The Scary Math Behind The Mechanics Of QE3, And Why Bernanke's Hands May Be Tied

Tyler Durden's picture

When it comes to the NEW QE, everyone has an opinion, and most seem to believe that the NEW QE will come next week, now that the US economy added "just" 96,000 people (but, but, the unemployment rate 'fell'). Certainly, and far more importantly, if the most recent FOMC minutes are any guide, the Fed shares this view. Sadly, as so often happens, most, and this includes the FOMC's various voting members, have once again made up their minds without actually evaluating the limitations posed by simple math. After all it is far easier to form an opinion, and actually think about the underlying facts later. The math, for those who actually have looked at the numbers behind the scenes, is scary (in UBS' words, not ours).

Here is the math.

As part of its Operation Twist, the Fed is buying long-term bonds, and selling short-term (0-3 years) bonds. As we reported in April, the biggest limitation for the Fed is that it is rapidly running out of short-term bonds to sell. There is a fix to this: the Fed will simply have to sell longer dated bonds from its SOMA portfolio, first up to 5 years, then 7, and so on. Of course, this will also force the Fed to extend its ZIRP language by an appropriate amount of time, through 2017, then 2019, and so on (which also means all bets that the Fed will hike any time in the next 5 years will be immediately null and void, and one can position accordingly in the Eurodollar space).

This move, however, will simply permit the Fed to extend Twist 2 beyond its year-end maturity. As a reminder, the primary role of Twist, aside from that stated one which is to keep the curve as flat as possible (i.e., boost housing which as we showed yesterday is not working, as refis have plunged recently despite record low mortgage rates), is to absorb virtually all the long-end supply: after all, it is all about the funding of the US $1 trillion+ annual budget deficit.

Said otherwise, when it comes to the 10-30 year sector the Fed is already monetizing all new issuance. This is part of the entire flow argument which we have been discussing for the past 6 months, and why we, correctly, say that Operation Twist is really QE 3 and QE 3.5 (for the recent extension of Twist). So far so good.

Here comes the important part.

Three weeks ago we presented a video courtesy of Stone McCarthy which showed a timelapse of the "takeover" of the Fed as the primary holder of public debt. For those short on time, here is how the Fed's holdings portfolio looked like then...

and now:

The shaded region is important for two reasons: this is where the Fed will be buying new bonds as part of any new QE Large Scale Asset Purchase program, and it tells us all there is to know about how big and how effective QE3 (really 4) will be. The bottom line, as calculated by UBS' Michael Schumacher and confirmed by anyone with access to the detail behind the Fed's SOMA holdings, which incidentally just hit a record 116 months two months ahead of Twist 2 schedule, is that "the Fed owns all but $650 billion of 10-30 year nominal Treasuries." Also as pointed out above, Twist 2, aka QE 3.5 is already absorbing all of the long end supply. And herein lies the rub. To quote UBS: "Taking out, say, $300 billion in long-end Treasuries almost certainly would put tremendous pressure on liquidity in that market....Ploughing ahead with a large, fixed size QE program could cause liquidity to tank."

In other words, anyone expecting a full blown LSAP focusing only on US Treasurys will very likely be disappointed as the Fed will certainly realize, quite soon we hope, that it has only $650 billion in total 10 year + bonds available in the entire private market!

Well, perhaps the Fed will just monetize MBS, as Bill Gross has been betting on for nearly a year now. It could do that... but when once factors in "math", the results are once again quite startling. Quote UBS again:

The alternative of tilting purchases toward MBS implies that the QE program would need to be quite protracted. Monthly supply of conventional 15yr, 30yr and 30yr GNMA has averaged about $85-90 billion over the past year and the Fed is already buying about $25 billion. The Fed might be able to buy another $40 billion without disrupting the market. Assuming that the Fed does a $600 billion program with 75% in MBS, it would need to buy $450 billion in mortgages, so in our estimation the program would need to last nearly a year. 

UBS conclusion is self-evident:

We doubt the market would respond well to that prescription from Dr. Bernanke.

Bottom line, if and when someone does the actual math on what the Fed can do, the results are quite disturbing, as they indicate Ben's hands are very much tied, and the Chairman no longer can conduct the type of bazooka event that most have expected. It certainly means that the Fed can not engage in anything remotely resembling the $1 trillion LSAP in QE3 (sic) that has been whispered.

