Fed Watch Thread

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www.zerohedge.com/article/massive-primary-dealer-year-end-window-dressing-key-reason-recent-bond-sell

Is Massive Primary Dealer Year-End Window Dressing A Key Reason For The Recent Bond Sell Off?
Submitted by Tyler Durden on 01/10/2011 09:00 -0500

Across the CurveBill DudleyLehmanNew York FedPOMO


Ever since Repo 105 (and long before that), it has been well-known that Primary Dealers enjoy padding their books before the end of every quarter, typically collapsing their asset holdings in the week just before the quarter end in order to have cash on the books, and to make their capitalization ratios appear better than they really are. Well, the "book padding" that just occurred in Q4 2010 was a doozy, with total PD asset holdings plunging by a stunning $126 billion in the past month, the bulk of which was due to a drop in PD holdings of Treasurys. Was this huge selling by the Primary Dealer community, either for window dressing reasons, or due to expectations of future increases in Treasury yields, one of the main reasons for the drop in bond prices? It is unclear, but the massive selling certainly has not helped. And now that window dressing is again over for at least three more months, PD holdings can only go up (or so the myth goes). So with PDs now back with fresh books for 2011, and once again lifting offers, is the sell off in bonds about to be replaced with a major buying spree?

Using New York Fed data, we have compiled weekly Primary Dealer holdings for all of 2010 (and going much further back). The window dressing observations are stunning, and shows that regardless of the short-term scandal over Repo 105, banks continue to pursue short-term book padding strategies. And in Q4 the difference from the peak in asset holdings, attained on November 24, when PDs accounted for $368 billion in total asset, to the drop, which as always just so happens was on the last day of the quarter, was a massive $127 billion, to a low of $241 billion.

The chart below shows total Primary Dealer holdings on a weekly basis, with the EOQ/EOY holdings highlighted in red:



The selloff was particularly evident in Treasury holdings, both Bill and Coupon. The chart below, which shows seggregated and total UST holdings by PDs speaks for itself:



From a weekly fund flow perspectve, the sell off was pretty much across the curve:



For those who want tabular detail, here are all the weekly PD holdings across all disclosed asset classes (equities, of course, are those that get goosed the most courtesy of POMO; these however are never disclosed as they are irrelevant for Fedcollateral purposes, until, of course we have another Lehman, and PDs pledge bankrupt stocks at 100 cents on the dollar with Bill Dudley).



What is notable in the chart above is that PDs year end comnbined holding position is only $22 billion higher than its was at the beginning of 2010, mostly due to an increase in MBS ($16 billion) and Coupons ($15 billion). What is troubling is that PDs actually closed 2010 with a $6 billion lower total position in corporate bonds compared to the start of the year. And this occured in a year in which corporate bonds closed at nosebleed levels, and saw tons of buying by hedge funds and retail. At least we now know who was dumping the hot grenades to the greater corporate bond foolds.

But probably the most dramatic chart is the one showing quarterly window dressing, together with quarter minimum and maximum holdings by PDs. That we closed at the lows as now traditional is not surprising. After all there is window dressing to be done. What is more troubling is that the closing Q4 level was the lowest close in all of 2010, and in fact the closing print of $241 billion was last seen back on December 30, 2009, when total holdings were $218 billion (only to increase by $34 billion in the next week).



Bottom line, now that the PD books are clean, look for PDs to start buying up all the bonds that retail and all other greater fools are finally selling after accumulating for one year, as the primary dealers reestablish much lower cost-bases. It also means that PDs will now be a bullish impact on bond prices. We are curious how this will be reconciled with the Fed's endless POMO machine, which demands that PDs flip at least half of their holdings in the Fed's endless quest for monetization

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Bernanke/Senate to States: Buzz Off! - Or Not?
Submitted by Bruce Krasting on 01/10/2011 11:47 -0500

Bankruptcy CodeBen BernankeFederal ReserveJohn CornynKent ConradMeredith WhitneyMuni BondsReality


Our boy Ben B met with senate leaders last week to discuss the sorry state of the States. It looks like all talk and no action, so far. I wanted to write about the non-event to have a record. When Ben reverses course later this year I will be able to point to this weekend’s comments and say, “I told you so”.

The setting was a hearing of the powerful Senate Budget Committee. The Chairman is Kent Conrad (D-ND). Last I heard ND has no muni problems, but it was pretty clear that this group of Senators were well informed on the issues that cities, towns, counties and states are facing. Senator Conrad: (Link to Bond Buyer story)



We’re talking about a significant problem here. We need to be prepared with a plan in case we are approached by one or more states.”

