Doubling Down To (DXY) Zero: Has The Fed, In Its Stealthy Synthetic Bet To Keep Long-Term Yields Low, Become The Next AIG?

When looking back at the Great Financial Crisis of 2008, the primary catalyst the pushed the system over the edge and required central banks around the world to institute a global bailout of unprecedented scale was one simple thing: the layering upon layering upon layering of bets (using "other people's money" and courtesy of recently unleashed "financial innovation" in the form of virtually margin-free securities such as credit derivatives, demonstrated best by this chart) that interest rates would keep dropping, primarily in the form of exponentially tiered credit structures such as synthetic CDOs (all the way to the cubed degree) together with CDS sold on such layered synthetic derivatives. Of course, when the black swan event occurred and rates surged, this relentless leveraging of wrong-sided bets promptly resulted in the liquidation of any institution that was on the wrong side of such bets. Most notably AIG. In essence, AIG took the "logic" that since a rate blow up would likely result in the collapse of the US (and thus worldwide) funding structure, it would invoke the biggest central bank Put of all: either the Fed would rescue the world, or capitalism as we knew it would end.

As it turned out, AIG was right, and following the sacrifice of Lehman Brothers, every other institution on the wrong side of the levered "rate" trade was saved by the Fed. But at what price? Simply said, the Fed, in bailing out the world (a meme that has only now received popular acceptance following the release of formerly classified Fed documents, despite our claims precisely to that end from back in October 2009) has become the world's largest hedge fund and with a DV01 of over $1.5 billion by now, has taken on virtually unlimited interest rate risk (a topic discussed back in April 2010). As such controlling inflation expectations, or more specifically, Long-Term rates (the part on the curve that Quantitative Easing is powerless to control) is the most critical aspect of the viability of the monetary system. Stunningly, today we learn that to keep long rates low, the Fed may have resorted to nothing short of the same suicidal trade that destroyed AIG FP and brought the entire system to its knees. Namely, Ben Bernanke is now quite possibly the second coming of Joe Cassano, since in order to keep rates low, Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low contrary to natural supply-demand mechanics. If so, the Fed is now basically AIG Financial Products, although instead of being synthetically long mortgages (and thus betting on a rate decline) and selling hundreds of billions in CDS to amplify its bet, Bernanke has done the same thing, only this time with Treasurys. Of course, Ben has the printing press on his side apologists will claim. Alas, that will have no impact whatsoever, if indeed the Fed has been reduced to finding ever fewer counterparties to a synthetic bet to keep long-term rates low, as very soon, with inflation ticking up, all hell may break loose in an identical replay of what happened to AIG once the Fed's put is called against it. Only this time there will be nobody to bail out the ultimate backstopper, resulting in the long overdue end of the current failed monetary system experiment.

Some may recall that over a year ago we made a curious discovery: by looking at the composition of securities held in the Fed's Maiden Lane I portfolio (than inherited from the collapse of Bear Stearns, which not even JP Morgan wanted) we uncovered that as part of the portfolio of toxic assets, which most recently was valued at $25.6 billion, the risk managed in charge of the book BlackRock had also put on a variety of synthetic hedges: "the FRBNY holds 5000 TYM0 puts, 3825 TYH0 puts, short 4000 FVH0,
short 7828 TYH0, short 2240 USH0, and is short a bunch of eurodollar
positions." The issue as we correctly specified, is that "while the Fed is pretending to care about interest rate concerns in an increasing rate environment and is hedging ML1, it has one billion DV01 risk for its house bailout package...This is a stunning number: the second rates commence
creeping higher, you can kiss all that profit on TARP and what not not
only goodbye, but the losses on the SOMA books will likely destroy
America." We then concluded: "the Fed has decided to protect against a major hike in rates [in the Maiden Lane I portfolio]. Yet
that which is truly relevant, the Fed's nearly $2.4 trillion in holdings
of MBS, Agency and Treasuries is completely unhedged [the number is now $2.7 trillion and will be nearly $3 trillion by the time QE2 ends]. Good luck finding
the counterparty that would be willing to put on a $200 trillion gross notional interest rate swap with the Fed." In other words, we were wondering why is the Fed not actively hedging its multi-trillion SOMA portfolio (including MBS, Agencies and Treasuries) if it was willing to do so with the far smaller Maiden Lane I subsegment of its holdings. Naturally, it may well have been doing so as there is no place in the Fed's weekly report (H.4.1) update that lists explicit derivative positions (more on this in a second). Ironically, it seems that we had the entire situtation backwards: it appears that far from being worried about hedging its SOMA book synthetically, the Fed may well have be constantly doubling down on its risk exposure in the form of off-book derivative contracts in order to "pin" Long-Term rates (read the 10 Year) by constantly selling Puts on Long Dated Treasurys at opportune times when there is no incremental buying of the underlying security, yet when, as the CDO and upcoming ETF debacles have so well demonstrated, the price of the derivative actually impacts the price of the underlying!

The missing sequential link in (lack of) logic comes from a report by Market Skeptics' Eric deCarbonnel who has combed through the June 24-25, 2003 FOMC minutes to find what could well explain the ongoing paradoxical flatlining in long-term rates even despite the threat of an end in QE2, which implies the removal of a buyer of some 83.4% of net Treasury securities, as well as the ongoing inflation threat so well described by James Grant earlier. What deCarbonnel has found is that as per then Fed secretary and economist, Vince Reinhart, and SOMA manager Dino Kos, the Fed has explicit authority and has in the past, sold puts on securities in order to bring various parts of the curve in line with "market expectations." The fragment from Dino Kos' transcript which implies that the Fed is likely actively pursuing a derivative feedback loop to keep long-term yields low (and thus prices high), is the following. Below, Kos discussed the "alternative approaches that would involve changes to how the Desk operates" in order to achieve the "conduct of monetary policy at very low short-term interest rates."

To wit:

The alternative approaches that would involve changes to how the Desk operates are summarized in exhibit 4. The alternatives that could be adopted while changing only the composition of the balance sheet are listed in the top panel. These include (1) extending the average maturity of the outright holdings in the SOMA, (2) setting explicit ceilings on longer-term Treasury yields, and (3) using derivative instruments.

As deCarbonnel points out, 1 and 2 have already been either explicitly or implicitly utilized by the Fed in order to prevent the yield curve from exploding, due to the fundamental dichotomy of Fed operations: the Fed can keep short term rates at zero easily, it is the long-term ones that are a key threat to tipping the Fed's unhedged book over.

Which leaves only option 3: "using derivative instruments" to keep LT rates low.

And this is where it gets both interesting... and very disturbing.

Going back to Dino Kos' speech:

The Committee could sanction the use of various derivative instruments on conventional Desk operations as a way to influence longer-term yields, which is outlined in exhibit 8. Options of some form are a possibility, as are forward operations. For example, we could sell a sequence of options on term RPs, covering interlocking time segments that collectively extend as far into the future as desired. In this way, longer-term yields could be influenced and a visible signal of the Fed’s desired path of interest rates could be demonstrated. Forward operations in term RPs could be structured in a similar fashion.

And the stunner:

Alternatively, we could sell put options on longer-term Treasury securities at strike prices associated with desired longer-term yields. Of course, the operating objectives set for the sale of derivative instruments would determine their proper structure and should be carefully formulated first.

At this point the lightbulb should slowly be starting to glow:

The sale of any options, or forwards for that matter, would not affect the domestic portfolio immediately and, in the case of options, may never do so. Auctioning derivatives is something we already have experience doing. In the event that options were ever exercised, the impact on the portfolio would be profound, assuming that more than just a symbolic amount of contracts were sold. Simultaneously controlling the funds rate means that any reserve effect would need to be immediately sterilized. The volume of options sold might be limited because of this concern. Alternatively, options contracts might be configured to make a net cash payout if exercised, perhaps by structuring them as interest rate caplets or pairing them with offsetting trades with the Desk at then-current market prices. This would insulate the size and composition of the balance sheet, but the payouts would appear very visibly as losses on the income statement.

Summary: not only does the Fed admit that it has already sold off asset derivatives as a means of controlling short and/or long-term rates, but the Fed in essence is willing to do with rates derivatives what Warren Buffet did with equities in the form of his gargantuan index put sales, and Joe Cassano has done with CDS sales on his CDO holdings.

Here the Fed, as any rational investor seeking to manipulate the price of an underlying instrument, although with the benefit of having a printer, expresses the logical concern: what happens if options are excercised, or in other words, what might happen if the "pin" bogey on the underlying is crossed and the Fed suddenly finds itself in a losing "In The Money" position:

Of course, a successful program would be one in which any options sold would never be exercised. Achieving this result, just as with interest rate ceilings, would depend on how well the characteristics of the options—the strike price and the expiration dates—corresponded to market expectations for future rates.

Ironically this is precisely what Jos Cassano thought... Until of course Goldman changed the rules in the middle of the game, hiked collateral requirements and forced a toxic feedback loop whereby AIG had to undergo a liquidation waterfall putting it deeper and deeper underwater, until ultimately it was so far undercapitalized it had to be bailed out by taxpayers.

Kos logically realized that it is far easier to manipulate short-term rates than long-term and as such advocated initially merely dabbling in repurchase options, which only impact ultra-short term rates: i.e., those critical to bank functioning whereby banks can borrow cheap and lend rich.