Most importantly, all of the above actually confirms our biggest worry: the Chairman is well aware of the math behind this analysis, and is the reason why month after month he has been forced to pull a 'Girl with the Draghi Tatto' and jawbone the market into submission, hoping nobody else does the math on what Bernanke's real options are, because once the details are out there, and everyone can do the math on their own, only disappointment can follow.

As it turns out, Adam Yogi Berra Smith Dzhugashvili was right: there indeed is no such thing as a free lunch, especially not under central planning.

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jcia's picture

print more BITCHEZZ

SeverinSlade's picture

The majority of the market has been expecting the new QE for a while now...With the S&P at its 2012 highs, food and gas inflation surging, and the UI rate dropping (manipulated BS, but it dropped nonetheless) I fail to see how Bernanke will deliver this upcoming week...especially when you consider that once QE is annouced, the market will rally briefly and then plunge, as well over 100% of the new QE is already priced in (as pointed out by ZH numerous times).

PLUS, launching it now would make the Fed appear to be a politically motivated agency (something that a former Fed governor pointed out last week).

Comay Mierda's picture

Silly Tyler

Math is for Terrorists

Manthong's picture

Simple math works when the real assets, liabilities, revenue and expenditures are revealed, honest and accurate.

So how much of our current Ponzi.. er, economy is revealed, honest and accurate?

Aziz's picture

70% of outstanding is not an absolute limit. It makes sense, though, that Bernanke keeps asking for help from the fiscal side.... because it gives him a larger pool of treasury debt to buy.

Anyway, isn't QE3 supposed to be MBS more than Treasury securities?

Dr. Richard Head's picture

Isn't QE3 indirectly buying MBS's being that Fannie/Fannie have the implicit guarantee of the Treasury?  Everyone loves a good circle jerk.

nope-1004's picture

So bond buying is limited.  Huh, who knew?  <sarc>.  Next up - pension theft, IRA confiscation, broker theft, on and on.

Already here, actually.

So long, MS.


philosophers bone's picture

Include War on your list of what's next up.  Canada apparently got the "heads up". 

From National Post:

"Canada severed all diplomatic ties with Iran on Friday, citing a long list of grievances including Tehran’s military assistant to the Syrian regime, rogue nuclear program and threats against Israel.  Foreign Affairs Minister John Baird said in a statement that Canada had closed its embassy in Tehran and that all remaining Iranian diplomatic personnel in Canada had been declared personae non gratae.

economics9698's picture

Bernanke can have Geithner print and then buy the print.  All we need is a credit ceiling extension to $20 trillion this time.  Skip the $18 trillion and go for the 120% GDP/Debt gold ring so coveted by Italy, Spain, and Greece.


clymer's picture

I keep hoping that I am going to wake up from this bad fucking dream and learn that a myriad of patents for zero-point, charge-cluster, cold-fusion new technologies have been released into the wild, rule of constitutional law is restored with a complete reset of the tax code, federal govt. is decidedly shrunken to a government-fear-the-public-again, manageable level and freedom once again reigns to restore the promise of the human experiment to explore the stars and pursue honest endeavor and pursuit of happiness.

But until then I just keep living this groundhog-day existence where inbred-control-freak-globalist-can't-cunt, pencil-dicked pukes maintain a stranglehold on anything that resembles freedom and possibility. fuckers

Michael's picture

After crowd sourcing my idea on ZH, this is what I got so far;


Got Guns & Ammo? Good!

I just made this up last night. It's like that Got Popcorn?, Got Milk?(meme)

People should make bumper stickers out of this saying.

People should make T-Shirts with "Got Guns & Ammo?" on the back and "Good!" on the front, or vise versa. I'm making some to sell at the gun show.

There's no time left to be discreet. My idea is similar to the V for Vendetta mask, only you don't need to hide behind a mask in America.

This is my response to the 1.4 billion hollow point bullet purchase by the federal government to be used domestically.

If someone asks if you own a gun while wearing the T-Shirt and you don't know them, just tell them, that's none of your business, or to be pleasant, I don't give out that kind of personal information.

