Federal Reserve

With the Federal Reserve now actively participating in capital markets, it should be noted that just like every other asset manager, the Fed has to be held accountable for its trading efficacy. After all, the Treasury takes every opportunity to remind the US public how courtesy of record amounts of new government debt, it has managed to make "profits" on its assorted investments, which are merely transfers of risk from one entity to another, and the "another" being the US taxpayer, although not directly, but indirectly via the now ludicrous amount of US debt which will never be repaid. Which is why the US taxpayer may want to know that in just the most recent POMO schedule - that from early November to December - the Federal Reserve has lost $2.4 billion in taxpayer capital by its mistimed market operations, primarily due to the recent rise in interest rates. This is $2.4 billion that has not evaporated, but instead has been transferred to Primary Dealers under the "profit on trade" category. This is also money that will be used to determine, and fund, banker bonuses.

The Federal Reserve is America's Fourth Branch of government and Ben Bernanke is, in effect, the economic czar of the country. The Fourth Branch? The Fed and the Fed alone has the power to determine how much money should be in the economy. Such vast power over our lives makes the Fed a de facto fourth branch of government. Yet, its powers are not defined by the Constitution, and neither the chairman nor senior officials are elected by the people.

Now that the Fed is firmly number one in the world in terms of US Treasury holdings (actual marketable paper, not the mythical paper held by various insolvent trusts) with $926 billion in Treasury paper post today's POMO, providing Fed balance sheet updates seems like a moot point. After all, most people by now realize how this will end. And once Trichet starts monetizing debt too (not if but when, which will be followed by Japan, Switzerland, and China), the global Weimer endgame will come quickly. But for now, for the sake of tradition, here is the weekly update of the Fed's most recent balance sheet.

The Federal Reserve's VISA credit card account offers a rare glimpse into the inner workings of the secretive Fed. This leaked transcript of the Federal Reserve's VISA credit card account provides a treasure-trove of insight into the Fed's recent actions. Nothing reveals a person or institution quite so indelicately as a list of credit purchases.

The Federal Reserve is an example not just of run-of-the-mill hubris but of the far more profound Pathology of Power. The rule of law has been supplanted in the U.S. by self-serving propaganda campaigns serving State and financial Elites: this is the Pathology of Power. The Federal Reserve is an instructive example because it is so blatant. Despite the dearth of evidence that goosing the stock market actually generates a "wealth effect" which "trickles down" from the top 10% who own the vast majority of equities to the bottom 90%, the Fed has waged a ceaseless propaganda campaign claiming this policy goal is now essential for the nation's well-being. No mention of its positive effect on Wall Street; cui bono (to whose benefit?) indeed.

Thanks a LOT ...

"Bring it on: let’s watch another wave of monetary policy history crash over us as you pull out the hammer and close your lips around another batch of coffin nails – ready to grasp the first nail to drive into the soon sealed coffin of Keynesian economics and then another in the coffin of fractional reserve banking and perhaps another into the coffin of fiat currencies. Oh, it’s all the same coffin? Fine – it will go quicker that way. Just remember to save a few nails for the millions of coffins of pensions and savings: for all of the responsible people who didn’t join in on the credit bonanza of the last few decades and spent their lives scrimping and saving. Let’s devalue their savings and nuke the US currency rather than go the quicker and more just road of default, shall we? Extend and pretend is the Fed’s motto, after all. Just watch out for those new crazies on the Hill that are starting to bang on the doors of the Eccles building. Will they break in and cart you off before you’ve finished your final magnum opus – the end of the US dollar and the US economy? Bring it on, Ben: take us that much nearer to the denouement of 100 years of US Federal Reserve. There won’t be a second hundred years. The final countdown starts now. " Saxo Bank

As of October 27, the Fed's balance sheet was $2.3 trillion, of which the $837 billion in Treasury debt is of course a fresh all time record, soon to be eclipsed by the tens of billions added weekly as per QE2. There is roughly $13 billion left under the current POMO program ending in the second week of November, which by then will be supplemented by a new and improved almost daily POMO. In the past week, bank excess reserves increased by $16 billion after declining by $34 billion the week prior: total reserves stood at $1,008 billion, up from $993 billion the week before. And once again foreign holdings of agency/MBS debt dropped to a new 3 year low, dumping over $100 billion agencies in the Fed's custodial account over the past two months. Last, we take a look at the one topic that will soon be the most talked about subject by every pundit in the econosphere: the duration distribution of Fed holdings.

Let A = America, B = Banking System, and C = the Crony System. Then, given a heavily subsidized and corrupt financial system in the U.S., we can infer that A + B = C. Since we know that C must fail due to its poor design and widespread moral hazard, and that B is too big to fail, where does that leave A?

