But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
The worst of the uncertainty is over
Prior to the December FOMC meeting, much of the uncertainty revolved around both the “when” and “if” questions regarding tapering QE. With the December move, the uncertainty regarding both was lifted. At his press conference, outgoing Federal Reserve Chairman Ben Bernanke was pressed about the Fed’s intentions going forward and whether tapering was going to be more or less “on autopilot” going forward.
The Fed’s balance sheet has gotten huge
Quantitative easing has grown the size of the Fed’s balance sheet almost eight-fold since the turn of the century. From holding just over $500 billion in assets in 2000, it has recently hit $4 trillion. Some of the participants worried that additional purchases would result in capital losses. This isn’t an insignificant fear—the Fed currently supports $4 trillion in assets with about $55 billion in equity. Under any other entity, that would be considered an unthinkable leverage ratio.
It was pointed out at the meeting, however, that these assets would provide income to the Treasury over the life of the program, especially when the effects of the program on the overall economy are taken into account, and that any potential reputation risks to the Fed from capital losses could be mitigated by pointing that out.
In other words, the Fed may (and probably will) lose money on these asset purchases. This is almost a mathematical certainty—the Fed has purchased trillions of Treasuries and mortgage-backed securities over the past several years when interest rates were at multi-generational lows. If rates go back to historical levels before these bonds mature, the Fed will undoubtedly take a capital loss.
The Fed is saying you can’t look at its balance sheet in isolation—its profits and losses flow through to the Treasury, and it has government support. If you look at the issue holistically, then any capital losses on these bonds will be more than offset by the additional economic growth that will come from QE (via increased taxes). Will the markets take that view? Time will tell. For the REITs, any turbulence will be felt in tightening credit.
© 2013 Market Realist, Inc.