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Modern Market Alchemy Explained: Converting Junk Debt Into Supersafe Treasurys Out Of Thin Air

Tyler Durden's picture


When it comes to the actual functioning of capital markets, there is always much confusion within the made for TV punditry for one simple reason: the number of people who truly understand collateral transformation courtesy of the shadow banking system, which until recently was a massive $23 trillion off the books repository of everything the banks did not want you to know about, can be counted on one hand. That certainly would explain the existence of such media trolls as "conscientious" NYT columnists, and various three letter "modern" theories explaining how money would work in a world if only all practical reality was removed.

And while we have previously explained extensively how it is that what actually happens behind the scenes is so very different from what most believe is market reality, especially with our three+ years series on shadow banking, confusion is still rampant. Which is why we hope an extract from Fed Governor Jeremy Stein's speech titled "Overheating in Credit Markets: Origins, Measurement, and Policy Responses", will finally make it sufficiently clear that when it comes to shadow banking collateral transformations, modern day alchemy does in fact work, and one can transmogrify junk bonds into Treasurys with the wave of a magic (yield) wand.

From Stein - extracted from full speech:

The maturity of securities in banks' available-for-sale portfolios is near the upper end of its historical range. This finding is noteworthy on two counts. First, the added interest rate exposure may itself be a meaningful source of risk for the banking sector and should be monitored carefully--especially since existing capital regulation does not explicitly address interest rate risk. And, second, in the spirit of tips of icebergs, the possibility that banks may be reaching for yield in this manner suggests that the same pressure to boost income could be affecting behavior in other, less readily observable parts of their businesses.


The final stop on the tour is something called collateral transformation. This activity has been around in some form for quite a while and does not currently appear to be of a scale that would raise serious concerns--though the available data on it are sketchy at this point. Nevertheless, it deserves to be highlighted because it is exactly the kind of activity where new regulation could create the potential for rapid growth and where we therefore need to be especially watchful.


Collateral transformation is best explained with an example. Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral must be "pristine"--that is, it has to be in the form of Treasury securities. However, the insurance company doesn't have any unencumbered Treasury securities available--all it has in unencumbered form are some junk bonds. Here is where the collateral swap comes in. The insurance company might approach a broker-dealer and engage in what is effectively a two-way repo transaction, whereby it gives the dealer its junk bonds as collateral, borrows the Treasury securities, and agrees to unwind the transaction at some point in the future. Now the insurance company can go ahead and pledge the borrowed Treasury securities as collateral for its derivatives trade. 


Of course, the dealer may not have the spare Treasury securities on hand, and so, to obtain them, it may have to engage in the mirror-image transaction with a third party that does--say, a pension fund. Thus, the dealer would, in a second leg, use the junk bonds as collateral to borrow Treasury securities from the pension fund. And why would the pension fund see this transaction as beneficial? Tying back to the theme of reaching for yield, perhaps it is looking to goose its reported returns with the securities-lending income without changing the holdings it reports on its balance sheet.


There are two points worth noting about these transactions. First, they reproduce some of the same unwind risks that would exist had the clearinghouse lowered its own collateral standards in the first place. To see this point, observe that if the junk bonds fall in value, the insurance company will face a margin call on its collateral swap with the dealer. It will therefore have to scale back this swap, which in turn will force it to partially unwind its derivatives trade--just as would happen if it had posted the junk bonds directly to the clearinghouse. Second, the transaction creates additional counterparty exposures--the exposures between the insurance company and the dealer, and between the dealer and the pension fund.


As I said, we don't have evidence to suggest that the volume of such transactions is currently large. But with a variety of new regulatory and institutional initiatives on the horizon that will likely increase the demand for pristine collateral--from the Basel III Liquidity Coverage Ratio, to centralized clearing, to heightened margin requirements for noncleared swaps--there appears to be the potential for rapid growth in this area. Some evidence suggestive of this growth potential is shown in exhibit 8, which is based on responses by a range of dealer firms to the Federal Reserve's Senior Credit Officer Opinion Survey on Dealer Financing Terms. As can be seen, while only a modest fraction of those surveyed reported that they were currently engaged in collateral transformation transactions, a much larger share reported that they had been involved in discussions of prospective transactions with their clients.

Mr. Stein may not have evidence... but we do. Below, direct from the NY Fed, is the total amount of collateral pledged any given month with the NY Fed, courtesy of Tri-Party repo custodian JP Morgan of course:

To summarize: the volume of "such transactions" is currently very large and rising rapidly.

Keep in mind the above is merely the base collateral: one can think of it as SM 0 (or Shadow Money 0). What must be done next is apply a specific "collateral chain" (as explained previously) to get the full level of explicit recycled collateral. The most recent estimate of the average shadow bank collateral chain from Manmohan Singh was 2.5x as of 2011. It is a certainty that this is now back to its 2007 levels of about 3x in net collateral rehypothecation. Which means that just the repo market alone allows market players to create some $6 trillion in credit money out of the Tri-Party repo alone. Add the nearly $2 trillion in hedge fund capital which is then transformed via broker-dealers in the same way, and one gets a whopping $12 trillion in buying power created by, using Stein's extreme example, using worthless collateral and converting it into pristine Treasurys, while promising pennies in front of a steamroller to all the counterparties in the collateral chain.

But wait, there's more.

Because as Matt King explained all too well back in September 2008, when the above alchemy happens, yields are created, trillions in counterparty risk is generated, collateral is transformed and can be used for fingible purchasing purposes and... nothing.

By nothing we mean there is no balance sheet entry!