In this regard, options on RPs with the Desk have a strong advantage over, say, options on Treasury yields because the policy rate over which the Committee has direct influence could be more directly linked to shorter term RPs than to longer-term Treasury yields. For these same reasons, options on Desk RPs could be structured to correspond directly with a policy commitment on the path of future short-term rates, and they could be effective through one of several channels.

We get even warmer:

First, even a relatively small program would undoubtedly add symbolic weight. Second, they would represent a monetary cost to the Federal Reserve of deviating from the implied path of future short-term rates, which might be seen as further binding the Committee to that path. For this effect, the more options sold the better. Third, a large volume of options sold could reduce risk premiums embedded in longer-term rates, independent of the level of credibility about any policy commitment. Here too, the more sold the more effective. As with interest rate ceilings, the question could be asked how effective the sale of options, either on Desk RPs or Treasury securities, would by itself be in reducing longer-term yields.

Kos' verdict: the Fed would need to sell a huge amount of Treasury puts to regain credibility that it would continue to sell even more puts should the situation require it: i.e., be the seller of only resort, and calm a Treasury liquidation wave by the market.

[The] ultimate success would hinge on the quantity of options sold—that is, how big a bet the Federal Reserve were willing to make. The more options sold, the greater the chance they would have the desired effect on longer-term rates even if not associated with any policy commitment, either by raising the costs to the Fed associated with options being exercised, or by lowering risk premiums on longer-term rates.

To be sure, Kos appreciated the downside risk associated with going all in on a losing bet, and then leveraging some more:

[O]f course the risks to the portfolio, to reserve levels, and of capital losses would rise in equal measure. And an exit strategy for options may not be as straightforward as it seems, even apart from the possibility of their being exercised. Of course, the Desk could stop auctioning new options at any time. But a decision to stop selling more options or not to issue new contracts with later expiration dates as time passes likely would be interpreted in the market as a statement about future policy intentions. The resulting rush to unwind market positions would likely be very disruptive and send yields sharply higher.

And that is the kicker. In essence the Fed may well be undergoing a program whereby via one of its Primary Dealers, most likely JP Morgan due to the banks key position as one of only two clearers of the repo system, it is selling Treasury puts, which would have an impact of pushing Treasury prices higher, and thus yields lower, contrary to all expectations in order to pin rates to specific levels. And as Kos admitted, the more long-term yields would run up, the more puts the Fed would be forced sell.

Since derivatives have little to no initial (or maintenance) margin requirements, especially not with a counterparty such as the Fed which can just print money any time there is a margin call, the Fed would be able to virtually print an endless amount of Treasury puts to keep underlying, and very much delta hedged, position, read THE YIELD ON THE 10 YEAR precisely where it wants it! The Fed says as much in Exhibit 8 to the June 24-25, 2003 minutes:

And before skeptics say the Fed would never do this in reality, Vince Reinhart admits that the Fed did very much that just over a decade earlier:

The System has also been willing to put its balance sheet at risk to encourage appropriate expectations about interest rates or to calm fears about funds availability. As plotted at the top right, the Desk sold options on RPs for the weeks around the century date change that totaled nearly $0.5 trillion of notional value. Given that the Desk already operates in all segments of the Treasury market, we wouldn’t have to move up a learning curve if instructed to increase purchases of longer-dated issues.

With lack of data availability one can only speculate how much options, most likely in the form of swaptions, the Fed would need to sell currently to keep 10 Year yields low, although if past is any indication, if the SOMA desk sold nearly $250 billion in repo puts back in 2000 when the Fed's balance sheet was a fraction of what it is now, it is safe to assume that a comparable amount currently would have to be in the trillions, if not tens or hundreds, considering the far lower notional impact on a security with material duration compared to one to impacted (and impacting) by merely ultra-short term rates.

As for the Fed's justification to impact the market in such a covert and off-balance sheet manner some might say, it provides the following justification:

The Federal Reserve has always appreciated the importance of correctly aligning market expectations about the economy.

Of course when the Fed sees the economy as the market, such as now, it is critical that the Fed do all in its power to prevent an efficient price discovery process from occurring.

For those for whom this is still unclear, basically what the Fed may well have done (and has admitted to doing in the past) is what the market does each and every day, when ETF buying results in a long/short gamma trade that pulls or pushes component securities higher or lower. There is a reason why the SPY and the ES are the two most liquid securities in the market: control these, and what happens to the underlying stocks is irrelevant. In very much the same way, the Fed which still continues to load up on Treasury securities (albeit far less so as the longer-end of the curve), is now most likely pursuing a goal of keep the curve as flat as possible and not losing the long end.

As a reminder, during QE Lite/QE 2, the Fed has practically forsaken the 30 Y sector of the curve, or the part the most reliant on long-term inflation expectations. Why would the Fed do this in the cash market unless it had some other way to definitively impact demand via synthetic instruments?

A synthetic off-book short put position also explains the confusion of those such as Bill Gross: when the Fed supposedly exits the monetization game, regardless for how short, rates would traditionally be expected to rise. Yes... but only if the Fed was not concurrently selling massive amounts of volatility. And while the actual buying and selling would remain hidden from public view, the aftermath would be visible in downstream market effects. Indeed, this is precisely the case. As can be seen on the below chart which maps the yield on the 30 Year during various QE regimes, and the level of the MOVE Treasury volatility index, during times when the 30 Year appears poised to break out higher in anticipation of a QE end, yet merely trades rangebound, the level of MOVE plummets.

Obviously, plunging vol ends up having an offsetting impect on prices. Were the vol not to drop so materially, the upward drift in Long-Term yields would be very pronounced, and result in the 30 Year breaking out north of 5%, after which the Fed would likely lose all control of the curve. The question then becomes: who is selling all this vol ahead of such a risky event as the end of a Quantitative Easing episode. Our bet: none other than the current Manager of the System Open Market Account: Brian Sack.

This however leaves open the question of just where on the Fed's books would Sack et al keep a record of how much the Fed has in Treasury yield exposure?

Enter Exhibit A: Federa Resere "Other Assets", which as we have been disclosing for quite some time is now a not too negligible, and very much record, $125 billion!  That's right, the Fed has $125 billion in other assets, whose definition is so broad they could well be anything and everything, and which we have a sinking suspicion could well include among them the "net" exposure the Fed currently is booking on its swaption book.

Naturally, the specific booking of these "assets" would depend on the format under which the Fed has contrived to make its synthetic but on higher Long-Term prices: whether these are outright puts, or, as was disclosed previouly when looking at Maiden Lane I, in the form of curve swaptions (and thus payers or receivers).

Recall that as per the latest breakdown of Maiden Lane I assets, the actively managed book includes, among other things, $675 million in net notional swaption exposure (gross could be anything), as well as ($3.3) billion in Interest Rate Swaps. Is this the same open market tactic that the Fed is applying to the broader Treasury curve? If so, keep a very close eye on abnormal activity in the swaption market, especially that originating from JP Morgan.

Which leaves open one question: with the Fed selling Treasury Puts, who is buying them? Well, the answer could be anyone. While nobody in their right mind would every transact directly with a Fed selling insurance on its own books, many Primary Dealers, and foreign institutions are certainly eager to hedge their surging Treasury exposure, courtesy of the trillions in new issuance each and every year. In this scenario, JPMorgan, the Fed's proxy, would all day, every day, especially on key inflection date such as ahead of the termination of a quantitative easing period, flood the market with an overabundance of Long-Term volatility (i.e. selling puts), which as shown above, would push the MOVE index lower, and result in a strengthening of 10 Year rates.

Yet what observent readers will realize is that those buying protection from the Fed would be analogous to those who would have been buying protection from AIG on its CDO books. However, unlike back then, when entities like Goldman were sure to be bailed out on their collateral exposure to Joe Cassano, this time around if the Fed does lose control of the long end, and the Fed ends up experiencing first tens, then hundreds of billions of P&L losses should rates jump by 1%, 2%, 3% or more, then all bets would be off, and everyone left holding Treasury protection, i.e., the bet opposite to that of the Fed, would end up with with a big, fat nothing as the monetary regime finally fails, fiat is dethroned, and alternative monetary systems are implemented.

If indeed the Fed is the primary driving force behind the long-end's continued resilience, one should first inquire whether or not this is an action that the Fed is misrepresenting as performing - after all in its description of activities performed under US Foreign Exchange intervention, the Fed clearly states "The Fed historically has not engaged in forward or other derivative transactions" - is this blanket statement true only for Fed's FX intervention regime or for everything, because as Reinhart has confirmed, if so, the Fed is engaging in activity that is not previously disclosed as performing. Second, if the bulk of Treasury put buyers were to realize that their ultimate counterparty, under the guise of various Primary Dealers, and especially JP Morgan, is indeed the Federal Reserve, they will promptly abandon the Treasury Derivative market, forcing the Fed to lose this key lever of reverse market influence, resulting in chaos when it comes to controlling the long-end, and leaving the Fed with a curve that is at or near zero on the short end and surging in the 10 Year and over spot, which would result in complete loss of control by the Fed regarding inflationary expectations, the collapse of the dollar (yes, even more than to date), and an explosion in commodity prices as the nation finally careens over to its Weimarian endspiel. Lastly, a key question to demand of Bernanke, if it is confirmed that the Fed is shaping the yield curve using derivatives, would be just how great the Fed's blended risk is currently over and above the DV01 on merely its underlying physical instruments, and just how the Fed will hedge not only its massive ~$3 trillion paper exposure, but possibly its multi-trillion synthetic exposure should inflation surge, and the Fed's SOMA desk finally lose control of the long end.