A “plan? What plan? From Senator Joe Manchin (D-WV)



“20 to 30 states could be in serious problems”

Jeepers! 30 States Joe? Senator Manchin sounds like he is more bearish than Meredith Whitney. John Cornyn (R-Tex) added to the sense of concern. From a spokesman:



“Senator Cornyn is exploring ways to address the state financial crisis, including amendments to the bankruptcy laws”

BK? A State? What is that about? Is this the "plan"? A state bankruptcy has not happened in more than 100 years. Chairman Conrad summed it up:



His panel needs to come up with a plan to help states that approach Congress seeking assistance because of serious financial troubles.

We all know that munis across the country are in the crapper. That said, I was surprised at some of the hard language. Normally these folks don’t talk like this. I am thinking, “What do these guys know that I don’t?” “Why is there a need to revise the bankruptcy code to facilitate Municipal default?” The answer to those questions can be found in the words from the committee and comments from Bernanke. D.C. Inc is not throwing any life-lines to the sick states. Senator Conrad:

“I don’t think the House or the Senate are going to be very interested in bailouts to states.”

“Not interested in a bailout?” The understatement of the new year (so far). But the real interesting stuff came from Bernanke. He says he is not going to be there if the States need some of that fast cash he is providing to the federal government with QE.



“We have no expectation of intention to get involved in state and local finance”

That’s nice to hear. But my concern is that Bernanke seems to be in denial as to the extent of the problems with munis. In his world if the S%P is higher then all must be well in the economy. When asked if there could be a problem in muni land he responded:



“We don’t at this point see anything of that magnitude happening.”


“State and local governments have the tools to deal with their fiscal problems and debt”


“The municipal bond market currently seems to be functioning reasonably well”

Huh? Not a big deal? States can handle it, no problem? Muni market doing just fine? (what the hell was December?) Ben is not concerned about this as he is flooding the markets with liquidity. He thinks liquidity is the solution to solvency:



“The bottom line is that there is a lot of liquidity in the muni bond market and it seems to be doing okay.”

Bernanke went on to confirm that EVEN IF NECESSARY the Fed could not intervene. Apparently it is against the rules:



“I don’t think the Federal Reserve has the authority and I don’t think it would be appropriate for us to do that”

The message I get is that (a) Ben is in denial and his hands are tied and (b) Congress is not going to lift a finger to help out the states. An interesting state of affairs.

Wait a minute. That is not how things are done in the USA. When there is a need, we bail! Right? We have already spent a few Trill doing that. I mean, do "they" think that saving Citi a few years ago is more important than saving California or NY in 2011? Let’s put it this way, if Cali goes down it will bring a dozen states with it. This would be a situation far worse than anything that we saw in 08.

When push comes to shove (it will) Cali/NY are going to prove once again that they send more tax dollars to D.C. than they get back. That fact is going to be impossible for Washington overcome. The bailouts that the Fed doesn’t see as necessary and congress doesn’t want to touch will happen. It has to. The reality is that Ben does see the problem and congress knows that it will HAVE to get involved. They admitted as much with this exchange:



Senator Conrad
“Maybe there are ways to help with creative financing.”


Chairman Bernanke
“We do have the authority to buy very short-term municipal debt”


Tell me again why I should be rushing out to buy some long-term muni bonds?

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Less Than 24 Hours After My Warning Of Extensive Legal Risk In The Banking Industry, The Massachusetts Supreme Court Drops THE BOMB!
Submitted by Reggie Middleton on 01/10/2011 13:01 -0500

BACCREFree MoneyGoldman SachsInstitutional InvestorsInsurance CompaniesJohn PaulsonMerrill LynchMorgan StanleyMortgage Backed SecuritiesMortgage LoansReal estateReggie MiddletonSecurities FraudTARP


The day after I posted “As JP Morgan & Other Banks Legal Costs Spike, Many Should Ask If It Was Not Obvious Years Ago That This Industry May Become The “New” Tobacco Companies” wherein I made clear my opinion that the legal and litigation risks that the banking industry faces is woefully underestimated, the Massachusetts Land Court Decision that invalidates foreclosures based on post sale assignments was up held by the Massachusetts Supreme Court. This is permanent, and precedent setting, absolutely justifies and vindicates my post from the day before, which also contained links to other posts which any declared sensational just a few days before, ex., The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! and As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves. This is a very big deal since it actually unravels many thousands of foreclosures and sets precedent to be examined across the country (all 50 state’s attorney generals are looking into fraudclosure issues) that will really cause material damage to the banks that are pursuing (have pursued) said foreclosures. As reported in the Massachusetts Law Blog:

Breaking News (1.7.11): Mass. Supreme Court Upholds Ibanez Ruling, Thousands of Foreclosures Affected

Update (2/25/10)–Mass. High Court May Take Ibanez Case

Breaking News (10/14/09)–Land Court Reaffirms Ruling Invalidating Thousands of Foreclosures. Click here for the updated post.

