Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

The Fed Balance Sheet

Here is the latest data from the Cleveland Fed:

As of April, 2010 the Fed has about $1.25 MBS (mortgage backed securities) on their books.  Other assets related to financial institutions are lending to financial institutions (about $150 billion) and liquidity to key credit markets (about $100 billion).

The liquidity and MBS activities are new during the financial crisis.  The lending activity is currently about double the pre-crisis level but 90% less than the approximately $1.5 trillion at the end of 2008.  Note that the increase in MBS basically offset the decrease in lending to financial institutions.

John Hussman has described (in February) how bad assets at the banks will be transfered to the tax payers by the Fed using Fannie and Freddie as intermediaries.

How to spend (up to) $1.5 trillion without Congressional approval (updated)

Step 1: Federal Reserve purchases $1.5 trillion in Fannie Mae and Freddie Mac securities, creating $1.5 trillion of monetary base to pay for these purchases.

Step 2: U.S. Treasury quietly announces unlimited 3-year support for Fannie Mae and Freddie Mac on December 24, 2009, indicating that it is acting under the authority of a 2008 law (HERA) that was originally written to insure a maximum of $300 billion in total mortgage principal (not losses, but principal).

Step 3: Fed Chairman Ben Bernanke testifies to the House Financial Services Committee on February 10, 2010 that "I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term. However, to help reduce the size of our balance sheet and the quantity of reserves, we are allowing agency debt and MBS to run off as they mature or are prepaid. In the long run, the Federal Reserve anticipates that its balance sheet will shrink toward more historically normal levels and that most or all of its security holdings will be Treasury securities." During the interim, the Federal Reserve indicates that it expects to limit the extent to which banks lend out the base money created in Step 1, through a policy of paying interest on bank reserve balances.

Step 4: On February 11, 2010, with Treasury backing in place, Fannie Mae and Freddie Mac (whose delinquency rates have more than doubled over the past year) announce the purchase of $200 billion in delinquent mortgages that they had previously guaranteed. The entire remaining principal balance will be paid to investors at face value. This action provides a glimpse into the future: Fannie and Freddie take bad mortgages onto their balance sheets, extinguish the MBS securities at face value, and rely on Treasury funding to fill the gap.

Step 5: In the next few years, the U.S. Treasury can be expected to issue up to $1.5 trillion in new Treasury debt to the public, taking in much of the $1.5 trillion in base money created by the Fed in Step 1.

Step 6: Proceeds (base money) received from new Treasury debt issuance are periodically transferred to Fannie Mae and Freddie Mac in order to cover cumulative balance sheet losses.

Step 7: Over a period of years, Fannie Mae and Freddie Mac use the proceeds to redeem mortgage securities held by the Fed, thus reversing the Fed's transactions in Step 1, without the need for liquidation or any other "unwinding" transactions. If the MBS securities extinguished in Step 4 are not directly held by the Fed, the Fed can be expected to simultaneously sell an equivalent amount of its own holdings out to the public, so that the publicly held stock of MBS remains constant. In any event, the base money created by the Fed ultimately comes back to the Fed, and the mortgage securities purchased by the Fed disappear, by burdening the American public with a new, equivalent obligation in the form of U.S. government debt.

Outcome: The Federal Reserve closes its positions in Fannie Mae and Freddie Mac securities, the quantity of outstanding Fannie Mae and Freddie Mac liabilities declines by as much as $1.5 trillion, thus allowing their remaining assets repay the remaining liabilities despite insolvency, and the outstanding quantity of U.S. Treasury debt expands by as much as $1.5 trillion in order to protect the lenders, while ordinary Americans continue to lose their homes and jobs.

This would all be really clever if it weren't so insidious.

On Bloomberg television last week, James B. Lockhart III, the former head of the Federal Housing Finance Agency (Fannie and Freddie's regulator) commented on the bailout funds already provided to Fannie and Freddie, saying "Most of that money will never be seen again. They were just allowed to leverage themselves so dramatically."

Disclosure: No stocks mentioned.