What if people walked around the airports and everywhere gathering in large groups with my t-shirts in an act of civil disobedience that is not, if you have the balls to do it?

It's expressing your 1st amendment right.

It's only four words.

Michael's picture

I'm giving it away for free.

You make thousands on it by printing hundreds of them and selling them before the market gets saturated.

Or before the Chinese do.

Michael's picture

The first person wearing this T-Shirt who goes through the invasive TSA pat down line at the airport, and gets it uploaded on Youtube first, is the winner.

Michael's picture

Jon Stewart, whom I think is on our side, and Stephan Cobert, whom I'm not sure about, has absolutely nailed the synopses of the RNC/DNC Conventions and the entire charade of disgusting display of acting presidential combat supremacy to a tee.

Those two are a sad but true display of the nation we have become brilliantly, in their owm magnificent performances. Divide and Conker brilliance, and we've all been had.

Shakes head for what is left of out country.

I wouldn't be surprised if the two of  them collaborated on each others shows.

I would love to have seen what a Ron Paul acceptance winner RNC convention would have looked like. Someting completely different from the same old shit.

Thank the creator Baby Go Go had better ratings.

Michael's picture

Comedy ChannelHD is really good tonight.

Michael's picture

Go sell your 9/11 Federal Government/MSM Pity Party some place else.

We're all stocked up here with the 5,000 homeless children streched across the 5 mile roadway of RT149 on route to Disney World, living in motel rooms, here in Florida.

Multiply that by the entire stretch of the USA.

Shove 9/11 up your fucking asses assholes.


MiltonFriedmansNightmare's picture

Is Chris Hedges president when you wake up?

e_goldstein's picture

Did you catch this?

I have absolutely no respect for Alex Jones. I have every respect for Chris Hedges. When the two agree on what is going on.... I'm pretty fucking sure that we have slipped over the edge into bizarro world.

jump to 1:12:00 to get to the interview and skip Alex's preaching.

Manthong's picture

“Anyway, isn't QE3 supposed to be MBS more than Treasury securities?

Sure, but the nature, methods and nomenclature morph to suit their need to maintain the illusion.

This is "no holds barred" in a match where things to grasp dissolve with every new reach.

 hmm..  maybe I should write that down somewhere.

AldousHuxley's picture

problem is


GOLD = SPY = BIG OIL since 2009



No REAL wealth growth, but sheeple think they doubled their stocks and are now spending on shit.





TwoShortPlanks's picture

On a different note, a letter I just received


After assessing global requirements for conducting international business, TD Ameritrade regrets to inform you that we have decided that we will no longer open or maintain accounts for residents of certain international jurisdictions.

Effective 3 December, 2012 we will no longer be providing brokerage services to residents of Australia.

Dr Benway's picture

Is this just generic demise of stockbroker due to stagnant trade volume, or is there some other background?

Griffin's picture

There are 2 graphs on the picture below, the first shows a 20th century business plan under the influence of common sense and the second one shows a 21st century business plan under the influence of postmodernised risk management.

Simple things are made extremely complicated because of all the scams that are running and the tools that have to be made to make them possible.

This escalades to the point where the central planners no longer understand what they are doing or have any control or oversight.  When that happens they stall, until the time is right for a crash.

When that happens, Firewalls will be built and assets ringfenced to defend the trillions in various taxhavens.

samcontrol's picture

Cool, i feel better now.

LMAOLORI's picture



I found it hilarious the thought of Banana Ben having his hands tied just think how much interest they will rake in by adding all that debt when the market's (hahaha that's a good one) force their hands.  That's the claim isn't it after all that eventually the bond holder's will force interest rates to rise on the debt.  Get it?

 U.S. money-market rates are negligible anyway

Quinvarius's picture

GE alone has 1/2 trillion in debt on their book.  Bernanke will find something to buy.  This all ends with the Fed giving all the banks and cronies a debt jubilee anyway.  Not you.  Just the banks and cronies.

spinone's picture

Giving them one?!?  If i could use dirty socks as collateral with the Fed too it would be the same as a jubilee!  They already got one!  They used it to pay bonuses!

Dr Benway's picture

LOL, who would have thunk? If you become the only buyer, you affect the price. Then you can't get out without collapsing the price, and eventually you have to buy just to support it.

