Financial Triangle

Published in Barron’s.

Henry Kaufman, as quoted by Randall W. Forsyth in “Where Wall Street’s ‘Dr. Doom’ Sees Danger Now” (Up & Down Wall Street, March 12), is so right that we have a “dangerous dependency on the Fed” and that “the central bank and the Treasury are ‘joined at the hip.’ ” Of course, a core mandate of every central bank is to finance, as needed, the government of which it is a part, although you won’t find this in the Federal Reserve’s public-relations materials. The close link of the Fed and the Treasury goes back to the Fed’s 1913 chartering act, which originally made the secretary of the Treasury automatically the chairman of the Federal Reserve Board.

But now, the joining at the hip is even tighter than Kaufman suggests, because it includes the mortgage market, too. With its $2.1 trillion and growing mortgage portfolio, the Fed owns about 20% of all residential mortgages. It buys mortgage securities with the guarantee of Fannie Mae and Freddie Mac; but with virtually no capital of their own, the value of Fannie and Freddie’s guarantees is completely dependent on the Treasury. Moreover, the Treasury is their principal owner.

Thus, the real joining at the hip is not only the Fed and the Treasury, but also the Fed and the Treasury and Fannie/Freddie—a gigantic government financial triangle.