Thanks to the magic of FAS 140 banks can literally transform worthless garbage into supersafe Treasurys, then use that newly transformed collateral via further repo as cash to fund simple stock purchases, and at the end of the day nobody knows where the exposure came from, who the counterparty is, and what the ultimate liability is!

And that is why in the current market, the Fed has no choice but to keep the music going, because while an unwind of traditional liabilities will result in a maximum collapse of some $13 trillion in conventional financial liabilities, it is the $15-20 trillion in shadow banking exposure which nobody knows about except for the banks themselves (we hope), and which allows banks and hedge funds to literally create purchasing power out of thin air, that once the house of out of control deleveraging cards starts falling, it is truly game over.


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Thu, 02/07/2013 - 12:49 | 3223275 Say What Again
Say What Again's picture

B, B, But...

S&P said they were AAA -- good as gold

Thu, 02/07/2013 - 13:03 | 3223296 Rubicon
Rubicon's picture

Alchemy is alive and kicking!

Thu, 02/07/2013 - 13:15 | 3223327 jekyll island
jekyll island's picture

Stop it, my head all ready hurts.  I am bittersweet about what will happen when the system finally breaks, but I am ready for that to occur.  

Thu, 02/07/2013 - 13:16 | 3223330 pemdas
pemdas's picture

Well good thing this kind of stuff does not happen with paper gold!!

Thu, 02/07/2013 - 13:20 | 3223333 hedgeless_horseman
hedgeless_horseman's picture



Thu, 02/07/2013 - 13:23 | 3223349 Divided States ...
Divided States of America's picture

Basel III is a smokescreen....they have already been relaxing the requirements and its not even 5-6 years from being put into effect. Much like any other regulation, if you are not in the circle, rules will not be changed for you. The banks are definitely in bed with the regulators.

Thu, 02/07/2013 - 13:38 | 3223387 Bicycle Repairman
Bicycle Repairman's picture

So how did Basel II work out?

Thu, 02/07/2013 - 14:30 | 3223580 Raymond_K_Hessel
Raymond_K_Hessel's picture

Bravo Mr. Durden. Thank you for shedding light on this. Fucking incredible.

Thu, 02/07/2013 - 18:43 | 3224409 dtwn
dtwn's picture

Yes, thank you Tyler(s).  I'll be making another donation to ZH as soon as I have a job/income.  Shit like this is un. fucking. believable.

Thu, 02/07/2013 - 19:02 | 3224443 trav777
trav777's picture

It's all kinda an exercise in absurdity.

At the END OF THE DAY, this shit only flies because the FED IS the counterparty!

They showed that when these credit instruments are threating to find real value that they will print them to at least nominal value.

That nominal value might buy a carton of eggs, whatever, but the Fed will liquify the transaction chain to prevent the mad scramble for the exits that the math and computers force.

Because just imagine if that pension fund were to get stuck with that shit collateral.  The buck might break on a MMF like Reserve Primary and then everyone and his mother goes to redeem and all hell breaks the fuck loose.

The Fed is there to ensure that if the buck breaks, that Reserve gets paid whatever the difference is to par.

It's a controlled deflation, not a collapse.  It's leaking air like a tire does, trying to come down easy.  Instead of blowing and scattering stuff all over the walls.  The problem is that absent real structural reform, the crooks who abused the previous system are now abusing this one.  And the Fed has not the inclination to stop them.  They keep hoping that if they facilitate, that there is some magic point at which this thing will go back to how it was.

Thu, 02/07/2013 - 14:37 | 3223602 resurger
resurger's picture

Basel III considers all Government paper to be AAA and it has 0% RWA

Thu, 02/07/2013 - 15:38 | 3223755 TruthInSunshine
TruthInSunshine's picture

A new Plaza Accord type arrangement will be made soon. It will be done to MANAGE what are the new currency wars (see last paragraph below).

All you need to read to understand the absolute, verifiable Ponzi of a foundation that modern finance and all that it impacts (e.g. real economy) truly is:

 * The Federal Reserve Bank of Chicago, describing, by their own words, the ruse of Modern Money Mechanics (quote from page 6, last paragraph):

"What they [banks] do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts. Loans (assets) and deposits (liabilities) BOTH (capitalization is mine) rise by [the amount of the "loan"]."*


Ask yourself two questions:  If you loan money to a friend, unless and until that loan is repaid, do you find that you have less or more money? Can you then demonstrate with verifiable proof (in technical compliance with the law) that you have MORE assets than prior to making that loan, while that loan is still outstanding?

If you answered "less money" and "no," you are not in The Big Club.

[Modern Money Mechanics was a booklet that was produced & distributed by the Public Information Center of the Federal Reserve Bank of Chicago]

And all these denials by Japan, the ECB and by the U.S. Treasury Secretaries, about how "we aren't intentionally devaluing our fiat currency" (Draghi today -- Currency war follows financial crisis--, Taro Aso of Japan yesterday)....don't be too surprised to find another Plaza Accord type event happening soon.

Thu, 02/07/2013 - 18:22 | 3224364 fourchan
fourchan's picture

At what point of saddling the us tax payer with 20 trillion+ in debt

and every nonperforming asset the fed's banks created, become unAmerican?

