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The Private Equity for Families Blog

The Fed’s Balance Sheet Mirage

Does anyone really understand what it means for The Fed to “monetize” Treasury Debt it purchases? Does it evaporate? Is it just a book keeping entry? Does it have to be paid back?  And to whom?  I was curious enough to consult The Google with the following search “What Does Monetizing Debt Mean?”

I ended up on where this really clear and concise answer emerged:

“Debt monetization or monetary financing is the practice of a government borrowing money from the central bank to finance public spending instead of selling bonds to private investors or raising taxes. The central banks who buy government debt, are essentially creating new money in the process to do so.

This practice is often informally and pejoratively called printing money[1] or money creation.”

So, just as I suspected the Treasury, finding itself unable to attract any real buyers for its low interest debt to pay for the five legislative responses to Covid-19, just sells it to Jerome Powell who then puts it on the Fed’s balance sheet. And because he knows it will not be repaid I don’t even think Mr. Powell had to fill out any credit approval paperwork or even submit his FICO score to The U.S. Treasury.

So far he has been able to book about $2.5 trillion of this special, evaporating Fed financing,  So, in essence, without Congressional approval, without taxing anyone, and without complying with debt ceiling limitations money can just be printed by the approval of the Federal Reserve Board acting through its Open Market Committee?

Who Are the People Making These Decisions

Given the enormity of this privilege and responsibility, I am really interested in who makes these decisions to print money. Supposedly, there are seven Governors of The Federal Reserve Board but that number is really five, with an open seat from 2018 and the recent resignation of Randal Quarles. It will be four people when Richard Clarida’s term ends in 2022. But further research shows I am wrong about the concentration of power in the Federal Reserve Board of Governors. It turns out that the Federal Open Market Committee makes the money printing decisions.

A portion of FOMC members are chosen from among presidents of the 12 regional Federal Reserve branches and guess what? They are appointed by those regional boards with any bank affiliated members abstaining. So, in essence, part of the group elected to make decisions to monetize the debt and purchase mortgage backed securities- so called open market activities – is a group of business leaders who are neither appointed by the President nor confirmed by the Senate.

What Is the FOMC and How Did It Get the Power to Print

According to the Fed’s website, the FOMC is comprised of 12 members of which seven are The Federal Reserve Board, and the balance are the representatives from the various Fed districts with the NY Fed representative always being a voting member, and the rest of the 11 districts sharing four seats on a four-year rotation.

Here is the division of monetary authority between the Board of Governors and the FOMC as described on the Fed’s website:

“The Federal Reserve controls the three tools of monetary policy–open market operationsthe discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations”

So it appears to me that FOMC is the group that can monetize the debt and make open market purchases of securities. In fact, since 2008 FOMC has purchased $2.5 trillion of mortgage backed securities representing 40% of the securities issued in that market since 2008 as well as another $2.5 Trillion of Treasury Debt issued to finance legislative responses to Covid-19.

FOMC Member, Fed Presidents, Recently Cited For Insider Trading

FOMC members must have missed a few ethics classes according to a recent Wall Street Journal article dated October 4, 2021,  written by Nick Timiraos.

According to this article, the Vice Chairman of The Federal Reserve Bank, Richard Clarida, the president of the Boston Fed, Eric Rosengarden, and the president of the Dallas Fed, Robert Kaplan, all made material personal investments in 2020 in advance of important Fed announcements that moved markets.

Senator Elizabeth Warren has asked Gary Gensler to investigate. Robert S. Kaplan President of the Dallas Fed and Eric Rosengarden President of the Boston Fed have resigned their Fed positions. Mr. Clarida”s term as Vice Chairman of The Federal Reserve Board ends in 2022 and it is not clear whether he will also resign.

Inflationary may be transitory, but unquestioned honesty and confidentiality from Fed officials should not be. The Fed’s balance sheet may not be the only mirage in the faithful management of the reserve currency for the entire world.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records. Founder and chairman of CW Industrial Partners (originally CapitalWorks, LLC), he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CW Industrial Partners or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.