Open Market Operations

Next week’s calendar is light, with another paydown on Thursday and plenty of POMO, so if ever stocks had an excuse to rally, this would be it.

Update: Hearing has been delayed until 3 pm.

While we await to find and bring to our readers the channel that will carry today's hearing between the House Financial Services Committee on the topic of "Federal Reserve Lending Disclosure: FOIA, Dodd-Frank, and the Data Dump" chaired by Ron Paul and Fed and NY Fed General Counsels, Thomas C. Baxter, Jr., and Scott G. Alvarez, below we present their prepared testimony that was just released by the New York Fed. The key section from the testimony: "We remain concerned that a more rapid release of information about borrowers accessing the discount window and emergency lending facilities could impair the ability of the Federal Reserve to provide the liquidity needed to ensure the smooth working of the financial system. If institutions believe that publication of their use of Federal Reserve lending facilities will impair public confidence in the institution, then institutions may choose not to participate in these facilities. Experience has shown that banks’ unwillingness to use the discount window can result in more volatile short-term interest rates and reduced financial market liquidity that, in turn, can contribute to declining asset prices and reduced lending to consumers and small businesses." Luckily, courtesy of $1.6 trillion in excess reserves, and the stigma now associated with Discount Window borrowings, for everyone except for Dexia, we doubt the Fed will ever have to worry about the discount window before the banking kleptoracy blows itself up once again.

The name Judd Gregg is not new to Zero Hedge readers. Back in the 2009-2010 battle for Fed transparency, which continues to be only fractionally on the way to being won, Gregg, who then served as the top Republican on the Budget Committee and a member of the Banking Committee, said that "opponents of Federal Reserve Chairman Ben Bernanke's second term are
guilty of "pandering populism"." Odd that these populism panderers, of which Zero Hedge was a proud member, ultimately succeeded in not only getting a one time Fed audit, but also won the legal case initiated by Mark Pittman to expose the Fed's dirty laundry, without which we would not know that not only did the Fed bail out primarily foreign investment banks during the financial crisis, but also that the biggest user of the Fed's somewhat secret Short Term Open Market Operations facility, also known as a 0.01% subsidy, was none other than Goldman Sachs, contrary to the firm's sworn statements that it did not really need bailing out. Gregg continued: "There's a lot of populism going on in this country right now, and I'm tired of it." Gregg warned that the growing tide of populism would threaten some of the most central institutions to the economy's recovery. "What it's going to do is burn down some of the institutions which are critical to us as a nation and as an economy to recover and create jobs," he warned." It was therefore only a matter of time that Gregg, following the end of his political career, has decided to step down, and work for one of these "central institutions to the economy's recovery" - Goldman Sachs. As such we present the list of companies that courtesy of their "top contributor" status with the senator over the years, are about to get preferential treatment from Goldman's sell side analysts, and see a prompt upgrade to Buy and/or Conviction Buy list in the near term. After all there is no such thing as squid-pro-zero in a world controlled by Wall Street's institutions "central to the economy's recovery."

About a month ago Belgium's biggest bank, and as is now well known one of the most active borrowers at the Fed's discount window in the days following the Lehman crisis, issued €3.2 billion in FRNs with a two year maturity that had an odd feature: an ultra short term put feature (as the Bloomberg screen shows below, puttable June 26, 2011 at par) which can be exercised up to 33 days ahead of the put day (underwritten by Barclays, Citi and MS) or in other words, today. Well, as our source has told us, following recent downgrades of virtually all banks with Greek exposure (a topic further pursed by the below IFR article), the two largest investors in the bond: Blackrock, which owns the bulk or about €2.6 billion, and Barclays (among others) have exercised their put option. The speculation is that "either someone knows something or had a very rapid change of heart" and concludes that "this should make the whole funding thing relevant again" especially since banks continue to rely on the ECB exclusively for short-term liquidity needs. Also possible a jump in Fed Discount Window borrowings if the ECB is unable or unwilling to cross-collateralize even more Greek debt exposure. The advice: "start watching Libor/Euribor and the Forwards basis" for some near-term volatility. If this is confirmed, look for any/all other comparable short-term put deals to suddenly spring the investor option to pull their capital, and the domino avalanche to set off in earnest.

And while the US is no longer allowed to auction off debt, in China the PBoC appears to be no longer able to auction off debt. As Business China reports, "the central bank scheduled the auction of RMB 20 billion worth of
one-year treasury bonds and RMB 10 billion in six-month bonds on the
country’s interbank bond market for May 13. But banks, faced with tight
liquidity, only purchased RMB 11.71 billion worth of one-year bonds and
RMB 9.63 billion worth of six-month bonds, the report said." In other words, there was a nearly 50% miss on the 3 month auction. The key reason: "The reference yield of one-year treasury bonds was raised to 3.0246% from the previous issuance, while the bond yield of 182-day discounted treasury bonds was 2.91%, the paper said." It appears investors don't agree with the central planners that 3% is an appropriate rate to compensate them for surging inflation. That, and also the fact that banks suddenly have no liquidity: "Tighter liquidity was behind the under-subscription, as the central bank resumed selling three-year notes on May 12 after a hiatus of more than five months, a bank analyst who was not named was cited as saying. The central bank also raised banks’ RRRs by 0.5 percentage points on the same day, effective May 18, the fifth consecutive month its has raised RRRs this year." And so the Catch 22 emerges: the more China fights inflation through RRR or rate hikes, the lower the purchasing power of domestic banks to purchase bonds (and yes, the US deficit is just a few hundred billions dollars too wide for it to come to China's rescue). Should the "15 minute" inflationary conundrum continue to express itself, and China be forced to rise rates even longer, very soon the country, just like the US to which it is pegged monetarily, will also be unable to raise any incremental capital.