Fri, 02/08/2013 - 00:47 | 3225179 TruthInSunshine
TruthInSunshine's picture

As long as the Proxy LameStream Media spews forth "green shoots, unicorns & rainbows" headlines, as long as the governmental and quasi-governmental agencies keep torturing inflation/employment/GDP data to produce a massively "bullish" outcome, as long as the EBT/SNAP swipe works, as long as the bloated army of federal, state & local government unionized workers get their private sector taxpayer extracted paycheck on time, as long as Medicare/Social Security/Medicaid/The Zillion Other entitlement programs keep paying out, as long as the U.S. Government is able to spend $1.46 for every $1 of revenue it takes in so long as the average hourly wage doesn't require 1/2 a day's work (for those employed) to buy a fast food meal --


-- as long as these things continue, it probably won't completely break down (although I can contemplate massively bearish outcomes that don't require any of these things to end).

Thu, 02/07/2013 - 16:20 | 3223967 pashley1411
pashley1411's picture

The assumption of the Basel committees is that an international body can rate debt, and that sovereign debt is the most credit worthy.   


They probably sit around now and talk about their mistresses and their golf game.

Thu, 02/07/2013 - 13:39 | 3223391 Stock Tips Inve...
Stock Tips Investment's picture

This has always been part of the plan from the Fed. And as in every aspect of this plan, success depends not been many variations (downward) in the prices of financial instruments or in home values??. We know what would happen if these falls occur.

Thu, 02/07/2013 - 16:47 | 3224062 midtowng
midtowng's picture

The alchemy never stopped. It almost did, but it was brought back to life. It's now a zombie that feeds on real assets.

Thu, 02/07/2013 - 13:07 | 3223306 Renewable Life
Renewable Life's picture

Those bankers must feel like I do, when I turn in my depreciating fiat dollars for solid OZ's of PM's!!!!

It's glorious! Almost feels like it shouldn't be legal;) uh oh

Thu, 02/07/2013 - 13:57 | 3223363 TheGardener
TheGardener's picture

tried transmogrify on the command line, shit I`am not the Unix hack I used to be, I just keep diminishing myself,
shit I`m off to space, control Strg out of reach, with the
00.1K bandwith I`am worth now : shit I`m down rated , glad space keeps
me afloat unlike in the movies...calling major tom

Now I`m save, still got to pee into the telephone booth before on line pickup, how the hell I got out of the matrix
into this filthy receiver ? Get me out of there !

Disclaimer : stuck in coding while fully rejecting logic if it refers to human affairs...

Thu, 02/07/2013 - 14:27 | 3223571 TheGardener
TheGardener's picture

Curious whether me or my junker misunderstood Tyler`s transmogrify ?

Thu, 02/07/2013 - 19:23 | 3224501 bobthehorse
bobthehorse's picture

I've got your modern market alchemy.

I've got it hanging between my legs.


Thu, 02/07/2013 - 13:01 | 3223290 Bunga Bunga
Bunga Bunga's picture

OT: Iran decrypts video material from captured US drone.

Thu, 02/07/2013 - 13:54 | 3223441 cossack55
cossack55's picture

Wish they would capture a SEC drone so we could view some top grade porn.

Thu, 02/07/2013 - 13:05 | 3223301 stinkhammer
stinkhammer's picture

stifle it Edith!

Thu, 02/07/2013 - 13:06 | 3223304 Big Corked Boots
Big Corked Boots's picture

"pristine Treasuries"

That's a laugh. Garbage in, garbage out.

Thu, 02/07/2013 - 13:09 | 3223309 francis_sawyer
francis_sawyer's picture

They should just label them as "kosher"... Probably a lot easier to understand that way & much more aligned with reality...

Thu, 02/07/2013 - 13:09 | 3223312 Renewable Life
Renewable Life's picture

Only as "pristine" as a shiney new drone armed with hellfire missiles, can guarantee!!!

Thu, 02/07/2013 - 13:16 | 3223331 jekyll island
jekyll island's picture

What exactly is backing Treasuries?  I think I missed it last time.  

Thu, 02/07/2013 - 13:26 | 3223352 francis_sawyer
francis_sawyer's picture

The full faith & credit that the chosen Sith overlords will tax your great great great grandchildren into the deepest parts of the stinkin' dungeon & turn you all into lepers...

Thu, 02/07/2013 - 14:13 | 3223511 Nothing To See Here
Nothing To See Here's picture

But as one CNBC talking head observed last week, nothing backs gold!

Now back to banging my head on a wall.

Thu, 02/07/2013 - 14:54 | 3223661 francis_sawyer
francis_sawyer's picture

Gold is backed by LEAD...

Thu, 02/07/2013 - 13:37 | 3223386 mayhem_korner
mayhem_korner's picture



The Fed is de facto printing Treasuries.  The only thing backing them is the illusion they will be repaid.

Thu, 02/07/2013 - 14:44 | 3223633 secret_sam
secret_sam's picture

     What exactly is backing Treasuries?

The most powerful military empire of human history.

Thu, 02/07/2013 - 14:53 | 3223665 Anusocracy
Anusocracy's picture

The faith and stupidity of a lot of faithful and stupid people.

Thu, 02/07/2013 - 16:42 | 3224044 secret_sam
secret_sam's picture

Hell, no.  The Saudis don't take dollars for oil because of any "faith," I assure you.

Thu, 02/07/2013 - 19:04 | 3224448 NotApplicable
NotApplicable's picture

I think they were referring to the "dollaraires."

Sat, 02/09/2013 - 06:35 | 3228382 WojtekSz
WojtekSz's picture

actually they accept dollars but DO NOT keep them but immediately invest into other tangible assets including gold and, unfortunately, also paper gold.

Thu, 02/07/2013 - 19:46 | 3224544 l.kimbot
l.kimbot's picture

At 1 soldier suicide a day, on average, and now setting the wheels in place to draft all women as well, in the soon-coming national emergency, will child soldiers be far behind.  

