Friday, September 20, 2013

Buffet- The Fed, The Largest Hedge Fund In History

Via Bloomberg

Billionaire investor Warren Buffett compared the U.S. Federal Reserve to a hedge fund because of the central bank’s ability to profit from bond purchases while accumulating a balance sheet of more than $3 trillion.

“The Fed is the greatest hedge fund in history,” Buffett told students yesterday at Georgetown University in Washington. It’s generating “$80 billion or $90 billion a year probably” in revenue for the U.S. government, he said. “And that wasn’t the case a few years back.”

The central bank has been buying $85 billion of bonds a month to help the U.S. recover as it emerges from the deepest slump since the Great Depression. Chairman Ben S. Bernanke and other Fed policy makers unexpectedly opted this week to sustain that pace of asset purchases instead of tapering it, saying they need to see more signs of lasting improvement in the economy.

The Fed remitted $88.4 billion to the U.S. Treasury Department last year. The payments have ballooned as the central bank built its balance sheet during the past five years.

The Fed “is under no pressure, none whatsoever to have to deleverage,” Buffett said. “So it can pick its time, and if you have somebody wise there -- and I think Bernanke is wise, and I certainly expect his successor to be -- it can be handled. But it is something that’s never quite been done on this scale. It will be interesting to watch.”


Buffett is correct. The Fed is the largest hedge fund in history with more than $3 trillion assets that are leveraged more than 60 to 1. Leverage that may understated in regards to a high likelihood of losses in the Fed's portfolio, a byproduct of higher interest rates. And Mr. Buffett is correct to say that the Fed is under no pressure to deleverage, at least for the timing being. It would not take much, considering that base money per unit of GDP is well ahead of 25 cents, to force the Fed into a position where it had to reduce its balance sheet in a hurry. Further still, any reduction to the Fed's balance sheet due to an external event will not be some small $10 billion, $20 billion or $50 billion. To normalize interest rates, the Fed may have to reduce its balance sheet by more the $500 billion. That would put a dent in asset prices wouldn't it.


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