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There are two numbers I can’t get out of my head. The numbers are $1.84 trillion and $1.26 trillion. These are estimates of what the deficit of the United States government is going to be for the fiscal year ending in September 30, 2009 and the fiscal year ending in September 30, 2010. (Note that revised estimates for the fiscal year were supposed to be put out in July, but the Obama administration postponed their release until sometime in August.)

It was announced Wednesday that the budget deficit in July reached an all time record of $180.7 billion and this brought the year-to-date deficit to $1.27 trillion.

Some simple calculations show that if the estimated number for fiscal year 2009 is to be hit, the budget deficits for August and September will have to average $285 billion per month.

This would mean that the deficits would be $100 billion more a month than the record deficit that was posted in July. This is not a good trend.

Some analysts are predicting that the current year deficit will actually top $2.0 trillion while the 2010 deficit will reach $1.5 trillion. With the deficit for next year at $1.5 trillion, the monthly deficits would only average $125 billion, a figure that would look pretty good given the July, August, and September figures presented above. But, is this realistic given all of the proposals and programs that are in the federal pipeline.

Gross federal debt held by the public increased by more than 28 percent, year-over-year, at the end of the second quarter of this year. That is up from 24 percent at the end of the fourth quarter of 2008 and 15 percent at the end of the third quarter of 2008. With the forecast figures for the deficit, these numbers are going to continue to be at relatively high rates in the near term.

According to the Congressional Budget Office’s alternative fiscal projections, the public debt of the United States could rise from 44 percent of GDP in 2008 to 87 percent of GDP in 2020. Adding this much debt to the world is going to place a tremendous burden on financial markets.

The Federal Reserve announced Wednesday that it was going to continue on its path to purchase the $300 billion in Treasury securities that it had already committed to, but would extend the program through October rather than ending it in September. The Fed will also retain its plan to buy as much as $1.45 trillion of housing debt by the end of the calendar year. By August 5, 2009 the Fed had purchased $543 billion in mortgage-backed securities.

Numbers like these only cloud the picture of what an “exit” strategy might look like for the Fed. In fact, it does not look like an exit strategy at all.

But, this is just one side of the coin. The other side has to do with existing bad assets. Elizabeth Warren, the chair of the Congressional Oversight Panel that is monitoring the bank bailout effort appeared on Joe Scarborough’s “Morning Joe” program today and stated that the “toxic assets” on bank balance sheets that got us into this financial mess are still there. And, they are going to have to be dealt with at some time in the future. For the near term she warned of a looming commercial mortgage crisis, one that will require more federal money, especially for smaller banks.

Oh, and about commercial mortgages, what about the problem the Fed faces with the commercial mortgages that it already has on its balance sheet. This morning in the Wall Street Journal there was an article about how the Fed has to deal with some debt it inherited from the Bear Stearns failure (See “Fed Grapples with Extended Stay”). On the balance sheet of the Fed there is a line item dealing labeled Maiden Lane related to the Bear Stearns sale to JPMorgan Chase (JPM). Included in this line item is a $900 million debt that the Extended Stay Inc. chain of hotels owes to the Federal Reserve among others. Extended Stay is in bankruptcy now and the issue is how the Fed is treated among other debtors and the deals that have been made between Extended Stay and some of the lenders. It is messy. But, this comes with doing the deals that the Fed has been doing.

And, apparently the Maiden Lane fund holds about $4 billion in debt backed by Hilton Hotels (HLT). Messy, messy, messy.

But, the Fed has also extended money to AIG, and to money market funds, and to commercial paper dealers, and has $543 billion of assets tied up into mortgage-backed securities. The Financial Times reported this last week that the Federal Reserve Bank of New York is hiring like crazy attempting to add positions to its staff as fast as it can, positions that will deal with all the future issues arising from all the new programs that the Federal Reserve System has gotten into over the last year or so. The administrative headaches of these actions are now being felt. (Question: if the Fed exits all of these programs, does the Federal Reserve Bank of New York need to create an exit plan to have a reduction in staff when these programs go away?)

And, the National Association of Realtors released information Wednesday that home price declines accelerated in the second quarter and Realty Trac said that foreclosure filings reached a level at which 1 in every 84 U. S. households had received a filing. ForeclosureRadar warned that California was on the verge of a new wave of foreclosure sales as notices of default, the first step in the foreclosure process, rose 12% in July from one year ago. Prime borrowers that were behind on their mortgage payments rose 13.8% between March and June.

On top of this household debt remains at about 130 percent of disposable income and household net worth continues to decline.

Business defaults are above 11 percent and are heading toward 13 percent according to some experts.

As we have reached a relatively calm period in economic and financial markets, more and more people are demanding that the Fed present them with a picture of how it, the Fed, might get out of the position it is in. With all the debt that currently exists and all the debt that is going to be created, the Fed seems to be at a loss about what an exit strategy might look like. In fact, with the growth of federal debt projected to stay in the double digit range for several more years, the realistic answer to the request for the Fed to devise an exit strategy is that there seems to be nothing to exit from.

If we accept this conclusion then we must argue that the problem is not with the Federal Reserve, the problem is with the federal government. The problem is with the Treasury department and with Mr. Geithner. The problem is that there is too much debt outstanding, and the creation of more and more debt by the federal government is not helping the problem, it is only exacerbating it. And Mr. Geithner only strains his credibility, and that of the administration, when he argues that there is already a plan to reduce the future deficits.

Source: Debt Problem Poses Two-Sided Threat to the Fed