The Federal Reserve's Nuclear Option: A One-Way Street to Oblivion

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

The Fed cannot create a bid in bidless markets that lasts beyond its own buying.

We all know the Federal Reserve (and every other central bank) has one last Doomsday weapon to stop a meltdown in the global financial markets: creating trillions of dollars out of thin air and using the cash to buy assets that are in free-fall. This is known as "the nuclear option"--the direct monetizing of stocks, Treasury bonds, commercial real estate mortgages, student loans, corporate bonds, non-U.S. sovereign bonds, subprime auto loans, defaulted bat guano securities, offshore loans denominated in quatloos--you name it: The Fed could print money and buy, buy, buy to create and maintain a bid in bidless markets.

The idea is to stop a cascade of panic by buying assets in quantities large enough to staunch the avalanche of selling. The strategy is based on one key assumption: that no more than a small percentage of the asset class will change hands in any day or week.

Thus a low-volume sell-off in the $20 trillion U.S. equity markets can be stopped with large index buy orders in the neighborhood of $10 - $100 million--a tiny sliver of the total market value.

But in a real meltdown, popguns will no longer conjure a bid in suddenly bidless markets, and the Fed will have to become the bidder of last resort on a massive scale in multiple markets. We need to differentiate between loans, backstops and guarantees issued by the Fed and actual purchase of impaired assets.

After poring over all the data, the Levy Institute came up with a total of $29 trillion in Fed and Federal bailout-the-financial-sector loans and programs. The GAO found the Fed alone issued $16 trillion in loans and backstops:

The heart of quantitative easing and ZIRP (zero interest rate policy) is the Fed's direct purchase and ownership of assets: residential mortgage-backed securities and Treasury bonds. The Fed has been operating not as the buyer of last resort but as the bidder who buys interest-sensitive securities to keep interest rates near-zero (known as financial repression).

The Fed's purchases of impaired mortgages has also made its balance sheet "the place where mortgages go to die:" the Fed can hold impaired mortgages until maturity, effectively masking their illiquidity and impaired market value. We can see these two major purchase programs in this chart from Market Daily Briefing:

Despite all the talk of "tapering," the Fed's asset purchases on a grand scale continues:

Such a handy word, "taper:"

The Nuclear Option rests on another questionable assumption: markets only go bidless in brief panics, not because the assets have lost all value. The basic model of Fed emergency loan programs and asset-buying is 1907--a financial panic that erupts out of a liquidity crisis.

In a liquidity crisis, the underlying assets supporting loans retain their market value; the problem is a shortage of credit needed to roll over short-term loans on those still-valuable assets.

But what the world is finally starting to experience is not a liquidity crisis: it is a valuation crisis in which assets and collateral are finally recognized as phantom. I explained the difference between liquidity and valuation crises in In a Typhoon, Even Pigs Can Fly (for a while) (January 30, 2014).

Let me illustrate why the Fed's Nuclear Option is a one-way street to oblivion.

What is the market value of a defaulted student loan that has no hope of ever being repaid by an unemployed ex-student debtor? The answer is zero: the "asset" has a value of zero and will always have a value of zero. It is not "coming back."

What is the market value of a commercial mortgage on a dead mall that has no hope of ever being repaid by an insolvent mall owner? The answer is zero: the "asset" has a value of zero and will always have a value of zero. It is not "coming back."

The New York Times recently published an article that nails the core issue in the entire U.S. economy: the top 10% is the only segment able to support additional consumption:The Middle Class Is Steadily Eroding. Just Ask the Business World     (Yahoo news version)

"The Biggest Redistribution Of Wealth From The Middle Class And Poor To The Rich Ever" Explained

This raises an obvious question: can the excess consumption of the top 10% support every mall, strip mall, premium outlet and retail center in the U.S.? Equally obvious answer: no. Most dead malls cannot be repurposed; the buildings are cheap shells, and while the land might retain some value for future residential housing, the coming implosion of the latest housing bubble nixes that hope: WARPED, DISTORTED, MANIPULATED, FLIPPED HOUSING MARKET (The Burning Platform).

What is the value of a company's shares if that company has lost any means of earning a profit? Answer: the book value of the company's assets minus debt.Given the staggering debt load of the corporate sector, the real value of many companies once their ability to reap a real (as opposed to accounting trickery) net profit vanishes is near-zero.