Thinking Iran-Iraq conflict and Germany WWII...

Thu, 02/07/2013 - 14:05 | 3223482 malek
malek's picture

I thought the bigger laugh is

"Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse..."

Ahem, how many derivatives are run through a clearinghouse?

Fri, 02/08/2013 - 00:08 | 3225100 socalbeach
socalbeach's picture

$1.96 trillion worth per the "Total Tri-Party Repo Collateral" graph.  Or are you talking about something else?


Tri-party repo

"The distinguishing feature of a tri-party repo is that a custodian bank or international clearing organization, the tri-party agent, acts as an intermediary between the two parties to the repo."

Sat, 02/09/2013 - 19:17 | 3229473 malek
malek's picture

And how big is the overall derivatives market again?

Thu, 02/07/2013 - 13:07 | 3223308 ziggy59
ziggy59's picture

Even Mr. Ponzi would be jealous!

Thu, 02/07/2013 - 15:15 | 3223751 hooligan2009
hooligan2009's picture

racketeering is not a crime if the goverment does it. who is going to bring the case? the government? 

Thu, 02/07/2013 - 13:09 | 3223310 NEOSERF
NEOSERF's picture

Criminal, the only word for it.  Government should be careful who they sue.  If they think S&P weren't working in the government interests they are completely wrong.  Their complicity allowed inflated housing, employment, money velocity and GDP numbers...if S&P starts doing its job as a consequence of this lawsuit, watch out below.

Thu, 02/07/2013 - 13:10 | 3223314 Bay of Pigs
Bay of Pigs's picture

Three Card Monte

Thu, 02/07/2013 - 13:12 | 3223317 otto skorzeny
otto skorzeny's picture

stocks flat by close. shitty economy #s now to be blamed on this weekend's big NE storm(global warming-bitchez)

Thu, 02/07/2013 - 13:13 | 3223318 ebworthen
ebworthen's picture

And isn't this the problem with the entire economy?

There is no such thing as risk or collateral except for the non-elite citizenry.

Thu, 02/07/2013 - 13:21 | 3223319 Mercury
Mercury's picture

Thanks to the magic of FAS 140 banks can literally transform worthless garbage into supersafe Treasurys,...

But at what kind of ratio/haircut?

$1mm nominal in worthless garbage can be converted into how much (generally) in repo-able Treasuries when all is said and done?

Thu, 02/07/2013 - 14:34 | 3223594 MachoMan
MachoMan's picture

In a fractional reserve world, why would you presume there is a haircut?

Thu, 02/07/2013 - 14:43 | 3223601 hedgeless_horseman
hedgeless_horseman's picture



Macho FTMFW!!!

OK to take a 2:1 haircut on the conversion, or whatever it may be, when you can lever it back out to the debt slaves 1:10 at prime or better.  Easy to make up the conversion costs by the time the repo is repoed.

It is good to be a bank.

Thu, 02/07/2013 - 13:16 | 3223332 Yen Cross
Yen Cross's picture

i Junk bonds < It's all in the pretty packaging. I'm going to start a new insurance company and start a derivatives division.

 Think I'll name it,  " Smoke & Mirrors llc."

Thu, 02/07/2013 - 13:17 | 3223334 Theta_Burn
Theta_Burn's picture

100 yr bonds, trillion dollar coins, tri-party repo fun, and everyone says the Japanese are fucked up..

This shit can go on forever, well i guess until they start advertising patriotic war bond buying...

Thu, 02/07/2013 - 13:17 | 3223335 Everybodys All ...
Everybodys All American's picture

Speaking of junk. Watch the stock market get all the way back to flat today from US 11:30 pm and close of Europe. Anyone willing to bet against me?

Thu, 02/07/2013 - 13:28 | 3223360 otto skorzeny
otto skorzeny's picture

Today is a POMO day-go find another sucker to bet-$1.25 billion waiting for 3PM ramp

Thu, 02/07/2013 - 19:06 | 3224457 NotApplicable
NotApplicable's picture

Isn't every day?

Thu, 02/07/2013 - 13:36 | 3223374 Everybodys All ...
Everybodys All American's picture

let me be clear ... I'm not playing the market on the long side. I'm just pointing out the pattern of deceit being played.

Thu, 02/07/2013 - 13:18 | 3223336 you enjoy myself
you enjoy myself's picture

so, this is just a slightly more convoluted version of the Fed's MBS purchases?

Thu, 02/07/2013 - 15:12 | 3223737 hooligan2009
hooligan2009's picture

if by that you mean the Fed has puchased problem agency MBS securitized assets issued by Fraudy and Funny (Frreddie and Fannie) who went bankrupt (sorry, placed in conservatorship) from the Chinese government, plus US, European and Japanese banks, with the intention of selling them back at some unspecified date (irredeemable repo) then, maybe.

you might view the housing stock behind the securitized mortgages as more secure than Government bonds, since you actually end up owning  land and buildings with people in them (call it a land grab without war), the Fed's actions could be viewed as defending the sovereignty of the USA. 


Thu, 02/07/2013 - 19:07 | 3224460 NotApplicable
NotApplicable's picture

Obviously not convoluted enough, if a Fed Head can detail it.

Thu, 02/07/2013 - 13:18 | 3223338 eclectic syncretist
eclectic syncretist's picture

"And that is why in the current market, the Fed has no choice but to keep the music going, because while an unwind of traditional liabilities will result in a maximum collapse of some $13 trillion in conventional financial liabilities, it is the $15-20 trillion in shadow banking exposure which nobody knows about except for the banks themselves (we hope), and which allows banks and hedge funds to literally create purchasing power out of thin air, that once the house of out of control deleveraging cards starts falling, it is truly game over."

