Saturday, December 20, 2008

Fed - a public hedge fund?

The financial sector’s debts grew even faster as banks sought to bolster their returns on equity by “levering up”. According to one recent estimate, the total leverage ratios (on- and off-book assets and exposure divided by tangible equity) for the two biggest US banks were 88:1 for Citibank and 134:1 for Bank of America. The bursting of the property bubble caused such ratios, which were already too high on the eve of the crisis, to explode as off-balance-sheet commitments and pre-arranged credit lines came home to roost. Only by borrowing from the Federal Reserve on an unprecedented scale have the banks been able to stay in business....

The result has been an explosion of the Fed’s balance sheet and of the monetary base. With assets approaching $2,263bn and capital of less than $40bn, the Fed increasingly resembles a public hedge fund, leveraged at more than 50:1.

-Niall Ferguson

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