How about the value of Greek sovereign debt? Zero. The value of mortgages on empty decaying flats in Spain? Zero. And so on, all around the world.

This leads to a sobering conclusion: Should the Fed attempt to create and maintain a bid in bidless markets, it will end up owning trillions of dollars in worthless assets--and the market for those assets will still be bidless when the Fed stops being the bidder of last resort.

Let's assume the Fed's leadership will feel a desperate need to stop the next global financial meltdown in valuations. Offering trillions of dollars in liquidity will not stop sellers from selling nor magically create value in worthless assets. The Fed can only stop the selling by becoming the entire market for those assets.

The list of phantom assets the Fed will have to buy outright with freshly conjured cash is long. Let's start with hundreds of billions of dollars in defaulting/impaired student loans. Once the debtors realize the system is swamped with defaults and can no longer hound them, the flood of defaults will swell.

The Fed can buy as many defaulted student loans as it wants, but it will never raise the value of those loans above zero. The market for worthless student loans will remain bidless the second the Fed stops buying.

The same is true of all the defaulted, worthless commercial real estate (CRE) mortgages on dead malls, decaying strip malls and abandoned retail centers: no amount of Fed buying will create a market for these worthless assets.

Dead Mall Syndrome: The Self-Reinforcing Death Spiral of Retail (January 22, 2014)

The First Domino to Fall: Retail-CRE (Commercial Real Estate) (January 21, 2014)

There is no technical reason the Fed cannot create $10 trillion and buy up $10 trillion of worthless or severely impaired assets; the Fed can become the owner of every dead mall and every defaulted auto loan in America should it wish to.

That would of course render the Fed massively insolvent, as its assets would be worth a fraction of its liabilities. But so what? The Fed can simply assign a phantom value to all its worthless assets and let them rot until maturity, at which point they vanish down the wormhole.

The point isn't that "the Fed can't do that;" the point is that the Fed cannot create a bid in bidless markets that lasts beyond its own buying. The Fed can buy half the U.S. stock market, all the student loans, all the subprime auto loans, all the defaulted CRE and residential mortgages, and every other worthless asset in America. But that won't create a real bid for any of those assets, once they are revealed as worthless.

The nuclear option won't fix anything, because it is fundamentally the wrong tool for the wrong job. Holders of disintegrating assets will be delighted to sell the assets to the Fed, of course, but that won't fix what's fundamentally broken in the American and global economies; it will simply allow the transfer of impaired assets from the financial sector and speculators to the Fed.

Anyone who thinks that is the "solution" should read QE For the People: What Else Could We Buy With $29 Trillion? (September 24, 2012).

The Retail Commercial Real Estate Domino with Gordon T. Long and CHS:

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Temporalist's picture

But CNBS says the money on the sidelines is just dying to come in...there is money on the sidelines...the sidelines damn you!

knukles's picture

Even the 1%ers and idiots get frightened

Who remembers portfolio insurance and a bevy of other bid less fuckups?
Hah ha ha ha ha

Richard Chesler's picture

Bag holder of last resort, you.


HyBrasilian's picture

Paper Changers can buy anything they want. But I draw the line at granny's tea set. They got nothing I want.

kaiserhoff's picture

The point isn't that "the Fed can't do that;" the point is that the Fed cannot create a bid in bidless markets that lasts beyond its own buying.


First principles well and cleanly stated.  This should be shouted from the roof tops.

HyBrasilian's picture

Forget about the markets... I don't even want their fucking currency...

Four chan's picture

Mortimer Duke: Turn those machines back on!

kralizec's picture

I'll take "Don't give a fuck" for $500, Alex.

PT's picture

It's like a Monopoly game - you know, the one where one player has all the properties and all the money.  Tell me again, what is the next move?

Bastiat's picture

Monopoly game where the banker has a color copier and a pair of scissors.

PT's picture

... and you are entitled to borrow $200 every time you pass Go.



... and the prices are actually 50 times the number written on the board.  The number written on the board is the down payment.  But the rents are the same.


Old Kent Road now goes for one dollar.  But comes with $17000 in property taxes, and doesn't rent out because it has been burnt to the ground.  Every time you visit jail, you have to pay the police to get rid of the squatters.