It'll be game over for the dirty bastards that created this mess.  Those with gold, silver, firearms, land, and other valuable non-perishable commodities will be OK and hopefully come together to ensure it never happens again.

Thu, 02/07/2013 - 13:38 | 3223388 kchrisc
kchrisc's picture

Keep the music going until a drunk partier bumps into the DJ table.


Thu, 02/07/2013 - 19:08 | 3224463 NotApplicable
NotApplicable's picture

You don't think the dirty bastards have all that shit sequestered?

Thu, 02/07/2013 - 13:20 | 3223341 NoDebt
NoDebt's picture

I recall an episode of the old TV series M*A*S*H where Hawkeye and Trapper were trying to put together some kind of deal for themselves but it was a multi-hop kind of affair.  Every agreement was predicated on some other deal happening.  As you might imaging, the first half of the show was setting up the chain of (rehypothecated!) deals.  The back half was watching it all fall apart in the same order as something broke in the chain of promises.

Like that, but with the world economy.

Agreed with what Mercury asked, above- At what ratio?  1:1?  IF so, this is a guaranteed failure.  It is predicated on nothing going wrong in the chain of rehypothecation.  The minute something goes the slightest bit pear-shaped, the whole thing goes down.

Thu, 02/07/2013 - 13:26 | 3223355 blindman
Thu, 02/07/2013 - 18:22 | 3224361 AUD
AUD's picture

King Midas received his gift of alchemy - turning whatever he touched into gold - from the god Dionysis.

Alchemy is the preserve of the gods.


Thu, 02/07/2013 - 19:01 | 3224440 blindman
blindman's picture

@"..of the gods." and man in the form of men/plural!
it is not that big a jump, addition or subtraction, to turn
base metal into precious metal?
[KR403] Keiser Report: The Birth of a Scandal
Posted on February 7, 2013 by stacyherbert
.." a currency war is basically a firing squad lined up in a circle" m.k.
..around a barrel of fish containing the populations the generals
of the currency war represent. no one of importance gets hurt, just
the fish in the barrel.

Thu, 02/07/2013 - 13:28 | 3223358 economessed
economessed's picture

After reading this excellent article, I'm beginning to wonder if it was such a good idea to give away our durable goods manufacturing base so we could focus on manufacturing debt strategies and other associated financial innovation?</sarcasm off>

It does not take more than a high school education to understand that this "sophisticated financial management strategy" does not produce any value -- it is a pure risk-averting maneuver.  The world is not a healthier, better place because some ethically-distorted MBA figured out how to obscure the product of their work temporarily.

There is a prickly, salty, uncomfortable corner of hell awaiting the financial elite who work so relentlessly to cover-up what they've done.

Thu, 02/07/2013 - 18:34 | 3224399 TrustWho
TrustWho's picture

The reason why I am still a believer in a religion that provides justice for political & financial scumbags. I pray the market crashes so cowardly scumbags commit suicide and spend eternity burning most of the time with ice cream sometime. You need the ying and yang to feel the true pain. I want to be the ice cream angel!

Thu, 02/07/2013 - 19:10 | 3224472 NotApplicable
NotApplicable's picture

Ya know, I read all of your posts in Nixon's voice.

Thu, 02/07/2013 - 19:39 | 3224522 JimS
JimS's picture

Au contraire, all they have to do, according to "Christianity", is to say that "Jesus, forgive me of my sins, I beieve in you", and poof, off to heaven they go. No, we need justice, here and now. The more painful and long lasting, the better. Extended water-boarding comes to mind, along with some fingernails, maybe some scalp, and some hot oil.

Thu, 02/07/2013 - 13:28 | 3223359 InconvenientCou...
InconvenientCounterParty's picture

Too big to fail gets smaller and smaller whilst the outcome of the fiat currency regime is clearer and clearer.

Thu, 02/07/2013 - 13:29 | 3223362 khakuda
khakuda's picture

Thanks again for such insightful work and for outing this stuff.

Thu, 02/07/2013 - 13:33 | 3223376 Vooter
Vooter's picture

Wild...keep stacking!

Thu, 02/07/2013 - 13:33 | 3223377 Walt D.
Walt D.'s picture

See the South Park Episode.


Best Of Margaritaville - South Park S13E03


Thu, 02/07/2013 - 13:46 | 3223419 kchrisc
kchrisc's picture

"...aaaand it's gone!"

Also the episode that predicts John Cozine's defense/attitude, "The money in your account. It didn't do too well, it's gone."


Thu, 02/07/2013 - 15:13 | 3223740 earleflorida
earleflorida's picture

i'm a bit surprised that the `south park's creators'... matt and trey, haven't done a partial episode about 'The Fight Club', ie. Zerohedge?

they're [SP] so avant`garde about america's immolating society... characterized only by an ever evolving hermetic iconoclast-- mostly an exercise in mental hygiene masturbation... culminating a abstract comedy ejaculation of uncontrollable, yet profoundly ironic laughter.

alas-- viewed by, and for, a sardonically addicted surreal audience... known only as the 'neo-chimerical satirist x minus yz, generation'?    

simply said... a hedonistic orgy of contradictions, regarding our own idiosyncratic commonality! 

so if your listening 'south park'... please give ZH a moar,  shout?!


thankyou Tyler

Thu, 02/07/2013 - 23:10 | 3224983 MeelionDollerBogus
MeelionDollerBogus's picture

what, no funny song / video link?

