According to today's H.4.1 report, as of yesterday, the Fed evaluates its holdings of the CDO-laden, Bear Stearns legacy Maiden Lane 1 portfolio at $28.4 billion, the highest it has been since October 2008. This represents a value of about 40% of what the Fed disclosed were Maiden Lane 1's assets as of March 31, or $73.4 billion. This in itself is not all too remarkable: as the chart below shows, the Fed's MaidenLane 1 custodian and manager, BlackRock, seems to correlate the asset vallue of ML1 not with any particular market, but merely with the exponential curve. The likelihood that this most recent "pricing" is indicative of the true value of the ML1 assets is laughable.
What we do note, however, was the May 21 update that the FRBNY posted to its ML1 holdings, which we had missed previously. Going through it, it becomes apparent that even as the passive section of the portfolio is completely dormant as it should be, BlackRock is actively rolling off interest rate hedges in what is certainly a sign that the Fed is ever less worried about increasing interest rates.
The table below indicates the Rate/FX hedges on Maiden Lane 1 as of January 29
While the hedges as of March 31 are shown below:
It is obvious that even as the Fed rolled its March 5,10 and 30 Year hedges into June, it let the March 2010 Eurodollar hedges expire without a comparable roll into March 2011, and neither did it roll the Mar10 TY C, and the Mar10 TYH0 P, and the April10 TYM0. Oddest is that while the March contracts, one can argue, merely expired, the April TYM0 was actively sold off as this is a snapshot as of March 31, i.e., prior to expiration. Also, the actual notional of all hedges, with the exception of the June and Sept Euro$ hedges, declined. And even that particular increase is a bet on potential FX vol, not interest rate volatility!
This is very troubling.
As the cost to roll and retain these hedges is negligible, especially since taxpayers are paying the cost of carry, this kind of lack of fiduciary prudence is cause for alarm. Either the Fed is convinced there is no chance in hell rates will ever go higher, or it is perfectly happy to risk impairing a $28 billion portfolio from a spike in interest rates. We previously discussed the hedging of Maiden Lane 1 by Blackrock here, when we asked why the Fed bothers to hedge its Maiden Lane portfolio when it has $1 billion DV01 on its broader interest-rate sensitive asset holdings. We now have our answer: in under a month, the Fed has reduced its interest rate hedges by roughly 60% (we don't have enough data to construct a full delta-hedged profile of ML1 at this point, and since the Fed is a bastion of secrecy, we likely never will).
What is critical is the thinking behind this process. Obviously the Fed, in an act that has no economic utility to taxpayers, has decided to save a few nickels as it is all too aware there is no interest spiking risk. As such, any interest rate hedging now is fully token. But one wonders, why did the Fed increase its FX hedging, even as it cut massively interest rate risk? Who else would do such a thing absent the near certainty that rates are not only going to stay flat, but decline? Is this indirect evidence that the Fed is continuously manipulating rate markets in a fashion that removes any uncertainty about widening? We submit this, among the other thousands of questions, that the only knowledgeable regulator, Brooksley Born, should ask of Ben Bernanke at the next opportunity by the FCIC to question to Fed chairman.