As of October 20, the Fed's balance sheet was $2.3 trillion, of which the $832 billion in Treasury debt was a new all time record. As per the revised TIC data, Japan's latest holdings of $837 billion are about to be trampled by Brian Sack once again. More importantly, in the past week, bank excess reserves declined by $34 billion: total reserves stood at $993 billion, down from $1.026 trillion the week before. This was in addition to the Fed's $11 billion in POMO excess liquidity. Probably most importantly, foreign holdings of agency/MBS debt dropped to a 3 year low, dumping $100 billion agencies in the Fed's custodial account over the past two months.

In the movie Terminator, various faceless machines, and one especially murderous one almost caused the end of the world. In an ironic twist of life imitating art, the very core premise of our capital markets - the effective allocation of capital to worthy assets on the basis of solid fundamental analysis (and yes, "information arbitrage") is on the verge of being eliminated by the same combination of forces: millions of faceless, anonymous algos, and one destructive endoskeletal machine. Remember: Ben Bernanke is out there. It can't be bargained with. It can't be reasoned with. It doesn't feel pity, or remorse, or fear. And it absolutely will not stop, ever, until both the middle class, and the dollar, are dead.

This week we have official confirmation of our speculation from last week, that the Fed is now the second largest UST holder institution after China, with $821.2 billion in Treasurys. And courtesy of yesterday's POMO schedule announcement, according to which the Fed will purchase $32 billion in UST through November 8, at which point it was have $853 billion, we now know that Brian Sack will be the biggest holder of US Treasurys in the world (surpassing China's $847 billion). Aside from this there was little notable in the weekly balance sheet update: bank reserves increased by $29 billion in the past week, as Primary Dealers added even more to their purchasing capacity post the end of quarter window dressing (more in an upcoming update).

Last week, during our regular scheduled Fed balance sheet update, we said "We believe that within one week the Fed will surpass Japan as the second largest holder of Treasurys, and China, the current top holder, in just over a month." Ww were right: as of Wednesday, the Fed disclosed it held $819.1 billion in US Treasurys. That excludes yesterday's $2.1 billion POMO which settled today, which does in fact bring the total to above the $821 billion held by Japan as of the end of July. With only $25 billion to go, and a rate of monetization of about $8 billion per week (and likely faster now that prepays are accelerating), we believe the Fed will be #1 by the mid-terms, just in time for the QE2 party to really blast things off. Aside from this there was little notable in the weekly balance sheet update: bank reserves increased by $16 billion in the past week, as Primary Dealers added to their purchasing capacity post the end of quarter window dressing.

At least Bank of America is honest as to why it continues to recommend investors pursue risk assets: "Liquidity-friendly global central bank policies remain the lynchpin of our constructive view on risk assets...Our economics team believes that QE2 will come in the form of purchases of Treasury securities of $500bn - $750bn every six months until the economy reaccelerates." In other words, this is precisely what Morgan Stanley's Jim Caron said on Friday when he confirmed that in this market nothing else matters, except what side of the bed Ben Bernanke wakes up on: "Investment decisions across many asset classes today are tantamount to an educated guess on what the Fed decides to do regarding QE. In the near-term this trumps fundamentals, valuations and almost everything else. Thus the risk in the market is man-made, not freely determined by the market. In general, this is not a good thing because it may invite greater risks in the future." To be sure, the market is now trading nothing less than QE news, but with that comes the added uncertainty of how the world's central banks will react to this latest dollar debasement episode: while QE1 was crucial and needed by the entire world to prevent the collapse of the system, things this time around are far less clear cut. Yet it is so difficult to fight the tape: as the attached chart demonstrates, for the duration of QE1 (3/5/2009 through 3/31/2010), global equities surged 80.5% while since April 2010, and without the benefit of the Fed's generosity, global equities have only generated 0.8% in returns. Furthermore, Jim Caron points out that unlike QE1, there is a very distinct possibility QE2 will fail miserably (all fans of buying what David Tepper is selling would be wise to be very weary). Luckily, just like in the Morgan Stanley case, BofA now highlights that there is a distinct possibility of "fat tail" risks and advises clients how best to position against these.

Probably the most interesting thing in this week's Fed balance sheet update is that Treasurys held by the Fed are now $812 billion, an increase of $7 billion from the week before, which those who follow the FRBNY's almost daily POMO liquidity explosion know all too well. Indicatively, Japan owns $821 billion and China, $847 billion. We believe that within one week the Fed will surpass Japan as the second largest holder of Treasurys, and China, the currently top holder, in just over a month. Another notable item: Fed excess reserves were at $981 billion, a decline from $1.01 trillion at the beginning of the month, but most notably, in the past month this number hit a year low of $932 billion on September 15. One wonders just what securities the banks were buying up with these reserves? Keep in mind the stock market closed essentially at the level it hit on September 20, making one wonder just how much of a factor the nearly $80 billion decline in bank excess reserves in the first two weeks of the month may have been.