Lost Word's picture

Selling junk to the Fed gets rid of something worthless,

and getting (almost worthless) money into the economy.

Better some money velocity than zero money velocity.

SDShack's picture

Exactly like Monopoly. That's what the author misses. His whole point is that the Fed is bidding on assets that have no value, thus destroying the true price discovery mechanism. He acts like there is still a functining market! WTF? Doesn't he realize the Fed is using PAPER FIAT that has no value to buy said assets that have no value? It's the perfect circle jerk by design! Using the author's own logic, he should see the ENTIRE financial system is a sham! There is no spoon! Instead, he treats this like some term paper where he is trying to point out a solution to the bankers.

Jesus Christ, can't anyone put themselves in the mind of a sociopath banker and see where this is going? The short term goal is too keep the lid on at all costs using printed money to depress interest rates to monetize the debt. This allows goodies to flow to the FSA, and the corporate welfare pigs as the govt keeps spending. Again, all in an effort to just keep the lid on. Short term, it is all about Flow, nothing more. Flow keeps the wheels turning and not falling off. Long term, it is all about the Nuclear Option. It has to be because if you take short term flow to infinity, you get the Nuclear Option by default... literally by default... and the ensuing bailouts that TPTB will organize. Will it work? Hell no. We all know it won't work and why. We just don't know when or how it will all fall apart. But that doesn't mean these sorry sociopathic bastards aren't going to try it. They have NOTHING else to try. This is all they do because it is all they know. They will never stop until it either all crashes down around them, or they control the entire world and everyone is a serf.

TahoeBilly2012's picture

Funny no on ever suggests that these Zionist Marxists might actually "want" to own everything in one "Central Bank". Isn't that the essence of total control? .

PT's picture

Yeah - "See, we bought it all fair and square.  It's not my fault that no-one else could afford to buy it.  It's not my fault people borrowed too much money and couldn't afford to pay it back.  If people would live within their means then we would not have had to get bailed out. ..."

SDShack's picture

They're called sociopaths.

q99x2's picture

How bout if they bundle it into a CDO and lend it to the Chinesers and then loan the Chinesers money against it.

For example: Q99X2 has been dying to use student loan money, which he hasn't taken yet, to buy a house with, while he goes to UCLA to get a degree with, so that he can then move to Thailand as a refugee from the United States of America.

He believes that GS and God's work will one day provide financialization to allow him to do this.

Banksters just did the mortgage scam AGAIN so why not keep doing it with ever increasing financial innovation and creativity typical of the .0001%ers.

And further:

Banksters recycle FED shit into Bankster shit and the FED recycles Bankster shit into FED shit in the same way that plants recycle carbon dioxide into oxygen and people recycle oxygen into carbon dioxide.


TheReplacement's picture

If the Fed printed and bought everything (or half the stock market as stated in the article) then wouldn't they (the private corporation that is the Fed) own everything?  Perhaps that is the point.  Socialism via capitalism - buy everything and then nationalize it.  Perhaps they (the statists) are working on this from multiple angles in case one or another fails to get results.

IPA's picture

Funny you should say that, looking at the graphs the first thing i though was dam, getting closer to privatizing the country. If the fed owns everything? 

sfisher's picture

Perhaps what is happening is exactly what they want to happen.  They print money at zero cost and buy everything.  Eventually, the money printed finds its tangible worth, the Fed (privately owned) holds title to $20-$40 trillion of assets (pre crash value, worth a bit less post-crash) and everyone is now a debt slave and can relocate to environmentally low impact areas to be subjects of the State. 

Or perhaps the Fed actually has good motives which are hard for us to appreciate.



SDShack's picture

Fascism at it's finest giving way to the New Feudal World Order.

Sudden Debt's picture

well... it's already taking them 7 years to do so... so they're FUCKING SLOW... or SO OLD THEY MOVE IN MINIMETERS!


GetZeeGold's picture



My Ra......put your IRA to work....and wave buh-bye to it.

kliguy38's picture

its dying alright, but suicide isn't in its best interest and it knows it.........Fed will announce 150B QE by May

Lost Word's picture

Or sooner, if the markets continue sinking.

