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Thread: US FED versus the Hunt Brothers !

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    Default US FED versus the Hunt Brothers !

    (snip)"The Federal Reserve's Market Corner Is Over
    by Daniel Aaronson and Lee Markowitz

    We previously wrote that the Federal Reserve's (Fed) quantitative easing program [ i.e. a deliberate program where the FED 'purchased' mortgage paper, corporate paper, etc. - sic ], aimed at driving fixed income asset prices higher and long-term interest rates lower, was a market corner similar to that of the Hunt Brothers' attempt with silver (). Given that all market corners eventually fail, the Fed's corner will as well, if for no other reason than that the Fed clearly laid out its strategy for entering and exiting the market. In contrast, during the Hunt's corner, market participants could only guess when the Hunts would exit the market.

    The effectiveness of the Fed's corner is already in doubt as long-term interest rates rose during the entirety of the Fed's purchase program and recently hit new cycle highs. This means that the Fed already has losses on its holdings. Should long-term interest rates increase further the Fed will generate even greater losses. This could lead the market to question the Federal Reserve's solvency, which would dwarf the consequences of higher interest rates on an already weak housing market and heavily indebted Government."(snip)

    (snip)"While most investors and commentators concentrate on the impact that higher interest rates will have on the housing market and US government finances, the mark-to-market losses of the Fed is a much more important issue because they can undermine the Fed's credibility and raise concerns about insolvency. Some investors will argue that the Fed has the ability to hold the recently accumulated securities to maturity. However, this is irrelevant if the market begins to focus on the Fed's losses as it did with Bear Stearns and Lehman Brothers.

    The Fed's asset purchases have increased its leverage. Measuring the Fed's leverage by its equity/assets ratio and adjusting it for the current market value of its gold holdings, the Fed's leverage has deteriorated from nearly 20% in 2007 to 13% today (its assets/equity ratio has grown from 5x to over 7.5x) (Figure 6). If the Fed's assets were to fall by 13%, the Fed's equity would be wiped away. Importantly, a 13% decline in asset values is foreseeable. For example, if 10-year Treasury rates rise from 4% to 5.5%, the Fed would lose over 10% on its 10-year notes. Moreover, a 1.5% increase in 30-year mortgage yields would lead to a greater than 20% loss on its 30-year mortgages."(snip)



    (snip)"Those who are not concerned about the negative consequences of money printing will argue that the Fed's solvency can never be questioned because of its ability to issue new Dollars to offset its losses. However, markets are unrelenting when the question of solvency is raised. When the Fed's solvency becomes a concern to markets, it will already be too late as the Dollar will be in freefall. The issuance of even more Dollars will be ineffective in restoring the market's confidence in the Fed.

    The Fed's massive buying spree has fueled the ascent of most asset markets. While the rise in asset prices was likely the Fed's goal, the method used to achieve its goal will result in a disastrous outcome. Given that all corners fail, the Fed's attempt to corner the fixed income market will as well. Although investors are euphoric over rising stock and bond prices, sentiment will change when the Fed suffers the same fate as the Hunt Brothers."(snip)

    from


    Perhaps a bit of additional explanation is in order to aid in understanding the authors' points. The FED's long standing history was of the FED holding only 'hard' assets ... such as US Treasury bonds, gold and silver, etc. ... which had an underlying true value that was arguably as solid as values get. However, as part of the 'bailout' program, the FED began selling off 'hard' assets ( on top of printing up dollars out of nowhere) and used the proceeds, for the first time in recent history, to purchase instruments of less solid value. These instruments range from Fannie/Freddie bundled mortgage bonds, to Fannie/Freddie direct debt paper, to other bundled bonds based on car loans, credit card loans, business loans, and who knows what else ! These unprecedented purchases did achieve the 'short term' goals of keeping some amount of mortgaga / car / credit card / business credit available, as well as shifting risk away from the Wall St. banks that formerly held these bundled bonds and debt paper, while at the same time keeping interest rates lower than they otherwise might have been.

    However, 'junk bonds' are still junk and bad debt paper is still bad even if owned by the FED. And the market value of any bond / debt paper is inversely proportional to current market interest rates. As such, the FED now faces a huge risk of losses as market interest rates rise. The author's first major point is that given the number of 'junk bonds' now on the FED's balance sheet, and the leverage the FED has employed, it is entirely possible that the FED could be rendered bankrupt if interest rates rise any significant amount, due to principal value losses on its 'junk bonds'. The authors' second major point is that the ONLY alternative left open to the FED to avoid bankruptcy would be shifting the US Dollar printing presses into overdrive in order to 'paper over' its 'junk bond' losses. The author's third and most important point is that, if and when the international community gets a whiff that the FED may be bankrupt, they will start liquidating their US dollar denominated assets and running for the exits ... which will crash both the US stock and bond markets, drive market interest rates sky high, and trash the US Dollar's exchange rate value.

    During the Hunt Brothers' famous market corner on silver, the losses experienced when the price of silver collapse were llimited to silver investors. Unfortunately, if the FED's market corner on non-treasury bond / debt paper collapses, every American will experience losses !

    ~
    Last edited by Melonie; 04-10-2010 at 06:01 AM.

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