Popo's picture

This is why the Fed won't be buying traditional paper.  We'll see a serious focus on equities and junk bonds next.   Of course, the problem will only compound as the Fed will find themselves 'stuck' in new asset classes with no ability to exit positions without collapsing markets.

The Fed can buy whatever they want.  Bernanke's initial "helicopter" thesis still stands.  The only thing that will stop Bernanke is oil.   (Not food).  America is capable of food self-sustenance, but America is still the biggest oil importer in the world.  It's the thorn in his side and it's eventually going to be the raging bull-cock tearing up his rear end.



BigJim's picture

As long as OPEC's leaders keep accepting USD, the US will be fine.

And as long as THEY keep accepting USD, they'll be fine, with the US doing everything in its consideable power to keep their reign intact.

Terrorist's picture


There are plenty of European bonds left to buy.

Squid Vicious's picture

That is f'in brilliant ... the Shalom should announce a merger of the Fed and ECB, call it Bank of the NWO... no wait,maybe something more palatable...and then he can buy whatever PIIGS paper he wants... and of course some domestic MBS just to keep it kosher...

MiltonFriedmansNightmare's picture

Merger?  Brilliant...

I doubt the shepple would even utter a bahhh, bahhhh...

101 years and counting's picture

we just need to step up issuance of 10-30 yr bonds.  Maybe O can get a $2 trillion stimulus thru and the fed can monetize all that.  Problem solved.

BooMushroom's picture

Just have them take a voice vote. It worked out great at the DNC.

"As president, I hearby affirm that the 2/3 vote required has been met. The new debt ceiling is hearby 10x10^100, and the constitution and bill of rights have been suspended. A new era of peace and prosperity has begun!"

Dr. No's picture

I cant figure out which I like better, thr DNC method of revoting until you get the results you want or the RNC method of makinng the decision, then have a vote just to try to add legitimacy to the decision.

MiltonFriedmansNightmare's picture

2 trillion stimulus?  Krugman just came at the thought.

midtowng's picture

Those are amazing charts. Tyler should add in the chart showing the hundreds of billions of dollars worth of MBS the Fed already owns.

NewWorldOrange's picture

"But Tyler's math doesn't count. Only our maths do. And our maths are based on simple math: i^2 = -1"

   -- Central Banker

HarryM's picture

The even bigger question


When will it be safe to short again?

lewy14's picture

Never. Next question?

vast-dom's picture

math huh? in other news 

Minnesota bank is year's 41st U.S. bank failure


hey Ty lets get a nice infographic of this year's vs. last 6 years bank busts? i guess TBTF requires a kind of collusive oligopoly and that's precisely what they're getting!


here is some more math (links show charts!):


and a little more math -- scary:

Atomizer's picture

Math is for Terrorists

LOL. The carpet munching squad has us scheduled to attend math thoughtcrime rehabilitation classes. Just think about the revenue stream cash cow. In Detroit.. you can now pay to put out fires.

Tourists paying to help fight Detroit's fires: Is this idea for real?





Hype Alert's picture

It's the anticipation more than the delivery.  I forget how many times the market has rallied on the same anticipation, but it can't be endless.  The game is about over.


It's like the ponzi that worked until there were no players left to get in.  It's just amazing that so many talk like it can continue.

SeverinSlade's picture

Precisely.  And Bernanke is well aware of this (as are all CB heads).  Hence why we get non-stop jawboning.

I still believe that formally announcing QE3 will signal the end of the dollar.  Won't happen overnight obviously, but the clock is ticking.  China isn't going to wait around until QE4, QE5, etc. to dump the USD and announce their ACTUAL gold holdings. 

iDealMeat's picture

Not so sure about that..  China probably figures they'll never get paid back..  So they BTFD on gold and silver with both hands. 

Then they'll encourage QE N+1.



trebuchet's picture

Yep  - BOJ  are very pleased for a GROWING foreign Reserve despite their dirty floating currency.... 




China maybe looking to do the same thing - they are now in a position to let their Yuan appreciate a bit  cos their foreign reserve position is protected with their recent gold binge) ... opens up some monetary policy options a BIT


Mary Wilbur's picture

Putin is also buying gold with both hands.