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Has The Fed, In Its Stealthy Synthetic Bet To Keep Long-Term Yields Low, Become The Next Aig?

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http://www.zerohedge.com/article/did-fed-its-stealthy-synthetic-bet-keep-yields-low-become-next-aig

When looking back at the Great Financial Crisis of 2008, the primary catalyst the pushed the system over the edge and required central banks around the world to institute a global bailout of unprecedented scale was one simple thing: the layering upon layering upon layering of bets (using "other people's money" and courtesy of recently unleashed "financial innovation" in the form of virtually margin-free securities such as credit derivatives, demonstrated best by this chart) that interest rates would keep dropping, primarily in the form of exponentially tiered credit structures such as synthetic CDOs (all the way to the cubed degree) together with CDS sold on such layered synthetic derivatives. Of course, when the black swan event occurred and rates surged, this relentless leveraging of wrong-sided bets promptly resulted in the liquidation of any institution that was on the wrong side of such bets. Most notably AIG. In essence, AIG took the "logic" that since a rate blow up would likely result in the collapse of the US (and thus worldwide) funding structure, it would invoke the biggest central bank Put of all: either the Fed would rescue the world, or capitalism as we knew it would end.

As it turned out, AIG was right, and following the sacrifice of Lehman Brothers, every other institution on the wrong side of the levered "rate" trade was saved by the Fed. But at what price? Simply said, the Fed, in bailing out the world (a meme that has only now received popular acceptance following the release of formerly classified Fed documents, despite our claims precisely to that end from back in October 2009) has become the world's largest hedge fund and with a DV01 of over $1.5 billion by now, has taken on virtually unlimited interest rate risk (a topic discussed back in April 2010). As such controlling inflation expectations, or more specifically, Long-Term rates (the part on the curve that Quantitative Easing is powerless to control) is the most critical aspect of the viability of the monetary system. Stunningly, today we learn that to keep long rates low, the Fed may have resorted to nothing short of the same suicidal trade that destroyed AIG FP and brought the entire system to its knees. Namely, Ben Bernanke is now quite possibly the second coming of Joe Cassano, since in order to keep rates low, Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low contrary to natural supply-demand mechanics. If so, the Fed is now basically AIG Financial Products, although instead of being synthetically long mortgages (and thus betting on a rate decline) and selling hundreds of billions in CDS to amplify its bet, Bernanke has done the same thing, only this time with Treasurys. Of course, Ben has the printing press on his side apologists will claim. Alas, that will have no impact whatsoever, if indeed the Fed has been reduced to finding ever fewer counterparties to a synthetic bet to keep long-term rates low, as very soon, with inflation ticking up, all hell may break loose in an identical replay of what happened to AIG once the Fed's put is called against it. Only this time there will be nobody to bail out the ultimate backstopper, resulting in the long overdue end of the current failed monetary system experiment.