SheepDog-One's picture

So it's like I said at the beginning of The Great FED Experiment....sure the Fed can buy it all up, but can't pass off the pump. Kill the Golden Goose to get all the eggs now, and wonder why the dead goose won't produce anymore. Simple Aesops Fables shit.

moneybots's picture

"But CNBS says the money on the sidelines is just dying to come in"


With the stock market dropping, money in the stock market is on the sidelines, looking to come into other assets.

doctor10's picture

All that is happening is that the owners of the FedReserve are buying the world with paper. 

At the end of the day-they have no intention of the "useless eaters"getting in their way.

I'm sure they've prepared their "humanicide"

Lost Word's picture

If the Fed is buying the world with paper dollars,

those who receive the paper dollars presumably can also buy something else with their paper dollars.

Like China buying the USA.

moneybots's picture

"At the end of the day-they have no intention of the "useless eaters"getting in their way."


Three bankers down in the last week.

The Dunce's picture

It always seems darkest before the dawn.  So I've been told.  Now I'm going to calmly walk down to my underground bunker and start counting my gold.  Bitches.

Clowns on Acid's picture's always darkest just before the lights go completely out...

Canadian Dirtlump's picture

Yeah the 2 narratives at CNB.O. are:


1) there is about 1.6 jodeciquillion dollars on the sidelines.

2) mom and pop got back in here in some measure, and they don't use leverage so don't worry about margin calls on dow drops because the chart which shows record margin is actually a drawing by a soothsayer who was channeling ashtar from the intergalactic federation of light.


The reality is, the Fed is the financial garbage dump. Where pieces of engineered financial feces go to die. People much smarter than I said that no small part of QE was to buy worthless MBSs off the banks for 100 cents on the dollar to recapitalize them. How one can't see this as the case is beyond me. I find a certain charm in believeing in Santa Claus et al, but to believe in these guys ( which most have ) is gonna end up costing the world dearly. That being the case, come quickly please.

John Law Lives's picture

Strange that money on the sidelines is not being used to buy junk from JCP or RadioShack.


Lost Word's picture

Why sell junk to buy junk?

Sell junk to buy something valuable.

John Law Lives's picture

Brick-and-mortar retail in the US faces some tough sledding ahead.

Sudden Debt's picture

I say they should go for it!


hugovanderbubble's picture

Excellent Exposition CHS

Ancona's picture

I thought I heard that Mom and Pop were jumping back in to BTFATH?

spinone's picture

I've said it for 3 years:  the Fed is the bad bank.

GetZeeGold's picture



It's a collection of bad banks actually......and not just a few unsavory characters as well.

moneybots's picture

"I've said it for 3 years:  the Fed is the bad bank."


A very bad bank.

youngman's picture

Watch the 10 year..that is where the tidal wave will start....when people...countries start dumping will be the canary in the coal mine

BandGap's picture

Agreed, that was part of the scenario presented a few years back. First the flight to "safety" in Treasuries, then the panic getting out.

Boston's picture

People, especially the experts, have been saying the same thing about JGB's starting about 20 years ago.

In the meantime, the Japanese 10yr yield has collapsed to 0.6% today.

Someday, the US Treasury market may very well crack, but you might be dead before that happens.

SDShack's picture

You don't think the Fed undertands the risk that the 10yr exposes them to? They have gamed the system this way for a reason. It's why their long term goal HAS to be to corner the Treasury market. It's the only way to eliminate the risk you so aptly identify. Start thinking like the Fed thinks if you want to know where this is going. And don't underestimate their ability to do exactly what they HAVE to do. They already control about 1/3 of the treasury market. Getting to 51% from here isn't that hard with a few more engineered crisis. Then it's game over for the bond vigilantes and on to stage 2 for the Fed... which is long term asset redistribution from the masses to the elites.

Clowns on Acid's picture

youngman - actually the 2 to 10 yr swap rate will be the real canary...

LawsofPhysics's picture

All of this is very old news.  The nuclear option has been activated for quite some time.

tarsubil's picture

Exactly what I was thinking. Hey, hasn't this been going on for a while? And you can make defaulted student loans worth something. Drop 100K from a helicopter into the kid's lap.

SheepDog-One's picture

Drop a free credit card into the kids lap....THEN you've got something!