While there are many questions embedded in the assumptions presented above, we are confident at least some unconflicted reporter will inquire Ben Bernanke on April 27 whether any of the above is in fact true.Which if confirmed, will be the biggest admission of market manipulation by the Federal Reserve in history.

Those who wish to follow deCarbnnel's thoughts on the matter can do so below...

And for those curious to see just how the Fed predicted this very course of action as long as 8 year ago, we urge you to read the following exhibit from the Fed June 2003 minutes in its entirety - link

What is most ironic, is that Mr Reinhart was kind enough to leave us with the Fed's next steps for when the SOMA manager finally loses control of the curve. From Exhibit 8 to the June 2003 minutes (presented below in their entirety):

FOMC20030625material

h/t Dnarby

Comments

[TruthInSunshine]

Operation Sock Puppet is Alive, Well, & Kicking Into High Gear.

[Ricky Bobby]

+1 One day www.zerohedge.com will come up with a Homeland Security message and that will be the end of it.

[akak]

See how many long posts there are that have nothing to do with the topic at hand? These are paid government disruptors. Now THINK about why there are so many paid government disruptors on this topic.

And as usual, as I have seen countless times in a number of totally unrelated online forums, it is ALWAYS the topics of precious metals as financial insurance, and the collapse of the dollar, that brings out the obvious disinformation agents and shills for the Establishment and status-quo.  Their playbook is utterly predictable.

[Squid-puppets a...]

Thanks for the opportunity to get back on topic.

Can someone smarter than me explain the implications from this article should JP Morgan take a massive hit

i mean, does this article imply that the Fed is utilising JP Morgan as a wagon to unload as much risk as possible, to jettison it over the cliff in a pinch - but if JP morgan takes a massive loss from other portfolio's (ie silver) what are the ramifications for the Fed

It just seems to me like the whole finance industry is like that james dean movie, racing in cars, screaming towards a cliff in a stupid game of dare , for the occupants (the oligarchs) to jump out at the last minute and let the cars (Fed, JP, Sachs, the world) sail over the edge

[topcallingtroll]

Dp

[sschu]

So the only way out of this is for the government to get on a path of fiscal sanity and stop the borrowing.  That can keep rates low for a while during the restructuring.  IMHO, this chance was missed in late 2008/09.

Some say cut government spending, that means a layoff of the 15M extra workers employed at all levels of government.  Sure.

Or Krugman says raise taxes, especially on the rich.  Sure.

Or confiscate assets, 401Ks, to kick the can. 

Certainly someone has told the politicians about this, maybe in simpler terms.  :-)  We need leaders and statesmen right now, few seem to be emerging.  They eventually will, but by then the crash will be history and life as we know it will be over.  What the new life will be like is what really matters. 

sschu

[bob_dabolina]

I don't know about other investors but I see how to strip these mother fuckers.

[vast-dom]

read this insanity:

http://www.marketskeptics.com/2010/04/gold-manipulation-officially-confi...

[DavidPierre]

 Ever thought of selling ALL PM stocks and going 100% physical?

Exactly a month ago, during the Japan PM smash, I thought of this but didn’t do anything about it.

Friday my account hit a new high DESPITE the MASSIVE CAPPING all the way up, and in just over 24 hours more than half of the hard fought gains have evaporated in an environment where the Dow is essentially at its high and both gold and silver are roughly at their all-time and 30 year ...essentially all-time in the PHYSICAL market highs.

The GOVERNMENT COMPUTERS run the stock market, the bond market, and the currency Market ...although no one seems to care that the DXY is at a multi-year low.

If there are 15 million shares of SLW buying, they’ll just short 16 million, and the only way they "let" the PM stocks rise AT ALL is if the Dow is rising.

As for the juniors, there just are not words to express how difficult their rises are, and how bottomless ...on no volume... their drops are each and every time the PM sector has even a minor decline.

Valuations in juniors are still 70% or so below where they were four years ago ... a with few exceptions), and not even the slightest hint that that gap is ready to start closing.

Sentiment is 100% under control thanks to the GOVERNMENT COMPUTERS that make sure no PM stock excitement ever occurs, even with record PM prices.

Just as sentiment toward the collapsing US economy is muted thanks to the GOVERNMENT COMPUTERS that NEVER allow the Dow to have a significant decline.

The only market they cannot control is the physical PM market, and that is why, with each passing day, I think more about going the Jason Hommel route of 100% physical.

I am on the verge of snapping after all of these years of abuse, and the past two days have been far worse than even last month’s PM attack.

I am all about making money, and it get harder with each successive smash to believe that the PM stocks will be able to break free from these monsters.

But I haven’t done anything yet.

Still thinking.

www.lemetropolecafe.com

[fiftybagger]

Mining Stocks Explained

http://www.youtube.com/watch?v=z2F50CamWlQ

[bob_dabolina]

tbdr

[topcallingtroll]

Have their been changes in zerohedge? Recently i can never get it to fully load on mobile and often it just freezes. Some of the recent embedded videos and texts have been huge, but this is now occurring even on articles without embedded texts.

Is it too many complicated javascripts from advertisers who want a lot of.visual motion in their ads?

Are the data downloads bigger now for some reason?

I have android verizon in arkansas. So far this isnt a problem on other websites.

[bruiserND]

"Which leaves open one question: with the Fed selling Treasury Puts, who is buying them?"

The portfolio managers of Japanese, Chinese & Middle Eastern Oil producer holdings of U.S. long dated Treasuries as their Monchock- Webber and Black Scholes computer models have instructed them to do 

I was on the trading floor of the CBOT in the bond pit for 14 years including the crash of 1987. This is the "TRIGGER" that Dr Michael Burry , M.D. said was non existent.

This is the worst financial news item and financial decision I've seen in 61 years. Nassim Taleb, author of “The Black Swan ,”  & Nouriel Roubini on a 3 day acid bender couldn't even make this one up.

[e-mail]

Please write Vince and tell him what you think of him as an American

I saw him referee a debate between R. C. Whalen of IRA and the ISDA in February of 2009 on CDS' , he's an ISDA plant at the Fed

[onlooker]

If the author had been anyone but Tyler I would have to give it partial attention. However, as Tyler seems to be a sober teller of opinion/truth I will have to copy and send this to my family and friends. This is truly a damning article of where the United States is/may be headed. I hope that Tyler is wrong. I hope he is way wrong.

[N57Mike]

Thank you Tyler. Question, does all of this corroborate with what Pimco is doing?

[thedrickster]

If the Fed is selling vol en masse, I can't imagine that Pimco or anyone else would be buying it with perfect information.

[N57Mike]

no, more like does it correlate, that Pimco is staying out of the market, because they know that crazy schemes such as this is going to end badly.

[thedrickster]

But Pimco is now quite literally, fighting the Fed.

http://www.google.com/url?sa=t&source=web&cd=4&ved=0CDUQqQIwAw&url=http%...

Anyone else nostalgically pining for the bond vigilantes? Oh wait......if TD is right then Bond Vigilantism is something akin to seppuku.

[zen0]

Not paranoid enough....not paranoid enough.

You think you can figure out the Fed?

You think you can figure out the Chinese?

You think you can figure out the Washington DC?

Fed don't know, Chinese don't know, WashingtonDC don't know.........

But you know.........right?

Nobody knows.

[honestann]

Oh, we know all right.

Not every detail, just the general plan.  How can that be?  This is roughly the 37th attempt by the predators-that-be to accomplish the same goal... world enslavement of mankind.

This time they might succeed.  Let's hope not, and take every action we can to thwart them, then hang them.

[Problem Is]

I always thought that slime ball Cassano looked like a clean shaven Bernank with a toupee...

[thedrickster]

So when the Fed loses the long end and blows up the world by letting go of the short, how long until Gross & ProShares holders are declared enemy combatants and shipped off to a freshly painted FEMA camp?

Tongue in cheek but the politicans will of course find a boogeyman and it AIN'T going to be The Bernank.

WWIII is their only way out isn't it?

[zen0]

No, fear not. They have found the alternative......fiscal insanity.

[honestann]

This is just the "usual plan" for these predators.  They make a huge disaster, then swoop in with actions that make the problem much huger while portraying themselves as saviors.  Then when they so utterly and completely destroy everything that no further actions exist that can push the day of reckoning out a month further.  At this point they point to the size of the disaster they created and asset that it is now necessary to steal wealth from everyone, and institute absolute, complete utter control and totalitarian dictatorship to "save everyone".

That has been the plan for their 100th anniversary of the federal reserve for the past 98 years.  They intend to complete their plan on time.  Then comes global civil war or the complete, permanent end of every shred of honesty, ethics, justice, liberty and individualism on earth.

