The Fed’s balance sheet used to hold only Treasuries. Now it holds Treasuries, Bear Stearns mortgage crap, and “investment grade” bonds pledged by Wall Street. Soon it will also hold equities.
That’s right: equities. To provide further liquidity to a tapped out financial system, the Fed will now accept equities and other collateral for emergency loans.
Stocks have thus far treated this once-in-a-generation financial crisis as if though it’s not even a run of the mill recession. Specifically, they’ve only fallen about 20%, versus the 30% in the standard bear market. This bear market is likely to be anything but standard.
From 2000-2002 and 1973-1974, stocks dropped 50%. In the 1930s, they dropped 70%. Let’s say we get lucky and they only drop 30%-50% this time. What’s that going to do to the Fed’s balance sheet?
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