None of this is the fault of the [debtor], yet the [debtor] suffers due to fewer (or no) bids in competition with the foreclosing institution. Only the foreclosing party is advantaged by the clouded title at the time of auction. It can bid a lower price, hold the property in inventory, and put together the proper documents any time it chooses. And who can say that problems won’t be encountered during this process?… Massachusetts Land Court Judge Keith C. Long

“[W]hat is surprising about these cases is … the utter carelessness with which the plaintiff banks documented the titles to their assets.” –Justice Robert Cordy, Massachusetts Supreme Judicial Court

Today, the Massachusetts Supreme Judicial Court (SJC) ruled against foreclosing lenders and those who purchased foreclosed properties in Massachusetts in the controversial U.S. Bank v. Ibanez case…

… For those new to the case, the problem the Court dealt with in this case is the validity of foreclosures when the mortgages are part of securitized mortgage lending pools. When mortgages were bundled and packaged to Wall Street investors, the ownership of mortgage loans were divided and freely transferred numerous times on the lenders’ books. But the mortgage loan documentation actually on file at the Registry of Deeds often lagged far behind.

In the Ibanez case, the mortgage assignment, which was executed in blank, was not recorded until over a year after the foreclosure process had started. This was a fairly common practice in Massachusetts, and I suspect across the U.S. Mr. Ibanez, the distressed homeowner, challenged the validity of the foreclosure, arguing that U.S. Bank had no standing to foreclose because it lacked any evidence of ownership of the mortgage and the loan at the time it started the foreclosure.

Mr. Ibanez won his case in the lower court in 2009, and due to the importance of the issue, the Massachusetts Supreme Judicial Court took the case on direct appeal.

The SJC Ruling: Lenders Must Prove Ownership When They Foreclose

The SJC’s ruling can be summed up by Justice Cordy’s concurring opinion:

“The type of sophisticated transactions leading up to the accumulation of the notes and mortgages in question in these cases and their securitization, and, ultimately the sale of mortgaged-backed securities, are not barred nor even burdened by the requirements of Massachusetts law. The plaintiff banks, who brought these cases to clear the titles that they acquired at their own foreclosure sales, have simply failed to prove that the underlying assignments of the mortgages that they allege (and would have) entitled them to foreclose ever existed in any legally cognizable form before they exercised the power of sale that accompanies those assignments. The court’s opinion clearly states that such assignments do not need to be in recordable form or recorded before the foreclosure, but they do have to have been effectuated.”

The Court’s ruling appears rather elementary: you need to own the mortgage before you can foreclose. But it’s become much more complicated with the proliferation of mortgage backed securities (MBS’s) –which constitute 60% or more of the entire U.S. mortgage market. The Court has held unequivocally that the common industry practice of assigning a mortgage “in blank” — meaning without specifying to whom the mortgage would be assigned until after the fact — does not constitute a proper assignment, at least in Massachusetts.

This is a very interesting development, and I would like to make note that the buck stops here since this is Supreme Court. I normally do not excerpt or quote this much of another blog or news source, but since the content is legal in matter and this particular blog (Massachusetts attorney) appears to have put a strong legal analysis on the topic, I will continue. I urge others to visit the Massachusetts Law Blog for more info. Back to his write-up…

•Despite pleas from innocent buyers of foreclosed properties and my own predictions, the decision was applied retroactively, so this will hurt Massachusetts homeowners who bought defective foreclosure properties.
•If you own a foreclosed home with an “Ibanez” title issue, I’m afraid to say that you do not own your home anymore. The previous owner who was foreclosed upon owns it again. This is a mess.
•The opinion is a scathing indictment of the securitized mortgage lending system and its non-compliance with Massachusetts foreclosure law. Justice Cordy, a former big firm corporate lawyer, chastised lenders and their Wall Street lawyers for “the utter carelessness with which the plaintiff banks documented the titles to their assets.”
•If you purchased a foreclosure property with an “Ibanez” title defect, and you do not have title insurance, you are in trouble. You may not be able to sell or refinance your home for quite a long time, if ever. Recourse would be against the foreclosing banks, the foreclosing attorneys. Or you could attempt to get a deed from the previous owner. Re-doing the original foreclosure is also an option but with complications.
•If you purchased a foreclosure property and you have an owner’s title insurance policy, you have a potential claim against the title policy. Contact our office for legal assistance.
Here he puts in some self promotion, but hey… I’m one to talk. I actually appreciate the legal analysis and am glad to have him offer services in the arena.