Thu, 02/07/2013 - 13:35 | 3223383 mayhem_korner
mayhem_korner's picture



(Ohhh) won't you tell me...where have all the credit spreads gone?

Thu, 02/07/2013 - 13:38 | 3223390 Downtoolong
Downtoolong's picture

Two separate parties have claim to the same piece of quality collateral (assuming you still consider Treasuries in this category) . And that's just in the first round. Imagine how easily this could be repeated many times over to increase the apparent size of quality collateral in the system multiple times over. Imagine how many parties may think they have claim to the same ounce of gold.

And the ultimate question is, why do we have to imagine it? Considering these are all major public companies committing this fraud, why aren't they required to tell us about it?


Thu, 02/07/2013 - 14:51 | 3223658 secret_sam
secret_sam's picture

I know it's a simplistic point of view, but I don't really think it's meaningful to call any virtualized asset "collateral."

The whole point of the virtualization is that there is no "there" there.  That's what makes virtualization appealing in the first place.

Ah, well.  Computer folks are probably the only people with an intuitive understanding of what's been done.  That's why so few people can grasp the scope of the "problem."

Thu, 02/07/2013 - 15:04 | 3223708 hooligan2009
hooligan2009's picture

exactly...the turn rate (number of times the SAME collateral is pledged) for "prime quality" repo of treasuries must be around 8-12 times. Note that "only 11 trillion of treasuries are in "public" hands.

this includes 1 trillion for each of the chinese and japanese, plus 1.7 million in fed hands.

i maintain that the 1.7 million in fed hands is a book entry and should be cancelled..

there is 5.6 trillion of us debt in foreign hands (whether this includes us subsidiaries operating overseas god only knows - and we trust god right? :>) )

the custodian banks (JPM, BoNY, SSgA and NT) operate bond bond repo/lending programs (where they keep 40-60% of the profit) for bonds they hold and these banks are the facilitators of hypothecation and rehypothecation. they are the oil that keeps the leverage in the system operating and are responsible for creating a lot of jiggery pokery and potential instabiity.

Thu, 02/07/2013 - 23:09 | 3224981 MeelionDollerBogus
MeelionDollerBogus's picture


I just realized the number of steps of rehypothecation in any part of the system is in fact that first math problem shown at the start of Good Will Hunting.

How many rehypothecations are there between any 2 given banks with 1 additional counter-party between them? (3 step walks)

Wow. That’s hilarious.

Thu, 02/07/2013 - 23:50 | 3225073 hooligan2009
hooligan2009's picture

the number of "turns" of repo rehypo..repo^2, rehypo"n will net off in the total trades reported through the tri-party repo custodian banks..

repo is different from a "real" sale of a treasury security from one person to another. there is settlement risk for non-delivery (which happens regularly in us treasuries..these are called prosaically enough, "fails" and occcur when someone cant settle correctly. wrong ISINs, bank account details, prices, counterparties, delivery instructions etc etc all constitute fails ..and the smart guys use fails for cheap funding (even negative funding these days).

the repo trade is slightly different. everyone claims the same bond is theirs and n-one else's. 

the analagy repo,, the same car is used for security for 10 loans..whereas in physical, the same car is passed around between a string of buyers and sellers.

these nuances are otherwise known as "it doesn't matter" until you there is a default of a counterparty AND NOT THE CAR.


Mon, 02/11/2013 - 16:21 | 3234510 MeelionDollerBogus
MeelionDollerBogus's picture

Thank you muchly for the clarification :D

Thu, 02/07/2013 - 16:23 | 3223971 Dewey Cheatum Howe
Dewey Cheatum Howe's picture

Bottom line these things always fall apart when to many people call in asking for the actual assets. That is the only way to force this whole thing to a head. That or a well placed computer virus wiping out all the records would cause a rush for claims on assets raising all sorts of hell in the process.

Thu, 02/07/2013 - 19:14 | 3224478 NotApplicable
NotApplicable's picture

So... you're saying they'll use a solar storm as an excuse to dump all of the evidence?

Thu, 02/07/2013 - 13:48 | 3223424 williambanzai7
williambanzai7's picture


Thu, 02/07/2013 - 19:19 | 3224489 falak pema
falak pema's picture


Only charlatans insist that economics is about equations. What it’s really all about is history.


Read more at 

Say it with a picture that speaks a thousand words; like Raphael did, as you do also :



Thu, 02/07/2013 - 14:00 | 3223467 malek
malek's picture

This is for what I love ZH!

Thu, 02/07/2013 - 14:01 | 3223470 buzzsaw99
buzzsaw99's picture

It doesn't matter, the whole works is guaranteed to always pay the biggest bonus possible.

Thu, 02/07/2013 - 14:03 | 3223477 Al Huxley
Al Huxley's picture

'Pristine collateral == Treasury Securities' - LMFAO.  Ok, now maybe I can finish Stein's article.

Thu, 02/07/2013 - 14:07 | 3223496 Al Huxley
Al Huxley's picture

Finished the article - wow, I can't see anything possibly going wrong with daisy-chaining multi-tiered asset swaps all resting on an underlying foundation of low quality, junk debt as collateral.  How could this possibly cause a problem?  These guys are fucking geniuses, no wonder they make the big bucks.

Thu, 02/07/2013 - 19:24 | 3224503 JimS
JimS's picture

Good one Huxley. I don't see a problem either, everything is copacetic. Life is beautiful on top of this mountain of humanity, if you got money and power.

Thu, 02/07/2013 - 14:15 | 3223521 carlsbro
carlsbro's picture


Thu, 02/07/2013 - 14:24 | 3223561 Al Huxley
Al Huxley's picture

Yeah, it's not like these kinds of activity have any history of blowing up in the past.

