Lately we're hearing announcements the government is makin' money. The Federal Reserve announced they made $77.4 billion in 2011.
The Federal Reserve Banks' 2011 net income of $77.4 billion was derived primarily from $83.6 billion in interest income on securities acquired through open market operations (Treasury securities, federal agency and government-sponsored enterprise (GSE) mortgage-backed securities (MBS), and GSE debt securities).
Yet the Federal Reserve gave $75.4 billion of that 2011 net income to the U.S. Treasury. Nice magic trick isn't it? Buying U.S. Treasuries from the Treasury and giving money back to the Treasury from the interest? Speaking of the Treasury, they too are makin' money, this time from mortgage backed securities. The U.S. Treasury reported a whopping $25 billion in profits from their portfolio of MBSes or toxic assets acquired during the financial crisis.
The Fed dramatically increased their U.S. Treasuries holdings in 2011 by an astounding $683 billion. Below is the graph of the Federal Reserve U.S. Treasuries holdings.
Total Reserve Bank assets as of December 31, 2011, were $2.919 trillion, which represents an increase of $491 billion from the previous year. Holdings of U.S. Treasury securities increased by $683 billion, GSE debt securities holdings decreased by $45 billion, and federal agency and GSE MBS holdings decreased by $156 billion. The balances held under central bank liquidity swap arrangements increased by $99.7 billion.
Graphed above are the total assets held as reported by the Federal Reserve press release. That's one frightening asset line, the sudden blast to the sky and now the ongoing high levels all the way to March 2012.
How exactly does the Federal Reserve make money by buying from the government, then selling to the government? If it seems like profits are coming out of thin air that because basically they are. The profits are actually the result of quantitative easing as well as operation twist. Earlier we called this the great financial circle jerk. Astounding where interest on worthlessness assets can really pay out. Yet, when one deals the cards and also sits at the great derivative gambling casino table, the game is clearly rigged. How can one lose buying up U.S. Treasuries from money one prints?
The $47 billion face value in assets, held by the Federal Reserve Bank of New York, are the same kinds of financial instruments that … caused record losses across the financial industry. Plunging values of the securities, called collateralized debt obligations, or CDOs, caused AIG’s near collapse and a government rescue in 2008. The $182 billion bailout was widely criticized because a chunk of taxpayer aid was funneled through AIG to large banks.
Banks want those toxic CDOs because it seems they pay out big time. Seeking Alpha explains the math:
For example, if you paid $50 for a bond with a face value of $100 that pay 8% interest, you would receive $8 per year in interest payments, which is equivalent to receiving 16% of your investment back each year. If $24 of the initial $100 in bond principal is repaid, then over a three year period you would receive $48 of your $50 investment. These figures are roughly analogous to where the Fed stands with the AIG CDOs. This sizable cash flow is also what is attracting banks to these assets. There are few, if any, securities available that have the potential to generate so much current income at such a low price.
So how do worthless CDOs manage to payout 8%? That question, on how these things manage to pay principle and interest is at best assumed because they were so originally overvalued. Yet considering their structure and what the CDOs are stuffed with, we find their profitability still hard to believe. Below is Seeking Alpha's explanation of AIG CDOs current evaluations and payouts.
When the value of the CDOs dropped due to the rise in mortgage default losses and uncertainty about who was likely to bear the losses, these banks demanded collateral from AIG like Treasuries and high-grade corporate securities. As AIG’s credit rating fell, it had to post more collateral and eventually ran out of eligible securities. Absent intervention, AIG would have filed for bankruptcy at this point and the value of the financial guarantees it provided on the CDOs would have collapsed. Instead, the Fed rescued AIG with a loan and later spent $25 billion to purchase all of the CDOs from the banks at par (100% of their original value).
According to the WSJ, the current market value of the CDO portfolio is just 37 cents on the dollar. This means that an investor could buy the entire $47 billion portfolio for just over $17 billion. (The original principal balance of the CDOs was $62 billion. In addition to the $25 billion payment from the Fed the banks were allowed to keep the $35 billion in collateral previously pledged by AIG. The remaining sum was provided by AIG to complete the transaction.) Despite dropping in price since the original bailout (the CDOs were valued then at 50 cents on the dollar), the Fed is unlikely to suffer losses because of the size of the interest and principal payments made since 2008.
From the Federal Reserve statement it appears the NYFed sold $26.4 billion in AIG CDOs, abet the more legit, stable ones. From the Federal Reserve annual financial statement:
The closing of the American International Group, Inc. (AIG) recapitalization plan in January 2011 resulted in asset reductions of $47 billion, inclusive of the full repayment of the revolving line of credit with AIG in the amount of $20.6 billion and the redemption or sale of the Federal Reserve Bank of New York's (FRBNY) preferred interests in two AIG-related LLCs in the amount of $26.4 billion.
The $47 billion worth of CDOs the banks want now are the toxic assets of the financial crisis. Yes, those toxic assets the New York Fed acquired, which were a glorified AIG bail out, are what the banks want now, as profits for themselves. What was that about privatize the profits, socialize the risk?
Things get weirder still with banks wanting to become landlords. That's right, your foreclosed property could possibly be rented to you by the bank. Leaky pipe? That should be an interesting fix. The Rolling Stone's Matt Taibbi calls banks as landlords yet another stealth bail out:
In con artistry parlance, they call this the "reload." That's when you hit the same mark twice – typically with a second scam designed to "fix" the damage caused by the first scam. Someone robs your house, then comes by the next day and sells you a fancy alarm system, that's the reload.
In this case, banks pumped up the real estate market by creating huge volumes of subprime loans, then dumped a lot of them on, among others, Fannie and Freddie, the ever-ready enthusiastic state customer. Now the loans have crashed in value, yet the GSEs (Government Sponsored Enterprises) are still out there feeding the banks money through two continuous bailouts.
One, they continue to buy mortgages from the big banks (until recently, even from Bank of America, whom the GSEs were already suing for sales of toxic MBS), giving the banks a permanent market for home loans.
And secondly, they conduct these quiet bulk sales of mortgages, in which huge packets of home loans are sold to banks at a "big discount."
By now we've come full circle. Banks create the loans, make money selling them off on the market at high prices, then come back and buy them again when they're low. When the GSEs are in the middle of this transaction, it makes mortgage lending a basically risk-free proposition: Banks get paid for creating home loans and they end up owning valuable property on the cheap, but in between, they offshore the market risk to a government entity and/or to the idiot individual who bought the home mortgage in the first place.
Does this ever end? Banks have become so powerful, so massive, it is to the point they are allowed to do just about anything. Go ahead, sell hyped out rigged mortgages, bundle them up and make profits on them, make more profits still when it is discovered the original mortgages are worthless, foreclose on the poor schmucks who were lent the original risky mortgages in the first place, acquire these same crab shack properties only to rent them out to people who lost everything in foreclosure and bankruptcy. The same predatory financial behemoths are now to become America's landlord. Next assuredly it will be out in the cold for you little match girl. These events are like watching thieves pick from the pockets of the dead. Nothing changes, nothing is stopped and America seems to be viewed as financial institutions' sucker pool.