Some may recall that over a year ago we made a curious discovery: by looking at the composition of securities held in the Fed's Maiden Lane I portfolio (than inherited from the collapse of Bear Stearns, which not even JP Morgan wanted) we uncovered that as part of the portfolio of toxic assets, which most recently was valued at $25.6 billion, the risk managed in charge of the book BlackRock had also put on a variety of synthetic hedges: "the FRBNY holds 5000 TYM0 puts, 3825 TYH0 puts, short 4000 FVH0, short 7828 TYH0, short 2240 USH0, and is short a bunch of eurodollar positions." The issue as we correctly specified, is that "while the Fed is pretending to care about interest rate concerns in an increasing rate environment and is hedging ML1, it has one billion DV01 risk for its house bailout package...This is a stunning number: the second rates commence creeping higher, you can kiss all that profit on TARP and what not not only goodbye, but the losses on the SOMA books will likely destroy America." We then concluded: "the Fed has decided to protect against a major hike in rates [in the Maiden Lane I portfolio]. Yet that which is truly relevant, the Fed's nearly $2.4 trillion in holdings of MBS, Agency and Treasuries is completely unhedged [the number is now $2.7 trillion and will be nearly $3 trillion by the time QE2 ends]. Good luck finding the counterparty that would be willing to put on a $200 trillion gross notional interest rate swap with the Fed." In other words, we were wondering why is the Fed not actively hedging its multi-trillion SOMA portfolio (including MBS, Agencies and Treasuries) if it was willing to do so with the far smaller Maiden Lane I subsegment of its holdings. Naturally, it may well have been doing so as there is no place in the Fed's weekly report (H.4.1) update that lists explicit derivative positions (more on this in a second). Ironically, it seems that we had the entire situtation backwards: it appears that far from being worried about hedging its SOMA book synthetically, the Fed may well have be constantly doubling down on its risk exposure in the form of off-book derivative contracts in order to "pin" Long-Term rates (read the 10 Year) by constantly selling Puts on Long Dated Treasurys at opportune times when there is no incremental buying of the underlying security, yet when, as the CDO and upcoming ETF debacles have so well demonstrated, the price of the derivative actually impacts the price of the underlying!

There's a lot more on this at Zerohedge see the link.

Unlike AIG which didn't have a magic printing press the Fed does. Plus unlike AIG which could go bankrupt the FED can't ever go bankrupt.

http://ftalphaville.ft.com/blog/2011/01/20/464471/the-fed-cant-go-bankrupt-anymore/

Earlier this month the central bank made a subtle change to its accounting methods. One that might make it impossible for the Fed to show capital losses.

The timing of the move was probably not coincidental, either.

No wonder the Fed did this, the risks it had taken on could have crippled it. Now with a bit of fancy accounting it can take what ever risks it likes....

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FED changes accountancy rules, JP Morgan becomes a COMEX house so it can make delivery of its Silver contracts - delivered to itself of course since it's now a COMEX house.

The frauds are not even attempted to be hidden any longer...

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http://www.zerohedge.com/article/did-fed-its-stealthy-synthetic-bet-keep-yields-low-become-next-aig

There's a lot more on this at Zerohedge see the link.

Unlike AIG which didn't have a magic printing press the Fed does. Plus unlike AIG which could go bankrupt the FED can't ever go bankrupt.

http://ftalphaville.ft.com/blog/2011/01/20/464471/the-fed-cant-go-bankrupt-anymore/

No wonder the Fed did this, the risks it had taken on could have crippled it. Now with a bit of fancy accounting it can take what ever risks it likes....

Fed will only go down (or be bailed out by the Treasury by authorising it to print) if the securities are defaulted. The Fed has a 0.25% (and it gets to alter that to any number,

including -0.1% if it likes) funding cost while AIG FP obviously have a much higher funding cost.

The only consequences of Fed doing stupid thing is inflation as it puts too much of the electronic green back into the system.

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If the Fed buys an asset for the market value, but it subsequently loses value.. then the fed 'loses' money on paper on that asset. If that asset had remained in private hands and lost the same value, then that amount of money would have been erased from the system. Instead with the Fed having paid the original market price, that money is still circulating in the system.

So far the Fed is taking the income stream from the assets it bought and remitting the profits to the US Treasury. Last year it was very large, something like 80 billion dollars dividend. Because the Fed's balance sheet has expanded from around 800 billion at the start of the crisis to 2,500 billion now. QE 2.0 will take it to 3,000 billion. My own estmate is it will have to go over 10,000 billion in order to stabilize the system.

If inflation does start picking up, the fed can sell assets back into the market place, which pulls that money out of circulation. Or it can increase interest rates which will slow down the rate of increase of private debts in the fractional reserve system. The Chinese central bank also adjusts the reserve requirement, which western governments haven't been willing to do.