•The decision carved out some room so that mortgages with compliant securitization documents may be able to survive the ruling. This will shake out in the months to come. A major problem with this case was that the lenders weren’t able to produce the schedules of the securitization documents showing that the two mortgages in question were part of the securitization pool. Why, I have no idea.
•The decision, however, may not prove to be anywhere near the Apocalypse it’s been hyped to be. The Court said that “[w]here a pool of mortgages is assigned to a securitized trust, the executed agreement that assigns the pool of mortgages, with a schedule of the pooled mortgage loans that clearly and specifically identifies the mortgage at issue as among those assigned, may suffice to establish the trustee as the mortgage holder. However, there must be proof that the assignment was made by a party that itself held the mortgage.” This opens the door for foreclosing lenders to prove ownership with proper documents. Furthermore, since the Land Court’s decision in 2009, many lenders have already re-done foreclosures and title insurance companies have taken other steps to cure the title defects.
I am not a lawyer and this is not my purview, but things may not be quite that simple. The securititized trust documents themselves have timing issues that may come into play. See the email chain conversation below for more on this topic.

•The ruling may be limited only to Massachusetts and states operating under a non-judicial foreclosure and “title theory” laws. The Court was careful to point out that Massachusetts requires very strict compliance with its foreclosure laws. The reason for that is Massachusetts is a non-judicial foreclosure state–meaning lenders don’t need a court order to foreclose–and that the state operates under the “title theory” which is a fancy way of saying that the bank is really the legal owner of your house.
•Watch for class actions against foreclosing lenders, the attorneys who drafted the securitization loan documents and foreclosing attorneys. Investors of mortgage backed securities (MBS) will also be exploring their legal options against the trusts and servicers of the mortgage pools.
It appears as if he contradicted his statement above. I can practically guaranteed that this significantly increases the risk. volume and velocity of litigation. Think about it. If you were a REMIC investors, would you be sitting pat, or calling your attorney.

•The banking sector has already dropped some 5% today (1.7.11), showing that this ruling has sufficiently spooked investors. (But Merrill Lynch just went on a buying spree on the banking sector–showing that the real experts are betting that this decision and others which will follow will not substantially affect banks’ profitability).
I have absolutely no idea what he means by Merrill Lynch going on a buying spree – actually using their (BofA’s) balance sheet? I seriously doubt so. I also take umbrage to the assertion that Merrill Lynch constitutes a “real expert”(s) in terms of mortgage and real estate valuation and risk assessment, since they “experted” themselves into a near collapse over these very same assets.

Interested parties may download the actual ruling here: Ibanez-Case-JAN-2011. I actually engaged in an interesting email exhange with a BoomBustBlogger over this fraudclosure issue, and would like to share the email chain with the blog.

10/21/10

Reggie,

You see that the various large shoes we were discussing have begun dropping. Multi-billion dollar demands by non-agency bondholders for putbacks, and now the government is being forced to take action. I read elsewhere that a group of hedge funds is organizing for a similar demand. I view with interest the tiny levels at which the banks are reserving against these events in comparison with the present (and probable future) size of the put-back demands. Again, this is only ONE tentacle of the monster.

So far, the putback demands appear to be merely rep and warranty driven, i.e, the failing loans do not meet the underwriting requirements as represented in the prospectus. This does not implicate the REMICs’ tax-exempt status. However, as claims for wrongful foreclosure based on the failure of loans to be properly deposited into trust are proved true — or as the same facts are brought to light by 50 state attorneys general — it will be implicated. This may produce a larger wave of claims by bondholders, both because of the loss of tax structure as represented and warranted, and because the knowing failure to properly deposit the loans (which will be inferred from the systematic extent of the failure) may support securities fraud claims. I will be very interested to see how you quantify the size of the problem for the banks.

1/1/10

Reggie:

… I assume you saw stories on the Mass. Court ruling in Ibanez. The obvious question was, “Why didn’t they just back up and start over after getting the assignments done correctly?” The answer: They had no choice but to either litigate the homeowners into submission or pay the homeowners to go away. They chose the former strategy and it failed. Why did they have those choices? As you and I discussed awhile back: the REMIC. If the loans were not originally assigned to the trust by the deadline, the REMIC lost its special tax status, and the banks were forced into the argument that an after-the-fact assignment had the effect of an original timely assignment (so that, getting a state court to bite on this, they could then go argue the same point to the IRS, i.e., “no harm no foul”). The Mass. Court, to its credit, saw through the bullshit and upheld the rule of law.

