Thursday, January 6, 2011

Bond Losses

A recent letter from Larry Levin.

Bond Losses

dollar zero

More encouraging economic data this morning in the way of the ADP jobs report and the non-Manufacturing ISM Index sent bonds down and equities higher.  Investors seem to be exiting bond positions and entering stocks.
For those investors who chased the bond bubble and bought late, the current decline in bonds is killing them.  When bond prices drop, yields increase. Therefore, a Treasury with a lower interest rate (that was purchased over the last few months) is worth less today than when purchased.  After all, who wants to buy an older lower yielding investment when a fresh government IOU today yields more?  
Surely there has been a lot of investor demand for Treasuries, but nobody has had as voracious an appetite as the Federal Reserve.  Remember that via POMO and QE2, your Federal Reserve Bank is taking the potential losing Treasury investment off of the books of the TBTF banksters…and giving a guaranteed loss to you, the taxpayer.  How very nice of the Fed.  It is hard to imagine ANY situation in which the Fed actually lost money in the end (because it can probably just declare “do over” and say the losing securities no longer exist. Who’s going to audit it – Congress?) but if it did lose money, the taxpayer will be on the hook.
Since Benny & The Inkjets have been monetizing near 100% of every Treasury auction for months, it owns a great deal of these securities.  So what happened to the value of its holding?  Oh yeah, it’s bad.  It is estimated that the Fed lost $10-BILLION today alone!
Zero Hedge has this to say…
The ongoing collapse in bond prices is making John Meriwether blush with envy at the wholesale wanton destruction of capital undertaken by Ben Bernanke. Keep in mind LTCM - the organization which proved definitively that Nobel prizes in economics are given only to the most consummate destroyers of value, logic, reason and humility - lost "just" $4.6 billion from its peak before it became the biggest systemic risk in the world back in 1998 and had to be rescued by a consortium of banks. The bottom line: with about $10 billion in SOMA losses today alone, Ben Bernanke has generated more than double the losses that nearly destroyed western finance 13 short years ago. And nobody cares.
John Lohman explains:
Chairman Top Tick continues to crash and burn, losing $7.2 billion in Treasury and Agency paper in today’s bloodbath alone.  Adding a rough estimate for the MBS holdings would put the session’s losses well over $10 billion.  Indeed, a baker’s dozen of John Meriwethers couldn’t destroy this much capital in such a short period of time.

And with all of the usual caveats that accompany a simple modified duration analysis (ignoring convexity, assuming instantaneous parallel shifts, etc.), the table below estimates the Fed’s losses for various upward interest rate shocks.  Again, keep in mind this 
does not include the massive MBS portfolio, which is extending in duration with every uptick in rates.

Soooooo…what will the Fed do?  If it sells its securities back to the banksters, the Fed loses a fortune (and this slide has just begun).  If the Fed holds the Notes & Bonds to maturity (I highly doubt it), it will receive its capital in full from the Treasury department BUT, the banksters will still have all that cash.  The Fed will not have “sopped up” the liquidity.  That money will eventually reach the economy and the inflation will be breathtaking.  The money the Fed will receive from the Treasury will be in devalued dollars so it loses money either way.  What’s more, the higher interest will absolutely annihilate the government’s ability to run the country.  At the current trajectory, the US debt will be near $20-Trillion in just five years and the interest payments will become unbearable.

Then again, since the Fed creates money out of thin air; can it really lose money it hasn’t earned?  It never existed before the Treasuries were purchased so why would the Fed care if it sold the securities for a loss if that would sop up the massive liquidity?  The Ben Bernank will just take the golf pencil out of the bag – the one with the fat eraser – and erase all of the necessary places on the balance sheet that it doesn’t like.  Poof, it’s gone!

One thing’s for damn sure: no matter the process, it will make bankers a great deal of money and you a LOT POORER.

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