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Farrell: Ben the Bold

The Fed went all in and is going to expand its balance sheet enormously. They will buy an additional $750 billion in mortgage backed debt. That will bring the total potential purchases to $1.25 trillion which would be almost 25% of all Fannie/Freddie mortgage backed debt outstanding, or 10% of all mortgage debt, agency or otherwise. They will also buy up to $300 billion of Treasury debt. This is a big surprise and yields will move sharply lower. The stuff eligible for the TALF program will also be modified so a range of collateral will be eligible which means less than AAA.

Figure that conforming 30 year mortgage interest rates will fall a lot, probably towards 4%. A lot of mortgages can be refinanced at that rate and new mortgages will be so much more affordable. The expansion of the TALF collateral will move that program forward and Nissan and Ford have already announced they will offer a total of some $4.5 billion of paper backed by auto loans. Credit availability is important. The American consumer can figure if they want to take on debt, but the chance to do so is required for economic growth.

$300 billion in longer term Treasury purchases (and longer term paper to Ben probably means up to 10 years in maturity) will drive that yield down and make the deficit that much easier to finance. Remember this is how World War II was financed. The Treasury Department issued debt and the Federal Reserve bought it. The large foreign owners of our debt, the Chinese and Japanese, will be thrilled by this as the value of their paper just jumped in price.

The downside to this is the dollar should weaken. But it won't be as bad as it could be since the rest of the world is so much further behind the US in addressing the problem that we are the best house in a bad neighborhood and the currency will reflect that. At some point this enormous liquidity surge will prove inflationary. But that is not today and with unemployment still rising, wages moderate, and ample unused capacity in the system it will be a while before inflation needs to be addressed. And when it does, we should all raise a cheer to the success of saving the system from the threat of deflation.

The stock market will like this, at least for a while.

The fundamental situation of the banks improves with this as funding costs will go lower and profit potential improves. The rally has been so sharp I do expect a rest period soon. We need to keep in mind the reason the Fed took its actions is that the economy is so bad that truly extraordinary moves were required. I still think we have a rally in a bear market and for the bear to end two things are needed. One is time and the other is multiple tests of the lows. We are well into this bottoming process as far as time goes and the test will continue for a few more months.

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