The implications of this for the REMICs (actually, the banks that created and sold them) and homeowners going forward are huge. Homeowners can now see the light, and if there’s any question about the ownership of the loan, stick a hot poker in that issue (demand proof of ownership, either directly before litigation or in discovery when litigation has started) until the banks cry uncle, meaning pay through the nose to buy off the homeowners and save the REMIC’s tax status. The banks face the prospect of enormously increased costs, for any of: (a) litigation expenses as this issue becomes harder fought by the homeowners; (b) increased settlement costs as homeowners realize their advantage and demand more pounds of bank flesh to go away; or (c) payments to REMIC investors for losses caused by the banks’ failure to properly assign the loans in the first place. Who’s going to suffer the worst?

Again, JPM et. al. have been much too optimistic in reserving for these occurrences, as clearly detailed in my post As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves. The legal costs looked bad before this decision, as stated in As JP Morgan & Other Banks Legal Costs Spike, Many Should Ask If It Was Not Obvious Years Ago That This Industry May Become The “New” Tobacco Companies and it simply looks much worse now. To think, so called experts wonder why I am bearish on JP Morgan and the big banks…



Please upgrade your browser
… There is no chance for appeal in the Mass case; the decision came from the state’s highest court. This quote from the court illustrates that this was not rocket science; the banks’ lawyers never should have taken the risk of the appeal rather than settling and leaving the record with an unreported trial court decision of much less import:

“The legal principles and requirements we set forth are well established in our case law and our statutes. All that has changed in the plaintiffs’ apparent failure to abide by those principles and requirements in the rush to sell mortgage-backed securities.”

… I agree with everything in your post [“As JP Morgan & Other Banks Legal Costs Spike, Many Should Ask If It Was Not Obvious Years Ago That This Industry May Become The “New” Tobacco Companies”]. I noted someone’s comment about BAC’s settlement with Fannie and Freddie (paying about 2 cents on the dollar to eliminate hundreds of billions of putback claims, a bailout in disguise for which somebody should go to jail). Otherwise, I think the banks differ from the tobacco companies in a couple major respects: (a) they don’t sell an addictive product which may be somewhat economically insensitive; and (b) they don’t have access to overseas growth like the tobaccos do. By failing to adequately reserve and kicking the can, they’re making the end only that much bloodier (or betting on TARP II, III and IV, which may not be a bad bet).

Actually, the banks did have an overseas growth model, the sales of securitized products. One would have thought that that model had come to an end due to the crash and burn effect, alas it has not and the reason is because the banks due sell what appears to be an addictive product.

1.The reach for unrealistically high yields in the case of yield hungry institutional investors such as pension funds. As stated Reggie Middleton vs Goldman Sachs, part 1, For Those Who Chose Not To Heed My Warning About Buying Products From Name Brand Wall Street Banks, and “Blog vs. Broker, whom do you trust!”, Goldman’s peddling of products often spells doom for the consumer (client) and bonus for the producer (Goldman). Goldman is now underwriting CMBS under a broad fund our $19 billion bonus pool “buy” recommendation in the CRE REIT space reference Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off .Now, after all of the evidence that I have presented against the CRE space, who do you think would be better for clients net worth, Reggie’s BoomBustBlog or Goldman? There is also the most recent evidence from just last week: Morgan Stanley Jingle Mail: Loses Properties To John Paulson Investment Consortium & Itself.
2.The satisfaction of the get rich quick(er) urges to be had in their retail, HNW and UHNW clients. A perfect example is the Facebook offering, of which I am preparing an extra special analysis for my blog’s subscribers to be released in a day or two wherein I will show how those Goldman clients are throwing their money into the Goldman bonus pool/Facebook working capital fund abyss – that is if I haven’t demonstrated such already:
◦
■Facebook Becomes One Of The Most Highly Valued Media Companies In The World Thanks To Goldman, & Its Still Private!

■Here’s A Look At What The Goldman FaceBook Fund Will Look Like As It Ignores The SEC & Peddles Private Shares To The Public Without Full Disclosure
■The Anatomy Of The Record Bonus Pool As The Foregone Conclusion: We Plug The Numbers From Goldman’s Facebook Fund Marketing Brochure Into Our Models
Now, back to the email exchange…

The limiting factors on the homeowner side are: (a) an imbalance of knowledge of their options as compared to the banks; and (b) an imbalance of resources ($) to pay lawyers to fight the banks. Although I think the internet and its democratic access to information changes the equation for the first issue, it’s still like retailers selling gift cards – they make money because they know a large percentage of people will stick the card in the drawer and forget about it, and in doing so will have given the retailers free money. Many homeowners who are in position to challenge a foreclosure, and thereby squeeze a bunch of money out of the banks, never will. The $64 question is, how many will?

