Holy Crap.

Preliminary and unresearched, but seemingly a bit more than plausible…

Uncertainty about asset valuation has investors buying Treasury securities rather than stock equity or bonds. The Fed is taking that investor wealth and buying bonds and equity in companies holding un-valuable assets derived from mortgage loans.

The assets cannot be worth zero because not every mortgage will default and they’re still tied to physical objects (houses) which have value. Real property is the only permanently scarce resource; if you can wait long enough, and if the population continues to grow, real estate will go up.

The assets at the core of the volatility are not valueless, just unable to be properly valued due to the magnificently complex and ingenious investment vehicles the banks created (and the insurers bought). Eventually, the true value will be determined. An ordinary financial services business cannot wait. Their investors want returns.

The Fed can wait. It cannot go bankrupt; it prints the money. They’re even somewhat insulated from the politicians who act in a role similar to investors in ordinary banks.

The Fed is buying assets at pennies on the dollar. They are justified by their charter to preserve an orderly market. To this line of thinking, whether that’s a “bailout” or “nationalization” is irrelevant. What matters is that they’re buying real value on the cheap.

We do not know exactly how many pennies on the dollar the Fed is underpaying. They may be overpaying. Which, again is at the root of this current intrusion into the market.

Here are some figures: The Fed has swapped half a trillion dollars of T-bills for interests in financial companies over the last year. If the true value of the assets the Fed bought are found to be double the price paid, the Fed makes a $500 billion profit. If the Fed is getting assets at 1/3, they make a trillion bucks.

Holy. Crap.

That’s about 10% of the Federal Debt. And that’s where the Fed’s profits go, to the US Treasury. If the Fed is paying ten cents on the dollar—not an unreasonable discount in panic-sale conditions—the profit would almost equal the $9.7 trillion owed by the US Government.

It may take more than a couple of years for proper asset values to be determined. The Fed may just be using real money to buy smoke and mirrors. But…there seems a possibility that Bernanke and Paulson are in the process of settling the national debt.