[Coldfire]

It is becoming clearer and clearer that the Fed will not survive. The cosmic conceit of its owners is that the world will end without it. No. The world of its owners will end, but life will go on. And will go on much better without the corrosive, corrupting influence of the biggest Ponzi scheme the world has ever known. (So far). Don't bother ending the Fed, as the Soviet Union of fiat it is doing a fine job of that by itself. Godspeed.

[chindit13]

<misplaced>

[AUD]

Good work but hardly new. Below is from Melchior Palyi in 1958

The money market can be kept liquid indefinitely if the Treasury prints certificates and the Federal Reserve monetizes them. But what happens to the liquidity of the monetizer? The assets in the portfolio of the Federal Reserve System amount de facto to permanent investments. It makes little difference whether they consist of short - term certificates or of long-term bonds. In effect, they are as good as non-marketable consols. (The same holds for assets of the Federal Deposit Insurance Corporation, another fountain of pseudo-liquidity.) Disposing of as much as ten percent of the portfolio would 'wreck' the credit markets. An over-indebted Treasury, one in deficit at that, cannot redeem the one kind or the other, but is bound to resort recurrently to more monetization.

By slow attrition, the result is likely to be the same as in the case of outright money-printing by the government itself. The old-fashioned technique of paper money inflation 'worked' faster than its modern, seemingly less reprehensible counterpart that camouflages the production of fiat money by channelling it through the money market and the central bank. The latter's liquidity consists exclusively of its gold reserve that tends to decline in proportion to its liabilities. The attrition of the gold reserve accelerates when the gathering of inflationary expectations induces non-resident owners of dollar balances to withdraw them (with residents joining, too). There can be little doubt of the final outcome, unless the process is brought to a halt.

[TruthInSunshine]

I am not the world's smartest man, by a long shot.

I am not the world's dumbest man, by a long shot.

I think it's fair to say I understand matters of finance, debt, deficits, the role and function of central banking, and fractional reserve  banking methodology and 'float' of government debt better than...I'll try to err on the side of caution...99.7% of the population.

Of all articles on finance, governmnent debt related, and the similar, this article is not only beyond excellent, but it scares the living shit out of me.

[Aknownymouse]

Thanks Tyler.  great piece.  A shift out of the USD as a reserve currency woul totally fuck up this plan by the FED - right?  USD would go down in flames, inflation would soar for americans and the puts go in the money and the FED is toast.  right?  I think that is the FED's black swan.

[dalkrin]

Tyler Durden, hats off to you man, this is by far the most compelling and convincing article I've seen posted so far on ZeroHedge.  I can't follow all the details of the bond market yield curves to my satisfaction, but with a background in math/chemistry I do know that this Fed abomination cannot endure, and that happily, gold and silver will never be printed. 

The sensation I am left with makes the 2008 experience seem like Arcadia.  I've been delving into the modern offerings of post-apocalyptic scenarios trying to prepare myself mentally for what is threatening to unfold, yet after reading this I am frozen with trepidation. 

You are doing all of us a service with these investigative articles, I hope you will remain to chronicle the downfall of this unprecedented affront to humanity.

[Yen Cross]

Tyler Durdan could care less about your sparkle in the eye humanity! Tyler Durdan wants. Wants for you idiots to think on your own, or DIE TRYING! End of story.

[chindit13]

Warning:  Scroll down if looking for insight or comfort in our time of collective insanity

To: undisclosed recipients

Dear Sirs:

God bless you and hope that this email finds you full of healthy goodness and generosity. Your precious name was provided to me by someone who wishes to remain synonymous, for reasons which I think you will never but fail to appreciate, but who vouched for the integrity of your character and high moral servitude.

My name is Barrister DeWashington Jones Okanopo, and I am Head of the Fixed Income Options Desk at the Bank of Nigeria’s branch office in Kano. I need your help in parking some $17,654,982.47 (seventeen billion six hundred fifty four thousand nine hundred eighty two dollars and forty-seven cents) of net value put options on 10-year US Treasuries. You see, I have exceeded my position limit by a factor of 1612x (one thousand six hundred twelve times), and I am afraid if my boss catches me I will lose my job, something I simply cannot afford right now. My wife Princess Obiella Okanopo (Gladys) is with child, our 11^th (eleventh), and with inflation being what it is---cassava root is up 68% (sixty-eight percent) since the Hajj---it is becoming difficult to make my ends meet. I dare not even mention the gall bladder operation our son DeWashington, Jr., aged 12 (twelve) needs, or that we have also already harvested 1 (one) kidney from each of our daughters and auctioned them off in Singapore just to keep the debt collectors at bay who want to repossess our 1981 (nineteen eighty-one) Chevrolet Caprice, which I need to drive our youngest boy to his physical therapy sessions he requires after the injuries he suffered in Fukushima where he was on a scholarship program studying ramen making so that he could work in the cafeteria at the School of the Blessed Virgin he attends here in Kano, for if I mentioned this your heart would surely burst and duly explode from the wave of compassion and empathetic feelings of rage against all that is fairly unjust.

Instead I humbly ask your assistance in accepting these positions that carry the “full faith and credit”© of the Honorable Mr. Ben-shabbat Shalom Bernanke, and which also carry an embossed Certificate of Authenticity signed by Mr. Djamie Dimon of JPFataMorgana Bank, who I believe is the illegitimate son and heir of Mr. Cecille Roads after his most secret dalliance with Mamie Van Doren, but please to not be quoting me on that pending conclusive DNA analysis.

Should the far end of the yield curve collapse while these positions are parked with your goodselves, you will be entitled to payments beyond the most wildly of your expectorations by the aforementioned Honorable Bernanke, though our Chief Economist Mr. Djoe Lah Vork Na at the head office in Lagos says this is a low probability event. I do not mind sharing this intimacy of my private parts with you, however, that I always fade Economist Djoe as my own assertations provided with me most exclusive proof of his cereballistic ineptitude. All that I most humbly request as per the international law of the land is that you post a small and wholly insignificant collateral in the form of gold bars carrying a Johnson Matthey assay for which we humbly hold with all solemness of purpose in our secure vault here in Kano, and granting you exclusive visitation rights to said metal at your most leisurely pace, lunch not included owing to hysterity measures.

With full and unencumbered pulchritudinous blessings,

Barrister DeWashington Jones Okanopo

Education: BS, MS (failed) International Finance and Culinary Arts

[Anonymouse]

Eric's video keeps referring to Fed selling puts as being "fraud".  Is it?

I know it adds risk, but is it fraud (from a legal standpoint)?  I don't know.

Can a company sell puts on its debt or equity?

Not trying to defend the Fed (never have, never will), but I honestly don't know.

Anyone?

[Catullus]

The fraud is that the Fed would sell puts without ever having the intent of exercising them.  It's entitity that would diliberately take on massive losses because it has the ability to print money ad infinitum. This is also another method for direct monetization of treasury bonds. 

[TruthInSunshine]

The fraud is far simpler than that.

When the Fed, or any central bank engaging in fractional reserve banking based on the London Economics Model, for that matter, unhinges the value of fiat to anything of inherent value (regardless of what the value is) that can't be produced in unlimited supply (as digital 0s and 1s can), the fraud is complete - you will inevitably have death of any store of value by dilution, whether over a 10 year period or a 2000 year period, depending on relevant circumstances and motives and who controls what and when.

Forget about gold. Its inherent value is tied in these days more to emotion than practicality. That it exists in finite supply, versus digital 0s and 1s, is what makes it one of what could be 1 million things better as a storehouse of wealth than unlimited, infinitely dilutable, fiat currency.

Loaves of bread would be generations better as a storehouse of wealth than digital 0s and 1s if wealth preservation was the name of the game. Even after 1 year, hard as a rock, and covered in mold, there are still practical uses for bread, and more importantly, an infinite supply of new bread can not be produced (thus making the expected life of a loaf of bread far less likely to be anything remotely close to approaching a month, let alone a year).

[Implicit simplicit]

The only way it is not fraud is  if you believe Blankfein is doing God's work, and God is the Fed. The fed controls everything. In a water analogy, they control the flow, the pressure, the hot, the cold, the purity, and probably even the electricity giving the HFTs faster or slower access. The only thing that this God can not control are natural disasters, and the inflection point failure of complex systems; they are only God of financial systems, not their interaction with all other systems.

[Squid-puppets a...]

tru dat.

Fraud? It' only a perspective. I personally think that the whole fractional reserve system is fraudulent - but i also acknowledge its usefulness in greasing the wheels of an economy. I just think that its robbery that the proceeds go to private hands. Reserve banking could be justifiable if a worker could go straight to the govt for a homeloan, so that the interest he pays back on fraudulent 'money' lent goes to the tax base

but then this also pre-supposes a true democracy in which tax dollars are spent both wisely and fairly.

And if that fairytale situation were to ever prevail it would only be temporary until the oligarchy fukt it up

[Anonymouse]

I understand all that.  My question is, why would this be any more fraudulent than anything else the Fed does.

I agree they are doubling down with this move, and it is scary.

And I suppose you could make the case that since they control the money supply, they control the value fo the puts and could force them to expire worthless, if there were no other intervening factors.  But nothing has happened when that is done in the PM market.

I guess I'm not asking it correctly.