Thu, 02/07/2013 - 14:18 | 3223537 SDRII
SDRII's picture

In view of linked article on Shadow Banks...

Vox article

"Relative to mid-2007, the primary indices that measure aggregate borrowing cost (e.g., BBB index) are well over 2.5 times in the US and 4 times in the Eurozone. This is after adjusting for the central bank rate cuts, which have lowered the total cost of borrowing for similar corporates (e.g., in the US, from about 6% in 2006 to about 4% at present). Figure 3 shows that for the past three decades, the cost of borrowing for financials has been below that for non-financials; however this has changed post-Lehman. Since much of the real economy resorts to banks to borrow (aside from the large industrials), the higher borrowing cost for banks is then passed on the real economy"


There is this from bloomberg Jan-28-13. All must be clear

"Banks are poised to overtake industrial companies as the safest borrowers in the $5.1 trillion U.S. corporate bond market for the first time since the start of the financial crisis, according to data compiled by Bloomberg. Investors demand an extra 154 basis points in yield over benchmarks to buy bonds of JPMorgan, Wells Fargo & Co. and other lenders, compared with 138 basis points for companies from Alcoa Inc. (AA) to Ford Motor Co., Bank of America Merrill Lynch index data show."


Thu, 02/07/2013 - 19:08 | 3224456 earleflorida
earleflorida's picture

and, then there was Lehman-- let go in all the chaos. why?

C'mon Mr. Hanky?

Simply delicious?! The 'Township of London', shall be granted a sacrificial slain calf of unimaginable wealth, and esoteric symbolism!

Barclays plc gets Lehman's trading/brokerage unit [all properties] for pennies on the dollar, whilst selling off their iShares/ ETF Unit of Barclay Global Investor to BLK c/o, 'Larry the 'Rat Fink'-- but what comes next is a super-duper delicious trick-or-treat? Rothschild LLc and Partners, purchase the banking side of Lehman Brothers for ~ $10bn, and taking said carrion private... generously parsing off a minute slice to Nomura Holding for asian... small`ish digestion?,... a u$ury penance, shall we say?

There you have it... from 'America with Love', on the taxpayers dime!!!


Thu, 02/07/2013 - 14:57 | 3223676 LongSoupLine
LongSoupLine's picture

Good luck getting the ADHD fucking X-Factor and Honey BooBoo watching voting retards of this fucking nation to understand that shit.


We're fucked, just call every Obama phone and ask what they think.  Stupid fucking Cramer following sheep.

Thu, 02/07/2013 - 15:04 | 3223704 Catullus
Catullus's picture

Exceptionally arrogant speech setting up a straw man with no context. The ole "here's a dumb perception in the market that I will righteously cut down and add to my credibility" trick right off the bat. Written and delivered by a real cocksucker, I'm sure.

The "primitive" view he's describing is actually pretty straight forward demand for money. But because it's immeasurable to these wonks and has little to do with sucking some regulator's dick in Washington, he won't consider and call it "primitive." then go into convoluted listing off all of the different factors on the supply of credit. So he says the three reasons things "overheat" are "financial innovation" (which I think this website has clearly identified as level and pervasiveness of fraud), changes in regulation (which we know are written by and influenced by market participants), and economic environment. Which in the end of the day was the "primitive view" states above. Because as the Austrian taught, the supply of money and credit is influence by the demand to hold to money. So the demand for money necessarily plays into the supply of credit.

Then he goes off on credit spreads as primitive as if the rate of interest signals nothing to the marketplace. He claims this by pointing out PIK and other non-price items inherent to bonds as explanatory. But BECAUSE they are different products, they're not equivalent rates. The PIKs are non-sequitur.

I can't read anymore. This whole speech is a baffling with bullshit exercise with arrogant chart-gazers. I'll go with the most reliable data set: these assholes are 0 for forever in seeing any of this unfold in real time.

Thu, 02/07/2013 - 15:14 | 3223744 dadichris
dadichris's picture

'supersafe treasuries' - ROFLMAO!

Thu, 02/07/2013 - 15:14 | 3223745 The Econ Ideal
The Econ Ideal's picture

Mmmm...endogenous credit-money. 

Thu, 02/07/2013 - 15:29 | 3223802 adr
adr's picture

So, I go take my father in law's 1982 piece of junk Chevy and pledge it as collateral for some treasuries using the inflation adjusted original sticker price, then I use the treasuries to take out a $50 loan, then I take the $50k to a Mercedes dealer and drive out with a brand new Benz?

The Mercedes is bought and paid for so I get to keep that. The loan is backed by the treasuries, so the bank gets those. So the guy who sold me the treasuries gets stuck with the 1982 Chevy worth $500?

MY GOD, WHAT BRILLIANCE!!! You can use worthless junk to buy expensive stuff. WHY DOESN'T EVERYONE DO THIS!!!!

Fuck the fuckers with a bigger fucking stick.

Thu, 02/07/2013 - 18:23 | 3224366 Al Huxley
Al Huxley's picture

You clearly have an excellent grasp of modern finance.  I recommend you seek employment at an investment bank, although the last line of your post suggests the possibility that you may have certain ethical standards that will disqualify you.

Thu, 02/07/2013 - 18:28 | 3224377 Michelle
Michelle's picture

The grand finale is when the Mercedes (Treasurys) gets wrecked and the insurance you thought you'd bought from a reputable insurance agent (insert any crook's name here) can't pay up because they are in fact insolvent (the U.S. government).