I have a very strong feeling that many distressed homeowners that read BoomBustBlog can be considered to be amongst that educated elite.

Now there’s a state appellate court decision for every other state appellate court to look to for guidance. Stupid. This is like a case I had in federal court several years ago against the U.S. gov’t. We obtained a ruling imposing estoppel against the gov’t – which is nearly impossible to get. The gov’t did NOT appeal that decision, only the decision granting us fees (which it lost). It avoided an appeal for the same reason – it did not want a Xth circuit decision upholding estoppel against it sitting out there for the rest of the world to model from.

The only logic that I see in the bank’s decision to litigate was that if you pay off one homeowner, you create a pattern where you will end up having to pay off others until it get’s to the point where you will have to litigate the issue to its ultimate conclusion anyway. Hard to say which route would have been more efficient and cheaper, but I do know that this is far from a desirable outcome for the banking industry.

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I'm a bit leery of combining shopping and banking...

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The Fed’s QE2 Traders, Buying Bonds by the Billions
By GRAHAM BOWLEY
Published: January 10, 2011

Deep inside the Federal Reserve Bank of New York, the $600 billion man is fast at work.

In a spare, government-issue office in Lower Manhattan, behind a bank of cubicles and a scruffy copy machine, Josh Frost and a band of market specialists are making the Fed’s ultimate Wall Street trade. They are buying hundreds of billions of dollars of United States Treasury securities on the open market in a controversial attempt to keep interest rates low and, in the process, revive the economy.

To critics, it is a Hail Mary play — an admission that the economy’s persistent weakness has all but exhausted the central bank’s powers and tested the limits of its policy making. Around the world, some warn the unusual strategy will weaken the dollar and lead to crippling inflation.

But inside the Operations Room, on the ninth floor of the New York Fed’s fortresslike headquarters, there is no time for second-guessing. Here the second round of what is known as quantitative easing — QE2, as it is called on Wall Street — is being put into practice almost daily by the central bank’s powerful New York arm.

Each morning Mr. Frost and his team face a formidable task: they must try to buy Treasuries at the best possible price from the savviest bond traders in the business.

The smallest miscalculation, a few one-hundredths of a percentage point here or there, could unsettle the markets and cost taxpayers dearly. It could also embolden critics at home and abroad who say QE2 represents a dangerous expansion of the Fed’s role in the markets.

“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses.

Whether Mr. Frost will reach that goal is uncertain. What is sure is that market interest rates have risen, rather than fallen, since the Fed embarked on the program in November. That is the opposite of what was supposed to happen, although rates might have been even higher without the Fed program.

Mr. Frost’s task is to avoid paying top dollar for bonds that could be worth less when the Fed tries to sell them one day.

Louis V. Crandall, the chief economist at the research firm Wrightson ICAP, said Wall Street bond traders were driving hard bargains. The Fed has tipped its hand by laying out which Treasuries it intends to buy and when, giving the bond houses an edge.

“A buyer of $100 billion a month is always going to be paying top prices,” Mr. Crandall said of the Fed. “You can’t be a known buyer of $100 billion a month and get a good price.”

Nevertheless, Mr. Frost and his team have been praised on Wall Street for creating a simple, transparent program. Neither the Fed nor Wall Street want any surprises. The central bank is even disclosing the prices at which it buys.

Mr. Frost and his team work out of a small, beige corner office with arched windows that used to be a library. There, at about 10:15 most workday mornings, one of them pushes a button on a computer. Across Wall Street, three musical notes — an F, an E and a D — sound on trading terminals, alerting traders that the Fed is in the market.

On one recent Tuesday morning, what Mr. Frost and his five young colleagues did over a 45-minute period might have unsettled even a seasoned Wall Street hand: they bought $7.8 billion of Treasuries.

Mr. Frost and his team drew up the daily schedule for what the Fed calls its Large-Scale Asset Purchase program. And that program is, by any measure, large scale: through next June, these traders will buy roughly $75 billion of Treasuries a month — on top of another $30 billion it is reinvesting in Treasuries from its mortgage-related holdings.

But depending on daily market conditions, Mr. Frost can decide not to buy certain bonds if they are already in short supply.

As offers to sell Treasuries flash on a bank of trading screens, a computer algorithm works out which ones to accept. The computer compares the offers from Wall Street against market prices and the Fed’s own calculation of what constitutes a “fair value” price.