Yes it is dumb, yes the whole fiat system is fundamentally flawed (to put it nicely), yes this is doubling down that will doom the economy.

But how is it any more fraudulent than anything else the Fed does?

I suspect this is ust a hyperbolic statement.

Video still excellent and makes a great point though.

[slewie the pi-rat]

i've been looking at this article for hours.  i can't understand it.  tyler's explanation is coherent, but who the hell trusts tyler? 

so, we have billions & billions of puts, which are used to influence T prices.  i looked at the FRBNY options from last year.  i read what deCarbonnel & Kos said.  and i read it again. what don't i understand?

i don't understand if this is the only way of conceptualizing all these short puts, or not.  some of FRBNY's stuff from last year didn't seem naked.  aren't there some covered options and spreads there?  i think so.

next:  is there any way to conceptualize these puts as covered?  in options if you are long a security, you can sell a call.  it is covered.  price goes up, call is exercised, security is delivered.  The End.  same with a short:  short the security, sell a put, the put is covered.

IF we look at the Treasury AND the FED as "two arms/hands on the same torso"  or "two pockets in the same pair of pants" for the purpose of this analysis, the Treasury is short the securities and the FED has sold the puts.  the puts are covered.

strange, but true.  (?)

[Yen Cross]

I like you  Slewie! 

[slewie the pi-rat]

hey, Y/C!  i got back to you on those Q's yest, belatedly: 

Friday Afternoon Humor

[topcallingtroll]

true, but it is called kiting when you break it down to the simplest terms.

[Abby Normal]

The treasury puts convert long term treasuries into short term treasuries undermining any price discovery of the long bond.  Also, the fact that the puts exist means the Fed is required to print more dollars to honor them thereby undermining the value of the dollar (while maintaining a low yield on the long bond).  Question: if this information is known/becomes known to all investors, wouldn't rational investors desire to immediately put their treasuries back to the Fed so as to take their dollars and reinvest them in other currencies/commodities?  The knowledge that the Fed is required to massively print dollars until they buy back all the treasuries means more QE - and no real treasuries.  Who would want to be the last person holding dollars in this scenario?

[magpie]

So this tells us PIMCO is loaded up to the gills with the puts, right ?

[Yen Cross]

Ya know those spikes are Bull Flags! I'm tired. Little couches. OUT

[Catullus]

I find something incredibly comical about this in two ways: (1) that anyone thinks Treasuries are good investment is beyond me.  You can only be a bagholder. Ever. (2) Most large non-financial corporations hedge interest rate exposure either via swaps or swapations and no one knows how they actually work. They're just told their hedged to interest rate risk. They put some meaningless disclosure buried somewhere on their 10k and 10q and no one every touches them again.

My guess is just like AIG, the banks buying the exposure from whomever is selling these swaps are unloading them onto balance sheets everywhere.  Any large corporate entity with rolling corporate debt would probably own this stuff as well.

[topcallingtroll]

they will paper over the weak link again, like they did with AIG.

[Bernard_2011]

Wow.  This is an extremely explosive allegation that Tyler is making.

I`ve read about a ton of shady financial dealings thus far, but this would take the cake.  This is a rather technical argument, so most people would not necessarily grasp the immense significance of this.

Ron Paul must demand an answer to this question from the Fed (given his oversight power in Congress).

Is someone able to advise Ron Paul of this information?

Nobody has ever really considered this issue before.

[mayhem_korner]

I think it's useful to reverse the lenses on these good diagnostics.  Symptoms emanate from the core, not the other way around.

The Fed is not the next & last host of a cancer, but the source.  AIG and the TBTF complex is simply the last wall of defense against the fiat money system loop coming to catastrophic close.

In a sound economic system, (PHYSICAL) PRODUCTION > CONSUMPTION = REAL WEALTH CREATION.

When the above does not produce desired results - unequal distribution or inadequate growth rate -  power structures intervene and corrupt the equation.  This is done by decoupling currency from physical production, aka fiat.  The new, unsound structure simply feeds the CONSUMPTION side, and creates a gap between real wealth (PHYSICAL PRODUCTION) and nominal purchasing power (FIAT).  The gap is DEBT and it grows in stealth, suppressed by the euphoria of perceived prosperity.

The flywheel has been churning for decades, the last nail in the coffin was Nixon in 1971.  All the market distortions we see now are a function of an increasingly chaotic, last-gasp flurry of defenses against an insurmountable gravitational force.

Selah.

[Arrowflinger]

The whole notion of a "balance sheet" for an entity that creates "money" from nothing is absurd.

The notion that the Fed could buy/sell $trillions in derivatives from sound institutions is also absurd.

The reality is that they create $trillions and throw them to the winds. The reality on the fiscal side is that there are zero financial controls, with millions of people empowered to create additional $trillions of government debt that must be monetized.

If you cannot see it, touch it, and verify it physically it is a digital figment, gone with a power surge. Yes, that has double entendre.

There is a silver lining. Got that?

[TankWolf]

Outstanding article Tyler...I have a few questions though.

Can long term treasury yields be pinned that effectively by selling puts? I mean I understand the volume of puts the Fed can sell is basically unlimited but at the end of the day arn't long term inflation expectations the main driving factor to long term bond yields? No matter how many puts the Fed sells to influence the curve I cant see how that would pin 30 year rates if inflation expectations started to get out of hand...

This is a HUGE gamble that they are taking if true to keep long term rates down, it honestly shows the arrogance of the central bank to think they will be able to manipulate the market to their exact desires. One wonders though why they didn't buy more of the 30 in QELite/QE2 instead of taking on double the risk via the POMO program and the selling of puts. You'd think as Tyler suggests they would hedge their books by BUYING puts instead of selling them but the only reason I can think of why they wouldn't is because if Treasuries die then the Federal Reserve does also. So it does seem like this is an all in more than ever. As the data from the 2003 FOMC shows they had to sell around 250B of puts back then and as the article says it would have to be in the trillions now, and yes I do understand the Fed has some fancy accounting tricks now that puts that risk back onto the treasury (tax payer) but surely they know that if that plays out the game & their reign is over anyway right?

Its all pretty confusing especially of late with all the hawkish comment from the Fed heads but there is absolutely NO WAY they can raise rates until the US government gets the budget in order. Someone is going to have to keep buying the bonds and if its not the Fed then rates will rise and the loss on the Feds books would mean be insane. The Fed surely has to keep quantitive easing going well into the future to ensure the US government doesn't default because that would ultimately lead to the end of the Federal Reserve system.

What Id like to know is there any scenario where this strategy can end well for the Federal Reserve at all because Im finding it hard to think of how the US other than by some hand of god has a super boom in the economy which enables the US governement to get the budget and the debt back to manageable levels which in turn would allow the Fed to offload their balance sheet. But as everyone on this blog knows due to globization and free trade agreements those economic conditions may never truly return to the United States.

Could this really be the setup trade to kill the US dollar and usher in the IMF's world currency maybe they get a deal where they get to be the central issuing branch of the IMF currency in the US, who really knows anymore its gotten ridicolous.

[jkruffin]

Response to your question in the first paragraph:

Why do you think the FED has consistently lied about core inflation and unemployment data for the past 2 years?  They have to at this point, because there is no way out. 

Markets are focusing suddenly now on the debt ceiling being raised by Congress. If they don't raise it; treasuries plummet, and if they do raise it; treasuries plummet still.  Backed into a corner to lose no matter which way they choose to go is where we are at.

The FED will lose the battle ultimately. They can kick the can for a while, just like AIG did, but it will get them in the end, as we saw with all of the crooks.

I think I will stick with Bill Gross on this bet.

[Stuck on Zero]

The Fed didn't bail out the world.  It just bailed out the world's billionaires.

[topcallingtroll]

good point.

[tellsometruth]

in the imortal words of the Dude: "That's a bummer man"

[hardcleareye]

Tyler, Excellent article, took me several reads, a good nights sleep and a few hours of research to fully understand it.

It would at first appear that the success of this venue lies in public igornance, "nobody in their right mind would every transact directly with a Fed selling insurance on its own books".

Your article will become "main stream", others will confirm what is painfully obvious and they will lose control of the long end. 

So it would appear that we are on the cusp of the Federal Reseve, "seeking legislation to expand it's authority".

Fedro failed, the Federal Reserve has the ring.

[JR]

Your article will become "main stream", others will confirm what is painfully obvious and they will lose control of the long end. – hardcleareye

Exactly! It’s a pretend game.

In a staged Bernanke market (no real supply and demand), the players are not real participants; only actors in a fiction – each banker a mere pretender in a stage play.  And, so, the ending as written is not a real ending, either; it’s stage fiction.

That is to say, at the end of Bernanke’s staged recovery,  the good guys in white hats won’t be getting the girl. When the curtain comes down, when Bernanke’s play is over, hard reality will set in.  Bernanke can’t produce a Hollywood ending with pretend value in a real world.

In the real world, the American people – who must produce value to live the American Dream  --  aren’t going to be slaves and submit to the wishes of a tyrant cartel by turning over their belongings, future and freedoms to a few tyrants running a printing press, just because they made up a play.