Thu, 02/07/2013 - 19:11 | 3224474 JimS
JimS's picture

Not a problem. You tow in the wreck, get another $50,000.00 on the new collateral you've presented, and it's off to the dealer again. Hell, you could do it forever with the Fed and Treasury back-stopping you. Isn't just a beautiful setup? What the fuck could go wrong?

Thu, 02/07/2013 - 15:40 | 3223810 emersonreturn
emersonreturn's picture

it is so massively corrupt that it's difficult to imagine anything bringing it down, the scheme seems to withstand war, every sort of disaster and so long as only the sheeple suffer nothing can harm the global banking mafia.  i continue to stack, not because i can see the end of this global ponzi greed, but because i want to live apart, in a universe free of TPTB.

Thu, 02/07/2013 - 15:52 | 3223889 DR
DR's picture

Good article. I knew leverage was moving up the markets but now I have a understanding of how it works.

Thu, 02/07/2013 - 16:00 | 3223911 venturen
venturen's picture

I am Jon Corzine and I approve this message!

Thu, 02/07/2013 - 19:03 | 3224449 JimS
JimS's picture

I would love to have 10 minutes, alone, in small room, with Jon Corzine. It would be so much fun, him, me, and my father's WW2 gurkha knife. I love the smell of warm fresh blood, in the morning.

Thu, 02/07/2013 - 16:16 | 3223953 Dewey Cheatum Howe
Dewey Cheatum Howe's picture

The whole damn system resembles Gresham's Law on steroids these days. Not only is it bad money but policy and ethics forcing out good.


Thu, 02/07/2013 - 18:25 | 3224370 maskone909
maskone909's picture

i fuckin love this website. i fuckin love fightclub fuck yeah!
the movie is so applicable to what is happening in the world today. especially the end when, well, you know what happens- WHERE IS MY MIND?!?! keep fighting the good fight fellas cheers

Thu, 02/07/2013 - 18:56 | 3224435 JimS
JimS's picture

I am almost 65, and I still would love to "fight-club" these fucking cocksuckers. (I still know how to box like a motherfucker, would love to spill a little blood, actually a lot of blood, and a lot of it wouldn't be mine either)

Thu, 02/07/2013 - 18:33 | 3224389 Meat Hammer
Meat Hammer's picture

Complete fiscal insanity is the new reality.  When all of it unwinds and the rules of market reality can no longer be constrained, people will go insane......and that's what's really crazy.

You can't make this shit up.......unless you're a banker.

Fuck you, Ben.

Thu, 02/07/2013 - 19:09 | 3224469 forwardho
forwardho's picture

Complete fiscal insanity is the new reality.

Denying reality is one definition of insanity, Check

Doing the same thing over and over yet expecting a different result is another, Check

By any definition this action is "insane"


Thu, 02/07/2013 - 23:43 | 3225056 MeelionDollerBogus
MeelionDollerBogus's picture

Doing the same thing over and over yet expecting a different result is another, Check

Unless we're talking about recursion with fractals. As it happens with chaotic fractal behaviour & HFT algos, that is the situation NANEX is exposing.

Thu, 02/07/2013 - 18:51 | 3224425 JimS
JimS's picture

".. creates additional counterparty exposure..." , not a problem. The Fed creates additional digital money, the Treasury back-stops the whole thing, the profits (if any) are privatized, losses are "socialized, the taxpayers get fucked, and the entire issue swept under the rug. Problem solved. Isn't Capitalism great? (sarcasm on)

Thu, 02/07/2013 - 18:53 | 3224429 steelhead23
steelhead23's picture

I am a bit queasy about the Fed telling the banks how to cheat.  That is, I think this speech was about as patriotic as a director of Central Intelligence raving about lapses in their cyber security.  Tyler's table suggests there is less than $2T in this risk merry-go-round.  I am wondering whether following Jeremy's description of the ruse, more would take place.  Keep that spreadsheet Tyler - we may wish to see where this goes.

Thu, 02/07/2013 - 19:03 | 3224447 grid-b-gone
grid-b-gone's picture

Gold = a whistleblower with inside knowledge 

Thu, 02/07/2013 - 19:09 | 3224468 besnook
besnook's picture

he misses the best part. since the entire swap is opaque no one knows how many times the same treasuries are being used as collateral for what or what derivatives are tied to each lending. given normal risk assessment the same treasuries could be "safely"(because they are so pristine,lol) swapped out 30 times.

Thu, 02/07/2013 - 19:17 | 3224486 Herdee
Herdee's picture

This type of highly leveraged positioning is always subject to something out of the blue.Meaning that on any type of bell curve,volatility curve etc.,most of the risk calculations don't include what's called "an act of randomness".In plain terms it is someone taking a monkey wrench and tossing into an expensive piece of machinery,then walking off the job in order to totally destroy.Right now if you look at how low volatility is falling it is telling you that it has a significant meaning to it.The volatility index falling to its lowest levels can be measured in a different form by using the ADX.The longer in time the ADX stays low,the larger the size of the move to come.

Thu, 02/07/2013 - 19:51 | 3224555 Yen Cross
Yen Cross's picture


    Are theses repos treated like swaps, with a set rate of future exchange?  Assuming there are 3 parties involved in said transaction, unless the "broker dealer" handles the "risk" of treasury notes as collateral, exchange for $cash >into stock market , it would be pretty tough to set a future maturity/exchange rate on these deals.

    If the swap deal turns to shit, the insurance company makes out, and the B/D makes out, and we get FUCKED! B/D has treasuries as collateral. Insurance company used SHIT as collateral in the first place!


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