralized debt obligation" would even exist.

Having established the Federal Reserve's right to exist, I think we need to seriously consider the question: Under what conditions will the Federal Reserve be allowed to exist? Certainly, I see nothing wrong with a Federal Reserve capable of intervening during times of acute stress in the financial markets. However, accompanying this incredible power should be at least some modicum of transparency. To use a popular cliche, "Sunlight is the strongest disinfectant". This concept of transparency is the ultimate equalizer in a democratic society; conversely, a lack of transparency by the Government is the most necessary element of tyranny.

Some may argue that to audit the Federal Reserve is to deprive it of the independence necessary to conduct it's job. That argument might be relevant in the event that HR 1207 proposed some sort of Congressional oversight of the Fed. However, audit does not equal oversight or interference. The Supreme Court is an independent branch of the federal government that rules on the constitutionality of federal law. Members of Congress do not influence Supreme Court rulings; however, at the end of the day, the public is allowed to read a majority opinion stating the Court's reasoning behind the decision. Why is there no similar measure of transparency at the Fed?

Finally, the primary problem with the current state of the Federal Reserve is that this board of unelected officials is arguably more powerful than the President of the United States. At least show us how you are choosing to exercise that power. Sphere: Related Content

The Fed: Bull-Dogged Into Regulation Z Reform

In what amounts to little more than a complete waste of time, Ben Bernanke and the Federal Reserve Board have been bull-dogged,rail-roaded, pressured etc. into suggesting several "reforms" to the Truth-In-Lending Act, known fondly as Regulation Z. Doctor Bernanke has spent the past two days in front of Congress, attempting to defend the Fed's mortgage oversight role, and apologizing for the Fed's lack of intervention into the mortgage industry's consumer-related practices. The Federal Reserve Board was politically adept enough to issue a press release on the subject, transcribed in part below:

"The Federal Reserve Board on Thursday proposed significant changes to Regulation Z (Truth in Lending) intended to improve the disclosures consumers receive in connection with closed-end mortgages and home-equity lines of credit (HELOCs). These changes, offered for public comment, reflect the result of consumer testing conducted as part of the Board's comprehensive review of the rules for home-secured credit. The amendments would also provide new consumer protections for all home-secured credit."

"Consumers need the proper tools to determine whether a particular mortgage loan is appropriate for their circumstances," said Federal Reserve Chairman Ben S. Bernanke. "It is often said that a home is a family's most important asset, and it is the Federal Reserve's responsibility to see that borrowers receive the information they need to protect that asset."

AND

"In developing the proposed amendments, the Board recognized that disclosures alone may not always be sufficient to protect consumers from unfair practices. To prevent mortgage loan originators from "steering" consumers to more expensive loans, the Board's proposal would:

• Prohibit payments to a mortgage broker or a loan officer that are based on the loan's interest rate or other terms; and
• Prohibit a mortgage broker or loan officer from "steering" consumers to transactions that are not in their interest in order to increase the mortgage broker's or loan officer's compensation. "

The sad thing is, these hearings were never intended to be conducted for the benefit of the consumer. Rather, the hearings and subsequent regulatory "reforms" are nothing more than a cheap circus act; performed by Congress, and designed to give them some face time spent scapegoating anybody other than themselves for the financial crisis. Bernanke and company understand this, and are simply participating in the insanity so that Congress doesn't strip away any of the Fed's cherished independence. As for the consumer, we would note that in all likelihood, nothing will change except for the fact that he will be forced (to pretend) to read another set of worthless "disclosures". And in terms of trying to prohibit mortgage brokers from "steering" clients to higher commission products: good luck. If a mortgage broker was engaging in this sort of behavior prior to Congress noticing, it is likely that nothing short of excommunication from the country will prevent him from continuing.

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Bernanke and the Fed: Firing on All Cylinders

The Federal Reserve Bank of New York has just reported it's activities under the Agency Mortgage-Backed Securities Purchase Program, for the 7 day period ending on July 22nd. For the mathematically lazy, the purchases documented below amount to (net) $21.125Billion worth of new agency securities. The majority of the lever-pulling is happening in the 30 year, and at the 4.5-5 coupon. These MBS's will presumably be tucked away in the Fed's gargantuan balance sheet, where they will co-exist with the Maiden Lane trio as well as any number of putrid securities. Purchases ($ million) Maturity Coupon Settlement Month FHLMC FNMA GNMA 30 YEAR 4 Aug 0 0 525 4.5 Aug 2,250 2,750 2,200 Sep 1,600 2,000 600 5 Aug 150 1,000 0 Sep 1,050 500 200 Oct 1,250 2,600 0 5.5 Aug 0 950 0 Sep 0 650 0 6 July 0 0 120 15 Year1 4 Sep 150 0 0 4.5 Sep 0 700 0 Other2 Total 6,450 11,150 3,645 1 Inclusive of 10 year product. 2 20 year, 40 year and other agency programs. http://www.newyorkfed.org/markets/mbs/index.html *InfoNgen facilitated this post

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H.R.1207, Federal Reserve Transparency Act Gains Tractions

Ron Paul's (R-TX) viral bill, introduced before the House as H.R.1207 in February 2009, today enjoys front page mention in this WSJ article. Having gained the support of a full two thirds (2/3) of the US House of Representatives, it is no longer feasible for major news outlets to ignore Rep.Paul's crusade to bring transparency (albeit limited) to what is perhaps the most powerful organization in the world. We expect Rep.Paul to be criticized further as this situation progresses; even the WSJ chose to reference his role in the movie "Bruno" as if it proved some point about the Texas Republican.