In the midst of a savings-and-wage-and-job wipeout, Bernanke can’t simply repeat over and over that his artificial economic progress is working, all’s calm, Joe’s in recovery, the banks are happy, and the play’s over. All isn’t going to be fine.  All is just make believe.

But the backlash, after the curtain comes down, isn’t going to be make believe; it’s going to be reality.  A people who expect to live a life of self determination are going to push for a supply and demand world.  And S&D will write the reality.

[topcallingtroll]

I admit this is troubling, but surely they will stop in time.

Banksters can't survive if fiat is repudiated.  Fractional reserve fiat systems feed them.

they can shear the sheeple twice a year, but only kill us once.

I just don't think they are going to destroy the system they need to survive.  We might get a bloody shearing.  We will get a bloody shearing, but they are smart enough to end this before repudiation, surely!

[JR]

An accused murderer who acts as his own lawyer faces one serious obstacle in the justice system: if convicted, any legal mistakes he makes in his own defense cannot be used as grounds for appeal later. 

This is Chairman Bernanke’s problem for personally paying the premium on the Fed's taxpayer insurance policy: there’s no appeal when he burns the house down. The public will not accept the claim.

This is the Chairman’s last card game and his bet puts nothing less than the Fed itself on the table. IMO.

[10044]

Tyler deserves an Oscar for this; just outstanding

[Yes_Questions]

Edward R. Murrow award?

[digalert]

Turbo Tax Timmy Geethner > ABC:

"Republicans agree the debt ceiling must and will be increased..."

[chindit13]

The more I consider this, the more confused I get, but it seems what it creates is a mismatch in funding and a prepayment that adds up to a kind of latent QE.

For example, Bank A owns $1M of  ten year USTs, and buys a put from Bernanke.  Result:  dollars out of the system (put premium), cash into the Fed.

Now suppose rates rise.  Bank A puts the bond to the Fed, the Fed pays the strike price.  Result:  dollars into the system (effective prepayment by the Fed of the Treasury debt).

Fed holds the bonds to maturity, collecting the coupon along the way, and the principle at maturity.  Result:  dollars out of the system, theoretically from tax receipts paid to Treasury.

Thus, this just seems to be a Fed option on QE, rather than QE the way Bernanke is doing it now.  In other words, it is like a latent QE, triggered only if rates rise.

My scenario goes out the window if these are purely cash settled and the Fed has written more puts than there are long dated bonds.

[Tyler Durden]

While the details are to be ironed out, if correct, at is base this is nothing than an off the books and massively leveraged version of quantitative easing. Basically the Fed has taken (or advised on) the risk and maturity transformation CDO concept of the EFSF and applied it to our own curve.

The Fed can end overt QE at any point, but continue with this operation covertly, in essence being the invisible hand though not for equities, but for the rates market which is 2-3x bigger.

[cosmictrainwreck]

yes..... "follow the (gross amount of) money"

[TankWolf]

If they were to end overt QE who would be buying treasuries though as you have pointed out several times the Fed was the buyer of some 87% of net issurance, wouldn't this ultimately lead to rates rising and the puts being excorised? Im not a financial expert by any means but in order for this to work would it not require a commitment from the PDs & other central banks around the world to buy the long end of the curve with the puts as their hedge after the Fed ends QE2?

[Muir]

Thanks chindit and Tyler.

Those comments clarified it for me.

[jkruffin]

Alot of fancy terms being thrown around, but to help those understand who don't:

It's a PONZI SCHEME!!!!  Plain and Simple.  Free Bernie!

[redpill]

The only part that is gnawing at the logical progression here is that if they have already been doing this in the past, and plan on doing it in the future, why bother with overt QE at all and provide fodder for a backlash?  Why not stay in the shadows and continue ZIRP indefinitely using these puts?

[poydras]

One can speculate on who is buying any puts.

Any currently out of the money bond puts are likely to expire worthless.

At some point inflation ends the game.  The UK offers the best view as their inflation is over 4% and the one year Gilt yields under 1.  ZIRP becomes impossible to support at some inflation level.  Seven or eight percent could be the level.

The govi end game is to monetize most of the govi paper and implement austerity.  The Fed can clamp down on inflation once purchasing power (and the real value of debt) declines materially.

There is always a risk for a creditor of a debtor that controls the value of the debt.

[Arrowflinger]

There is always a risk for a creditor of a debtor that controls the value of the debt.

Succinct and meaningful, that was.

A reminder to fiat holders.

Thanks.

[Creed]

nice detective work TD

the risk with ending QEII is that they can't stop the slide once it begins & it devolves into worldwide chaotic deflation

so you end openly with one hand and continue secretively with the other hand to keep things from... getting out of hand :)

looks like a massive juggling act

[Strategery]

Great article, great discussion.
Observations: I believe the so called deflationary threat is a red hearing, a straw man set up to justify the Fed's actions. Don't accept the buy risk or a car conclusion; that is the bankers' dream that got us in this mess.
Two: treasury put buyers have been warned.
Three: is this really high risk, or the well orchestrated plan on how to kill the dollar and make it appear to be an unintended consequence of a grand but futile effort by the Fed?
Four: When the Fed needs a backstop, the working class of America are sacrificed.
Result: A ruling class of mega wealth and a populace of serfs to work for them.

[twotraps]

I agree with your deflation thoughts but found a comment a little earlier very interesting saying that deflation actually lets the fed out of their position.....so should it occurr, who wins and who loses?  Can you see some combination of deflation with a well timed series of rule changes that will ultimately suit the banking establishment, while making a 1/2 orchestrated 're-pricing' seem like pure mkt forces at work and allowing for the cycle to start over...............How are you positioning yourself if at all, how can you preserve wealth at this point??

[Strategery]

Maybe the question behind the final observation is when the Fed, faced with crisis is forced to sell more puts in a frantic effort to unwind it's position, how far will it, or can it go, in theory (with a money machine), to quell the crisis, and what will the dollar look like at the end of that exercise? Best bet: lots of inflation

[Ricky Bobby]

My God it is the Banque Générale. I stand is disbelief at the arrogance of these men.

Res publica mortuus est, vivat imperium

[twotraps]

How can you protect yourself in case of your scenario?

[Dejean Splicer]

I don't know why you would delete my posting especially when there is a possible link between HAARP and FED assets.

I know you will say that it's too speculative but are we not here to exercise thoughts and gain knowledge?

Why not let the junk feature allow the community to remove my posts instead of being an overlord?

I'm not trying to hijack. With all due respect to your work. This article is not new or ground breaking. You have been laying the ground work for this argument since day 1. Anyone not able to connect these dots should be banned for not paying attention.

~D'jean Splicer

[Tyler Durden]

How about just using a link to comments that are more than 3 pages in length?

[Dejean Splicer]

Good grief, all right, I appreciate the heads up at least. Nice to finally know who's on the other side.

[Bringin It]

Please post the link.  thanks

[Atomizer]

Oh my. Some dumb fuck progressive junked Tyler.

[Creed]

you bring HAARP into a discussion of the FED & question why your post got deleted/

bwhahahahaha

[A_MacLaren]

Heads UP ZH Community: http://www.govtrack.us/congress/bill.xpd?bill=h112-1638

H.R. 1638: To stimulate the economy, provide for a sound United States dollar by defining a value for the dollar, to remove the authority of Federal Reserve banks to pay earnings on certain balances maintained at such banks, and for other purposes.

The text of the proposed legislation is as yet unreleased.

Cui Bono analysis will be critical.

[Dejean Splicer]

"To stimulate the economy, provide for a sound United States dollar by defining a value for the dollar"

Nice huh? I thought the futures exchange already defined the value for the dollar? Is this a new price discovery mechanism?

[magpie]

hm price discovery could be a bugger sans government debt and central bank, i believe. Not that i advocate such sudden "discoveries". But we learned that Texas is at least some ounces gold richer today.

[snoopy]

This is easily one of the most disturbing articles in the past year.

Now the questions that I have are

- who in their right minds would by Treasuries w/out the put option?

- who actually has it and who has not? (ie all larger pension/mutual funds, central banks?)

- why did PIMCO sell all their Treasuries, if they had the option to sell it to the Fed? (or maybe they exercised the Put???)

- what should I as an individual investor do (already sold all bonds that I had directly/indirectly)?

Snoopy

[Kimo]

"- why did PIMCO sell all their Treasuries, if they had the option to sell it to the Fed? (or maybe they exercised the Put???)"

perhaps fund investment restrictions on holding instruments of mass destruction?

[ivars]

Have a look at governor Palin at Wisconsin Tea party rally yesterday:

http://saposjoint.net/Forum/viewtopic.php?f=14&t=2663&p=31841#p31841

This will be the end result of FEDs game. Third party taking over.

[Creed]

Ivars I saw that story on Drudge but the video had been removed from Breitbart

so I started Scroogling and found the same thing, video gone

finally found it but I thought it was odd since initial impressions are that she gave a top drawer fiscal conservative speech/ seems like something people would be interested in seeing

[ivars]

It is on Youtube:

http://www.youtube.com/watch?v=C5cZWRx_AMs

Really fiscal conservative, and in the right place to do it. Not stupid at all. Start small, where things start small (relatively). Go with the flow, then, as they expand, ride the wave.

Arrive on top and ahead of the pack when everyone realizes things are as they are. Dire. Tough action needed.