A game of 20 questions with the Fed Chairman...

"Dear Dr. Paul...There are serious questions about the legality of Quantitative Easing. You are among the few who are well-qualified and well-placed to get to the bottom of it. Most people believe, and the media confirm them in that belief, that the Fed can legally create dollars ‘out of the thin air’ in any quantity, and can do with them as it pleases. This may well be the pipe dream of Dr. Bernanke who is quoted as saying that the U.S. government has given the Fed a tool, the printing press, to stop deflation — but it hardly corresponds to the truth. The Fed can create new dollars only if some stringent legal conditions are satisfied, and then, it can only dispose of them in certain ways prescribed by law." Antal Fekete

Looking through the Federal Reserve’s newly released Discount Window data fills in some missing pieces surrounding the credit crunch in 2008. We now know why Senator Chuck Schumer was so concerned about IndyMac. In the three business days after June 19, 2008, IndyMac had to double its discount window borrowings from $200 million to $400 million. Four short days later, Schumer’s leaked letter forced IndyMac to ask the Fed for $1 billion. Beyond some of these little details that end up providing granularity to the whole picture, there is still one piece of data that stands out as a singularity. Although it had become public knowledge over a year ago, the Lehman Brothers activity on September 15, 2008, still flashes a deepening warning as our economy and markets depend more and more on central banks. On the surface, Lehman’s use of the Primary Dealer Credit Facility (PDCF, the investment banker’s discount window) seems to be insignificant. It was a momentous day, after all, with turmoil in every corner of the global marketplace. Why shouldn’t Lehman borrow $28 billion from the Fed on that Monday? It had filed for bankruptcy at about 1:30am that morning, so clearly it was in need of financing. A lot has been published already about that volatile week. However, I still believe there is a hole in the “official” story as it relates to overall monetary policy. What is truly striking is not that Lehman used the Fed that Monday; rather the significance was that it was Lehman’s first use of the PDCF since April 16, 2008. Lehman Brothers did not use the Fed’s liquidity until after it had declared bankruptcy.

Key Highlights:

• GDP revised modestly lower from January meeting on surging commodity prices
• FOMC sees stronger recovery, higher inflation
• Fed officials divided over tighter policy
• Almost all Fed officials saw no need to taper QE2 buying

This morning GDP was released and it came in slightly, but statistically insignificant, better than the previously released 2nd revision of the 4th quarter 2010 GDP Estimate. The main issues that popped out of the release was the downturn in imports which, given the rise in oil prices in the first quarter of 2011, is very unlikely to be a beneficiary to GDP in the coming months. More importantly, the acceleration in the Personal Consumption Expenditures (PCE) reflects a continued drag on the consumer base (70% of the recent release) and their ability to continue at their recent pace of consumption as the acceleration was largely in food and energy. This has been quickly reflected in the large drop in the recent Durable Goods report earlier this week. None of this is very surprising or enlightening. In the coming releases of GDP we will see the import component jump, exports lag, and consumption fall. Analysts are already scrambling to bring down their overzealous estimates from the end of last year and this will all eventually show up in corporate profits.

The US is now being run by an oligarchy, with lip service being paid to the electorate in allowing the people to vote for the candidates that the parties and the powers will put forward. There will be no recovery for the middle class until they assert themselves. I know I have stated this often in my tag phrase, “The banks must be restrained…”

So, let's see which of the things we've been ignoring suddenly matter today...

If after years of explanations, and cartoons with bears, readers still have not quite gotten the grasp of how QE should work in theory (in practice the only thing about QE is how dramatically its intended and realized goals have diverged) perhaps this animation from the AP will finally put all doubts to rest. So for those still confused by terms such as "money printing", "open market operations", "outright monetization", and "Weimar hyperinflation", this brief and concise clip is for you. And once you see it, forget everything, because what QE2 has done has been precisely the opposite: rates have gone up, but the Fed does not care - as everyone now knows, the Fed's only true goal was to provide Primary Dealers with the capital to bid up stocks. End of story. Lastly, keep in mind, that the Fed is now implicitly funding the US deficit: as it purchases more and more bonds, the interest that is owed to the Fed is subsequently remitted to the Treasury as an actual revenue item, completing the world's most unprecedented Ponzi scheme constructed since the days of Rudolf von Havenstein.

As part of GATA's ongoing crusade against the Fed's gold price manipulation efforts, the organization recently succeeded in extracting some novel clues on how and why the Fed views its sworn duty as keeping the price of gold low. While much of the requested documents demanded by GATA in a lawsuit with the Fed have been exempt from disclosure under the law, one that was made public consists of the minutes of a private meeting of the G-10 Gold and Foreign Exchange Committee in April 1997. And while we will leave it up to our readers to parse through the bulk of the comments (attached below), we would like to draw attention to one, attributed to Peter R. Fisher, head of open market operations and foreign exchange trading for the Federal Reserve Bank of New York, or in other words the equivalent of our very own Brian Sack. Fisher's comment relates to what would happen to the Fed's securities portfolio should there be a sudden or gradual revaluation in the price of gold. His conclusion is that in order to keep the Fed's balance sheet stable, an (acknowledged) surge in the price of gold would lead to a forced selling in Treasurys. Of course, that would mean that the Fed would have to actually value gold at its actual market price, instead of that relic price of $42.22 per ounce. Which means that valuing gold at fair market value would result in dumping over $300 billion in Treasurys, something the Fed can not afford to do at a time when it is engaged in purchasing $100+ billion each month.

Newest Stock World Weekly: "The Fed has no means to fix the problem of joblessness, besides trying to stimulate the economy by flooding it with liquidity, or “printing money,” thereby devaluing the Dollar. Devaluing the Dollar is contrary to the Fed’s mandate for price stability."