The real work is done by three traders who are referred to during the operation as trader one, trader two and trader three. They sit at a long table against the wall, tapping at seven screens.

On one recent morning, trader one was Tiffany Wilding, 26. While she reviewed the stream of offers and then the prices finally accepted by the algorithm, trader two, Blake Gwinn, 29, double-checked her decisions and trader three, James White, 29, made a duplicate of everything in case the computers crashed.

All the while, Mr. Frost stood behind his colleagues, ready to intervene — and even cancel the Fed’s purchases — at any sign of trouble.

They have their work cut out, trying to outwit the 18 investment firms that deal directly with the Fed. These so-called primary dealers — the Goldmans and Morgans of the world — employ some of the sharpest minds on Wall Street.

Mr. Frost — a Rutgers math grad who has worked at the Fed for 12 years, lives in the Borough Hall area of Brooklyn and takes the subway each day to work — is fairly well known within the dealer community. He and his team talk to the big banks most days.

The job carries great responsibility and is prominent within the Fed. But outside the Fed he and his colleagues are still seen more as staid central bankers doing a job, bankers say, not necessarily Wall Street hotshots likely to be snapped up by the likes of Goldman Sachs.

When devising the program, Mr. Frost and his team decided to focus most on buying Treasury notes with an average maturity of five to six years. That is because the yields on these notes have the biggest impact on interest rates for mortgage holders, consumers and companies issuing debt, and on banks’ decisions to lend to businesses. Over the weeks and months of the program, his purchases should drive up the prices of these securities — because they will be in greater demand — and consequently push down their yields.

The trouble is, though yields fell sharply between August and November as the markets anticipated the new program, they have risen since it was formally announced in November, leaving many in the markets puzzled about the value of the Fed’s bond-buying program.

Mr. Frost, and his boss, Brian P. Sack, insist the program has succeeded. Mr. Sack, 40, joined the Fed 18 months ago to run the entire markets group. He has a Ph.D. from M.I.T. and worked most recently for a Washington consulting firm. In 2004, he wrote a paper with Ben S. Bernanke, the future chairman of the Federal Reserve, and another economist about unconventional measures for stimulating the economy in extraordinary times — just like large-scale purchases of Treasuries.

“We didn’t know then that the Fed would be putting it to the test,” he said.

He said the Obama administration’s $858 billion tax compromise with Congressional Republicans in December complicated the macroeconomic picture.

But the biggest reason for the rise in interest rates was probably that the economy was, at last, growing faster. And that’s good news.

“Rates have risen for the reasons we were hoping for: investors are more optimistic about the recovery,” said Mr. Sack. “It is a good sign.”

[flow5]

The world's most accurate foreign-exchange forecasters say the dollar will be the best currency to own this year as the Federal Reserve's bond purchases bolster the US economy instead of debasing America's legal tender.

Wells Fargo & Co , Bank of Tokyo-Mitsubishi UFJ and SJS Markets, the top analysts in the six quarters ended December 31, according to data compiled by Bloomberg News, say the dollar will strengthen against the euro, yen and pound. Nick Bennenbroek , the head strategist at Wells Fargo in New York and the most accurate of the group, predicts about a 5% gain against the euro over the year and 11% versus the yen.

The survey underscores the sudden turnaround in the US economy two months after the greenback fell to its weakest level in almost a year in November. Traders have turned their focus away from the Fed's plan to print cash to buy $600 billion of Treasuries and toward Europe's debt crisis, deflation in Japan and UK austerity programmes.

"The superior growth performance of the US should shine through in 2011," said Bennenbroek, 40, who joined the bank in 2007 and began his career in the forecasting department at the New Zealand Treasury in Wellington. "We will see the economic recovery in the US outpacing that of Europe, Japan and even the UK, which would see the dollar stronger against those currencies."

Better Economic Data

The dollar's outlook improved as data showing gains in jobs, manufacturing and retail sales the past six weeks helped drive IntercontinentalExchange Inc's dollar index up 7.1% to 81.012 on January 7 from last year's low of 75.631 on November 4. That was a week before the Fed began buying government debt to spur the economy in a policy known as quantitative easing, or QE. The index rose 0.1% to 81.110 at 11:42 am in London on Monday.

"Back in September and October, the world was debating the prospects of more QE in the US - dollar negative - while now investors are debating the chances of the Fed doing less than the $600 billion of QE - dollar positive," Valentin Marinov, a currency strategist at Citigroup in London, wrote in a research note on January 6. The US economy will expand 2.6% this year, according to the median of 68 forecasts compiled by Bloomberg. Growth in the euro region will rise 1.5%, with Japan at 1.3% and the UK at 2%, surveys show.

