The Federal Reserve System, America’s private central bank, has a problem. Actually, make that two related problems:

  • Their massively bloated balance sheet shows assets worth $4.5 trillion, and…
  • In the Bank’s new era of “transparency” unwinding that balance sheet will disrupt markets.
  • The Fed has painted itself into a dangerous corner, and the smartest way to get themselves out of it is probably what they are least likely to do.

    Here’s what markets can expect from Fed decisions, and how to play stock and bond markets the way insider Fed members will be instructed to play them…

    How Fed Transparency Became a Market Necessity

    Historically, Fed officials didn’t speak much about prospects for the economy or markets, or about their policy decisions. In fact, they don’t speak much about why they do what they do even when they were conducting open market operations.

    As recently as 1987, in his testimony to Congress, then Fed Chairman Alan Greenspan explained, “Since I’ve become a central banker, I’ve learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.”

    That all changed with the 2008 financial crisis.

    With markets in freefall, two major investment banks wiped out, and the biggest banks in America essentially insolvent, the Federal Reserve took unprecedented action.

    The Fed was providing unlimited liquidity to faltering banks – including foreign banks – and agreed to let both Morgan Stanley and Goldman Sachs, two giant investment banks, become commercial banks to get access to the Fed’s Discount Window and liquidity lines. All the while, critics in Congress who blamed the Fed for creating the subprime crisis and then bailing out their bank constituents demanded transparency out of the nation’s private central bank.

    The cries of “Audit the Fed!” over the Fed’s hand in abetting the crisis with their artificially low rates andbailing out of bad actor banks wafted through Congress. Pretty soon, Fed officials (starting with Fed Chairman Ben Bernanke) began a course of greater transparency.

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