[Creed]

Arrive on top and ahead of the pack when everyone realizes things are as they are. Dire. Tough action needed.

I agree, I believe the Tea Party is the tip of the ice berg.

Once Americans begin to see the money being withheld from their paychecks & govt checks and realise that it's going to repay the money given to the bankers in 2008 & ff there will be hell to pay.

[topcallingtroll]

the tea party is not going away.

I just wish they would be slightly more libertarian, but I totally approve of their slash and burn philosophy to government spending.

[cabernet]

While many people would like the FED to blow-up, I do not think it will happen. If the FEDs interest rate risk is really $1 DV01, the FED could suck up an 80bp rise in rates over a years time before it suffers a loss to equity. If memory serves, the FED paid the Treasury about $80 billion in interest this past year. If rates rise more than that, the FED will simply not revert interest to the Treasury. Taxpayers lose. Recall, the Fed has a new accounting policy that shifts capital losses to the Treasury. 

If rates backed up, the FED could engineer a financial event that creates a bid for Treasuries. It could go like this. The Fed announces the end of QE and goes even further saying it will let portfolio holdings run off once again, to shrink its balance sheet. Conventional wisdom suggests that without QE, there will be nobody to buy Treasury debt, so rates rise until buyers emerge. What level of rates that is, I do not know. Buyers might emerge because with the end of QE, inflation expectations would likely fall. But the real heat will be felt in the equity and commodity markets. They are likely to take a spanking since they have been a big beneficiary of easy credit. With inflation expectations falling and inflation hedges going south, there might be a flight to safety in Treasuries. This solves the FEDs rising interest rate problem and it has a kicker. It solves JPMs silver short position as well. Remember silver got hammered in 2008. In a sharply falling market, people sell what they can, not necessarily what they want.

At the end of the day, we are in a the depths of a huge game theory problem. Furthermore, I think it is really hard to blow up an organization that has lots of interest income and close to zero interest expense. Seems to me that rates would have to rise 5% or more for anyone to really become concerned about the solvency of the FED. None-the-less, this is a great piece of work by ZeroHedge.

http://www.TheAngryGrapes.Com

[bruiserND]

by cabernet

Great thoughtful reply post. Something substantive that has been lacking on ZH lately.

[buzzsaw99]

Nicely written. This scenario also sets the stage for QE3.

[topcallingtroll]

absolutely correct.

unless of course we have no deflation after the end of qe2 and no significant inflation.  If we enter into a goldilocks zone of a sustainable recovery then fed work is done after qe2.  This is of course what the fed is hoping.  They do not want to have a qe3 unless their backs are against the wall.

The fed doesn't know what is going to happen anymore than we do.  They aren't about to start qe3 right away.  They will wait and see what happens.

[blazen]

Cool post! This is exactly what I think will happen. It suffices that PPT takes a few days off and it ignites all what you described - all done at minimum cost. Then, after deflationary threats, it enables QE3. Crash is not allowed to happen before end of June, however - that would make look them like fools and QE would be questioned immediately. If it happens after (July could be very good date - it's heavy delivery month for Silver) - not only idea of QE won't be punished, it will be screamed for and considered neccessary for the economy to function at all. This way you have further permission to inflate your debt (and forget about economy, it never was about economy).

[topcallingtroll]

right.

Bennie and the fed do not have any legitimacy if they start qe3 before the population and congress are screaming for it and scared of deflation.

There must be a deflationary scare first.  QE2 will end and there will not even be any fedspeak about qe3 unless deflation is scaring the shit out of everybody.

So buy risk when everyone is scared of deflation.  Sell risk when everyone is scared of inflation.  Be a classic contrarian in these next few cycles and I think you will make money.

[RecoveringDebtJunkie]

Along these same lines, I have written a few pieces beginning last week about the elites' need to maintain a stable treasury market, Pimco's net short bet against treasuries and, most recently, a discussion of this report and a response to ZH's analysis.

They can be found at The Automatic Earth, with the following links in respective order:

"Jumping the Treasury Shark" - http://theautomaticearth.blogspot.com/2011/04/april-10-2011-jumping-trea...

"Bill Gross: Master of Monetary Psy-Ops" - http://theautomaticearth.blogspot.com/2011/04/april-12-2011-bill-gross-m...

"Bailing out the Thimble With the Titanic" - http://theautomaticearth.blogspot.com/2011/04/april-17-2011-bailing-out-...

[New_Meat]

cabernet--look back at post WWII environment where long bonds were kept (perhaps artificially) low.  Of course, they had growthiness on their side, something that seems too hard to do these days.

Good post and I/we'd appreciate your thoughts.

- Ned

[topcallingtroll]

we had  real growth, huge growth, and as the world reserve currency, before anyone had built up any reserves, we could expand the money supply without penalty.   Every bond and every dollar was sucked up as if the world were a vacuum cleaner.

The fed was able to cap long bonds in such an environment.  I don't see that it will be possible much longer in this environment.  A slow decline in bond prices as the economy improves is normal and acceptable.  Will real growth occur in time?

[topcallingtroll]

This is similar to what others have been saying (me) that in order to get to a point where things are rebalanced in a sustainable way that we will have several inflationary and several deflationary scares along the way.  The old ratios have to be restored between real estate and food, etc.  Bond prices will need to come down eventually, but not too fast. etc.

In order to let mild three to four percent inflation play its sneaky game they fed will have to put the breaks on every once in a while to keep inflation from getting out of control and to fool the people.  If everyone knows that the fed is trying to engineer a mild long term inflationary solution then the fed actions will be nullified via mechanisms of expectations theory.

The fed will keep us guessing by putting the breaks on every once in a while and starting a deflationary scare, but then expanding again quickly.  the deflationary periods the fed plans are meant to be brief, and just long enough to stop inflationary expectations from getting out of hand.  Then the fed starts another round of inflation.  the cycle continues until we are rebalanced satisfactorily.

Where is the endpoint?  What is the 50 year mean in housing prices to income ratio?  That is probably the endpoint where the fed will breathe a sigh of relief and hopefully we come out of this a little poorer and wiser, and laugh about it over our 15 dollar supersized big mac meal.

[KickIce]

But it does nothing to solve unemployment or low consumer demand.  High interest rates would kill what is left of the housing market and would probably be the final nail in the coffin for small businesses as well.  PMs would certainly take a hit but I'm not so sure about food commodities as we are experiencing both inflation and actual hits to the supply side.  Oil would come down but it should be down anyway because reports say there is planty of supply.  Bottom line, all this stimulus/bailouts are causing bubbles and sooner or later something will have to give.  The question is, what do we get?  A NWO where we continue to be slaves of the state or an honest reset where we can rebuild and re-establish The Constitution.

[cabernet]

Everyone, thanks for all the comments. Lots of great ideas. This morning we got a new wrinkle in the mix. S&P has put the US Gov on watch for a downgrade. It is a rather wimpy move, as a downgrade to AA+ would have showed some resolve. Reality is slow to reveal itself within the financial establishment. Wonder what took them so long. Where is Moody's? Now the political pyrotechnics are about to start. I am sure the politicians first move is to bad mouth S&P. Second move, litigation over rating process. If there is no real spending reduction along with a debt ceiling increase, a credit rating reduction should follow if the agencies have any spine. Bonds are about to go on a wild ride. I see 30-years are down this morning, while 2-5s are up a smidge. The FED has got to be doing some sweating. Its vol time!        

[RecoveringDebtJunkie]

Seems just as calculated as everything else, IMO. What's a little downgrade by S&P when the entire EU is on the perceived brink of implosion, after the Finnish election? And forget about Japan's public funding situation...

If anything, it seems like a move designed to let the big wigs load up on treasuries at lower prices as they start to take profits on equity/commodity investments, and further justify planned austerity for the middle and lower classes over the next year.

[wretch]

When facing riot police, wear used up motorcycle gear -- helmet, gloves, jacket, boots -- and do your best to return lost teargas canisters back to sender.

Use a simple mixture of water and cider vinegar in a spray bottle to wash faces after teargas attack.

For the love of humanity, resist arrest.

This advice is all relevant to the news that the man practices synthetic derivatives fraud.  It's relevant to all the news posted on this site.

[topcallingtroll]

Wear gloves when picking up hot teargas canisters.

 Launch them back with a gazilcher....a three man slingshot invented at rice university with surgical tubing or bungee cord. One man holds each end the third guy pulls the slingshot back in the middle, aims, then fires. You can easily return a teargas canister 100 yards and more with practice.

Cheap 15 dollar respiratory gear from any place like lowes, or home depot will protect you from intermittant non sustained tear gas volleys. It will protect you enough to pick up the canister and launch it. For 50 bucks you can get a real gas mask with several charcoal replacement canisters. You are immune at that point.

Dont break shop windows. That is uncool. Small business owners are not against you until you start doing stupid shit.

[New_Meat]

and stay there until the entire song is sung. - Ned

[jkruffin]

The one man that has the money at his disposal and the means to bet against what the FED is doing and put a hurt on Benny Bubbles is none other than Bill Gross. Who has openly began shorting everything related to treasuries and the dollar. I have a feeling China is not only selling what they don't want anymore, but are shorting as well.  If I had the means to play the game at their stakes, that is what I would be doing.