We're torn, in a way similar to many, between the prospect of a Fed allowed to proceed in secrecy, and a vote-yearning political class; eager to assert it's oversight power by "slaying" the Fed with hearings, investigations, studies, committees, and any other process-formalities favored by Congress. At present though, Rep. Paul's bill appears benign and measured enough - it orders that the Fed be audited, not placed under direct Congressional supervision - that support for it would seem the wise option.

Rep. Paul's official website can be found at www.CampaignForLiberty.com

You can sign the petition to Congress in support of HR1207 by clicking here

H.R. 1207 - Audit the Fed Sphere: Related Content

A Closer Look at JP Morgan and Maiden Lane LLC

One of the shadier - for lack of a more appropriate adjective - aspects of the Federal Reserve's activities is the presence of three borderline translucent LLC's on it's balance sheet: Maiden Lane LLC (ML LLC), Maiden Lane II LLC(ML II LLC) and Maiden Lane III LLC(ML III LLC). For now we will focus on ML LLC, the entity created to "acquire certain assets of Bear Stearns and to manage those assets through time to maximize the repayment of credit extended to the LLC and to minimize disruption to financial markets" (from NY Fed website). The creation of ML LLC occurred as a means by which to assist JP Morgan(JPM) complete the purchase of the investment bank formerly known as Bear Stearns. Presumably, the assets that found their way into ML LLC were selected due to their sheer toxicity, and more importantly, JPM's desire that it not acquire said assets. In other words, ML LLC is the financial equivalent of a leper colony, comprised of those assets deemed unsuitable by JPM.

Unlike a traditional leper colony however, ML LLC makes regular interest payments to JPM; payments that have amounted to nearly $300M since the inception of the limited liability corporation. This is a fact that receives little acknowledgment by those charged with the assessment of bank earnings. As Bank of America (BAC) and Citigroup (C) have been derided by the financial press and analysts for reporting "weak" earnings that were "bolstered by one-time gains", JPM's secretive subsidy is largely ignored; allowing the large bank to wallow about in it's largely favorable press coverage. Perhaps this means that JPM has quietly acted shrewder than even Goldman Sachs (GS), as that (investment?) bank has been the subject of mounting excoriation from an angry populace.

Nevertheless, a brief look at ML LLC's assets would suggest that the Fed is choosing to value it's holdings in an exceedingly optimistic light. The Fed states that in March of 2008, ML LLC's assets totaled roughly $30B. As of March 31,2009, the value of these same assets is reported at $25.3B, a decline of 15.6%. In it's brief explanation of the valuation methods applied to these securities, the Fed states that they are held at a "fair value", based upon the price at which a buyer would be willing to pay under "orderly market conditions". No definition of orderly is provided. Based upon the limited information provided by the Fed, we can determine the following concerning the composition of ML LLC's assets:

• 45% of the residential mortgage loans were secured in either California or Florida
• 79% of the commercial mortgage loans are classified under the "hospitality" property type
• 51% of the non-agency CMO's were secured in either California or Florida
• No private investor would ever want to touch these securities

What price could ML LLC's assets fetch under today's market conditions? Absent any real data, it is impossible to know. However we did find an interesting REIT, Hospitality Properties Trust (HPT), whose stock trades publicly on the NYSE - in theory subjecting it's property portfolio to a market based valuation. According to HPT's website, the trust's strategy is to "maintain and grow an investment portfolio of geographically diverse hotel and travel center properties". At the end of Q1 '08, HPT's share price stood at $34.02; by the end of Q1 '09, a share of HPT could be had for $12 - a decline of 64.7%. Obviously, the share price of HPT is not the most accurate bellwether for estimating the true value of ML LLC. However, with a notable dearth of information of any kind concerning ML LLC's rotting assets, it stands to reason that our approach is as good as any. That being said, we would encourage all readers to contact your Congress person and express your support for HR 1207, introduced by Ron Paul in February. You can do this by clicking here - the process takes less than a minute.



And that's the way it is.

*no position in any securities mentioned, although arguably, our tax dollars helped facilitate the Maiden Lane transactions.


Maiden Lane LLC Financial Records 2008 Sphere: Related Content

Federal Reserve Impotence

In mid-March, the Federal Reserve announced its intention to purchase $300Billion worth of US Treasuries, triggering an almost immediate 50 basis point decline in the 10 Year Treasury yield. At the time we proposed that the Market, being a force far superior to the Federal Reserve, would eventually counter-strike, much to the dismay of the Fed. We also stated that this initial $300Billion figure would be a mere drop in the bucket when compared to the volume of Treasuries ultimately purchased by the Fed. At present, approximately one month after the Federal Reserve officially embarked upon a program of Quantitative Easing, the Market has already counter struck, rendering the practical effect of the Fed's program useless. The yield on the 10 Year Treasury has returned to 3%, the same level it sat prior to the QE announcement.

The sheer speed at which the Market has assessed the Federal Reserve, formulated a counter strike, and implemented said strike is troubling at the least. The 10 Year is by the far the most important part of the Treasury Curve-its yield influences a vast spectrum of financial instruments, including but not limited to Mortgage Rates, the lowering of which has become a centerpiece of Government policy. That the Fed could only influence this rate by 50 basis points, for approximately one month, is a testament to that Institutions dwindling credibility and ability to manage the economy.

As for the Fed's next move, we are sticking with our assertion that Trillions more will need to be committed to the Treasury Market in order to keep the cost of capital sufficiently low throughout the economy. The alternative, allowing the Treasury Market to proceed unimpeded, would be the equivalent of dousing the purported "green shoots" with a solution comprised of 1/2 Raid and 1/2 Arsenic. We think the Fed's next move is quite clear.

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