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If the Fed buys an asset for the market value, but it subsequently loses value.. then the fed 'loses' money on paper on that asset. If that asset had remained in private hands and lost the same value, then that amount of money would have been erased from the system. Instead with the Fed having paid the original market price, that money is still circulating in the system.

So far the Fed is taking the income stream from the assets it bought and remitting the profits to the US Treasury. Last year it was very large, something like 80 billion dollars dividend. Because the Fed's balance sheet has expanded from around 800 billion at the start of the crisis to 2,500 billion now. QE 2.0 will take it to 3,000 billion. My own estmate is it will have to go over 10,000 billion in order to stabilize the system.

If inflation does start picking up, the fed can sell assets back into the market place, which pulls that money out of circulation. Or it can increase interest rates which will slow down the rate of increase of private debts in the fractional reserve system. The Chinese central bank also adjusts the reserve requirement, which western governments haven't been willing to do.

1. The USTreasuries can't 'lost' value if held to maturity. The total interest collected + principle payment will always > price paid. (though this is left hand paying the right hand )

The MBS are a different story, of course.

2. In theory, Fed has a capital (don't know how much, BoE has about £5bn) and the securities have to be marked to market. So, if the 'lost' at a particular time > Fed's Capital,

technically, the Fed is bust. If they don't tell anyone about it, they will be allow to hold them to maturity. Otherwise, we will have the UST selling securities to the Fed to

get new cash, and then the UST will buy capital instruments (e.g. more 'shares) from the Fed and hence 'recapitalise it' (it is just money printing merry go round).

3. It is not go go 2007 but the system has already stabilised. Printing 10T..... think that is a bad idea.

4. Not Western government not willing to raise 'reserve requirement'. There is no reserve requirement in some Western banking system (e..g UK). UK thinks Basel Tier 1

capital is a better measure (so the banks can load up AAA toxic securities...)

In the United States the required reserves, also called the liquidity ratio, is set by the Board of Governors of the Federal Reserve System. Requirements vary based upon the size (in total amount of transactions) of the depository institution. For institutions with up to $10.7 million, there is no minimum reserve requirement. Institutions with over $10.7 million and up to $55.2 million in net transaction accounts must have a liquidity ratio of three percent. Institutions with more than $55.2 million in net transactions must have a liquidity ratio of 10%.

The Bank of England holds to a voluntary reserve ratio system, with no minimum reserve requirement set. In theory this means that banks could retain zero reserves, effectively allowing an infinite amount of credit money creation. However, in practice the average cash reserve ratio across the entire United Kingdom banking system is higher, with a 3.1% average as of 1998.

5. Can sell asset, and will sell asset are two different things. Fed's policies are not symmetric on deflation vs inflation.

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Unless I am mistaken, America still has the global military hegemony, by a HUGE margin.

Ultimately, America can do whatever it wants, for as long as they can keep their empire afloat at home. The FED still, and will be their de-facto currency issuer, unless America once again slips into revolution.

If that means inflating their currency into the stratosphere and effectively nullifying the value of foreign interests US treasuries, so be it. If it also mean militarising their economy (oops, silly me haha) then so be it.

Some would call that an act of war. Gee, how many Americans are on foreign soil, waging war at the moment, and where are they?....

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Fed will only go down (or be bailed out by the Treasury by authorising it to print) if the securities are defaulted. The Fed has a 0.25% (and it gets to alter that to any number,

including -0.1% if it likes) funding cost while AIG FP obviously have a much higher funding cost.

The only consequences of Fed doing stupid thing is inflation as it puts too much of the electronic green back into the system.

Yep - increasingly the Fed is just a money-printing bailout machine for the chosen few on Wall St. with the public (around the World, not just in the US) paying the price through debasement of the currency.

The ultimate price will be a collapse in the credibility of fiat currency. Only a matter of time before clever people figure that they can either work their behinds off to produce goods/ provide services to make money ... or they can get into a cushy cartel where money is magicked out of thin air to allow the members to become rich, at everyone else's expense.

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  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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