Benny Bubbles will go down.....it's just a matter of time.

With all this going on, don't expect gold or silver to stop rising signficantly each week as a result.  New highs in each metal will happen faster and faster.

[curious1]

This article from 2007 makes me laugh and cry the same time :(

Quote:

"It is not the responsibility of the Federal Reserve to protect lenders and investors from the consequences of their financial decisions," he warned at Jackson Hole.

raders have forgotten Bernanke's telling comment to CNBC's "Money Honey" Maria Bartiromo at the White House correspondents dinner. "It's worrisome that people would look at me as dovish and not necessarily an aggressive inflation-fighter," he said, thinking it was in confidence.

How many times has Bernanke had to re-read his own words from 2002 when he spouted off as a junior Fed governor, forgetting he was no longer in the lecture hall? "The US government has a technology called a printing press that allows it to produce as many US dollars as it wished at essentially no cost," he said, adding with flourish that the bank could even drop banks notes from helicopters.

http://www.telegraph.co.uk/finance/2815914/Bernanke-will-prove-sterner-t...

He'z a frigging liar.. asshole...

[Atomizer]

You'll need too read thru the truths and have truths..

http://www.leap2020.eu/GEAB-N-54-is-available-Global-systemic-crisis-Autumn-2011-Budget-T-Bonds-Dollar-the-three-US-crises-which-will-cause_a6340.html

[AN0NYM0US]

'

[AldousHuxley]

When dollar becomes worthless, Fed will issue a new currency. $1000000000=1whatever

This game has no end except this:

http://www.youtube.com/watch?v=Jt15F21jpN8

"if you need cooking oil, you have to exchange in gold"

[Leraconteur]

In that video a loaf of bread is .1 grams of gold.

That's about $5.24 at today's spot of $1485. A fortune in that country.

[AldousHuxley]

This is real and still no mass protest:

http://www.youtube.com/watch?v=I20UNlC6qWY&feature=related

US is getting to the point where only antidote is violent uprising or leave the country.

Thank your leaders and banksters for having your children become illegal immigrants to China and Mexico.

[topcallingtroll]

I don't think a european socialist solution is going to save us.

[steveo]

Boatload O' Charts
Cable will find support or lose support at this line.     Euro looks ready to tank also, see 2 charts.  Also got charts on Copper, Cotton, Gold, Lumber and more.   Check it out.   Entered the weekend as heavy short as I have been in 6 months, most Fridays I sit in 100% cash except for some long term "investments" in gold miners and natty.   I am cognizant that I am a lightning rod for sentiment.    I will likely move my stops to breakeven today, even with risk of a stop out and then continued move down.   

http://oahutrading.blogspot.com/

Full moon means earthquakes.   The last "little" 5.9 quake sent radiation levels skyrocketing, which probably doesn't mean new cracks in containment, possibly just stirring up the radioactive saturated ground water which we already "proved as fact" due to the refilling of the pumped out areas.

[topcallingtroll]

Beware of tautology offered as wisdom.

either a male or female will be revealed when we remove the person's costume.

The dog should either start making some noise in the next five minutes or continue to remain silent.

The stock market should go up from here.  If not it will meander trendless or start going down.

Cable will find support or lose support at this line.

[Rome is burining]

So where does one place their bet?

[gwar5]

Thanks TD, for plumbing the bowels of the Federal Reserve like no other.

Seems pretty clear the Fed has painted itself into a (dunce) corner. High inflation destroys the USD and Fed hegemony, or high interest rates forced by whatever means will take out the Fed.

The US taxpayers are already exhausted and getting creamed. Their marrow is being sucked out to buy time for TPTB. The US taxpayer is no longer the human shields of the Fed and backstop of last resort to the world.

Goodbye cruel world.

[--- - .. ... .....]

The futures market controls the physical and other markets by synthetically representing the largest buyers and sellers in the market. Futures contracts trade in large denominations that do not represent the average transaction. The largest set of transactions sets the lowest price for the rest of the market because the largest sales logically command the lowest prices per unit. The largest transactions set the starting price.

The base price in a market is the lowest bulk price, Other prices for smaller quantities are derived from the bulk price. Futures markets are supposedly backed by a reserve of commodities for delivery. Unbacked markets are fraudulent. If the market that sets the base price is a fabrication then the fabricators control other prices that are derived by adding to the lowest possible price.

Similarly, so called lowest possible “risk free” rates prevailing on government debt set the price of other debt. Because government debt markets are the largest debt markets in any country or zone they set the price of all smaller debt transactions. Also, the widespread perception that debt denominated in a currency can't be any riskier than the currency itself further enables central control of the lowest possible price.

Credit money systems overlay an infinitely compounding financial system on natural ecosystems that tend towards equilibrium. They inevitably overtake their host ecosystem. Government's debt markets in credit money systems have a life cycle that is closely related to the self destruction of assuming compound interest forever. The end of the life cycle is monetization which happens after either debt saturation or resource depletion.

The US financial system has grown so far beyond its host ecosystem that it takes trillions of abstract resources to maintain the fiction that perpetual compound growth is possible on a sphere.

[Fiat Money]

 "The US financial system has grown so far beyond its host ecosystem that it takes trillions of abstract resources to maintain the fiction that perpetual compound growth is possible on a sphere." 

Exactly.   Sad to realize, for all our technology (micro-chips and trillion-dollar city-vaporizing nuclear missile systems, etc.) and societal / civilizational "sophistication,"  we are no more than killer apes, squabbling (in warlike fashion, = premeditated murderous intent)  over who gets "rights" to (harvest) the fruit   from a local fig tree....

[Fiat Money]

as if the above isn't awful enough, the 'god' of the bible (old testament) is a near perfect representation of that alpha male "killer ape" tendency towards violence as a solution to strains in the eco system's ability to feed all comers.

  Looks like we 21st century humans are about to make the parable about GETTING EXPELLED from Eden come true - regardless of what the bible says,  planet earth IS, still, a ASTRONOMICAL GARDEN OF EDEN...

  ...but we are fouling it, with diabolical, relentless intensity, with uranium & plutonium,  oil spills, DU, nuclear radiation, climate change, coral reef killing nitrogen & pesticide runoffs, etc. etc. etc.

[El Hosel]

Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low "contrary to natural supply-demand mechanics".

   WTF! ... Natural supply-demand mechanics? Fuck that. Its all smoke and mirrors now baby, reality is for everyone else. 

  Boo Ya, corruption squared =  the American dream today.

[benbushiii]

Good explanation as to what the FED has been up to, but let's add a few other details:

1. The FED can control the upward bias in the market and prevent declines my drving the S&P futures to a premium.  This causes the arb crowd to buy SPYs and sell the futures to look in the spread.  The HFT computers take over as the SPYs are bought by buying the underlying stocks, causing the runaway upside swings we have been witnessing over the past two years.
2. The FED has been selling puts / CDS across the board over the last couple of years, which explains why there have been no major declines into expiration Fridays.  They cannot afford to have the markets crater and have the puts exercised.

[PulauHantu29]

Can't the Fed 'just walk away?" After all, it is the thing to do:

Morgan Stanley Fund Defaults on $3 Billion Tokyo Real Estate Deal

via Reuters:

TOKYO (Reuters) – A Morgan Stanley property fund failed to make $3.3 billion in debt payments by a deadline on Friday, handing over the keys to a central Tokyo office building to Blackstone (BX.N) and other investors, the largest repayment failure of its kind in Japan.

Taking advantage of a run-up in property prices, MSREF V refinanced its debt on the Shinagawa property in 2007 with new debt worth 278 billion yen, twice the value of its purchase and likely yielding a tidy profit for the fund.

The refinanced debt was sold in six different tranches by Morgan Stanley to investors.

http://news.yahoo.com/s/nm/20110415/bs_nm/us_morgan_stanley_real_estate

James Gorman, the CEO of Morgan Stanley, saw his 2010 compensation rise to $15.2 million from $6.5 million in 2009, according to an Associated Press analysis of data filed with regulators.

http://www.businessweek.com/ap/financialnews/D9MJM2QO0.htm

BOOOYAAAH!!!!!!!!!!!!!!!!!!!!!!!!!

[palmereldritch]

In addition to the derivative contracts, is there any truth to the rumor that 33 Liberty is also a primary holder and storage facility for spent MOX fuel rods?

The Fedushima awaits its tsunami.

[TruthInSunshine]

A MOX suppository for every central bankster, with an extra large on tap for The Bernank & The Dudley?

Beautiful imagery.

[palmereldritch]

Ha! If only...they're so toxic it probably would have no effect..all the more reason to send them to Japan for reactor remediation duty.

Here's a recently discovered video of the Bernanke et al conjuring FRNs from their keyboards ;)

http://www.youtube.com/watch?v=kXD6Gtinvbc

[steveo]

http://screencast.com/t/9ZWhjldUv

Cable Break - important IMHO

[N57Mike]

Thank you, I asked about Pimco, a few hundred comments back. Now I understand.

[Youri Carma]

FRAUD: Federal Reserve Is Selling Put Options On Treasury Bonds To Drive Down Yields http://youtu.be/ZnZnkaq8Nf8