Surging Dollar

The dollar jumped 3.70% against the euro last week, the most since August, to $1.2907. Japan's currency fell 2.4%, the biggest weekly decline since December 2009, to 83.15 per dollar. The pound slipped 0.4% to $1.5548. The greenback will end the year at $1.31 per euro, 90 yen and $1.58 to the pound, based on the median of more than 30 forecasts compiled by Bloomberg.

Bennenbroek said the dollar will benefit from rising interest rates on US bonds. Inflation-adjusted, or real, yields on 10-year Treasuries climbed to 2.18% last week from 1.46% at the end of October. The dollar surged 8.06% versus the euro in the period, 3.42% against the yen and 3.15% to the pound.

[scaredshirtless]

Then again...

The State of VA is considering an alternative currency?

Just in case??

Scary stuff!

[bimetalaupt]

Fed pays US Treasury record $78.4B last year
Fed pays US Treasury record $78.4B last year, makes money off programs to aid economy
ap

*
Topics:
o Economy, Government & Policy

Jeannine Aversa, AP Economics Writer, On Monday January 10, 2011, 2:11 pm EST

WASHINGTON (AP) -- The Federal Reserve is paying a record $78.4 billion in earnings to the U.S. government, reflecting gains from the central bank's unconventional efforts to lift the economy.

The payment to the Treasury Department for 2010 is the largest since the Fed began operating in 1914. It surpasses the previous record $47.4 billion paid in 2009, the Fed said Monday.

The bigger payment mostly came from more income generated by the Fed's massive portfolio of securities, which includes Treasury debt and mortgage securities.

Critics in Congress have expressed concerns that the Fed's purchases could put taxpayers at risk by reducing the amount turned over to Treasury. The Fed is funded from interest earned on its portfolio of securities. It is not funded by Congress. After covering its expenses, the Fed gives what is left over to the Treasury Department.

Income from the Fed's portfolio of securities came to $76.2 billion last year, up from $48.8 billion in 2009, Federal Reserve officials said. Such income rose largely because the Fed bought a greater number of securities. Increases in the value of securities also played a role.

In early November, the Fed launched a program to bolster the economy by purchasing $600 billion worth of Treasury debt through June. The program aims to boost the economy by lowering rates on mortgages and other loans and by lifting stock prices. Republicans in Congress and others have criticized the program, saying the Fed is printing money to pay for the U.S. government's swollen deficits and debt.

To fight the financial crisis and lift the country out of recession, the Fed bought $1.4 trillion of mortgage-backed securities and mortgage debt as well as up to $300 billion worth of government debt. The Fed completed the mortgage purchases last year.

The purchase programs have helped boost the value of securities held by the Fed.

But the Fed could lose money if the central bank had to sell those securities and their prices were to fall. Once the economy is on firm footing, the Fed will need to mop up some of the money it pumped into the economy. The Fed could do that by selling some securities to reduce its balance sheet to a more normal size.

Federal Reserve Chairman Ben Bernanke has said the Fed's goal is to eventually return the portfolio back to holdings of only Treasury securities. The Fed's balance sheet now stands at $2.4 trillion, nearly triple its size from before the financial and economic crises.

The Fed's securities could lose value if low interest rates shoot up. That means the Fed would pay the government less money -- or none under some circumstances.

"It's possible that there might come a period where we don't remit anything to the Treasury for a couple of years," Bernanke told the Senate Budget Committee last week. "That would be, I think, the worst-case scenario."

Bernanke said in most cases the Fed will continue to return to Treasury "significant amounts of money."

The figures provided by the Fed on Monday are preliminary, unaudited results. Final results will be released later this year.

[scaredshirtless]

Sorry;

I'd feel much better if I saw a few banksters in handcuffs.

Maybe its just me.

Cold in Hong Kong today. 9 degrees C.

I've discovered a lot of A/C units over here don't even have the heating unit in them.

Makes for a pretty cold room.

[flow5]

Yeah, but I hear they have heated toliets?

[flow5]

Reuters) - The U.S. Federal Reserve's journey to the outer limits of monetary policy is raising concerns about how hard it will be to withdraw trillions of dollars in stimulus from the banking system when the time is right.

While that day seems distant now, some economists and market analysts have even begun pondering the unthinkable: could the vaunted Fed, the world's most powerful central bank, become insolvent?

Almost by definition, the answer is no.

As the monetary authority, the central bank is the master of the printing press. It can literally conjure up money at will, and arguably did exactly that when it bought about $2 trillion of mortgage-backed securities and U.S. Treasuries to push down borrowing costs and boost the economy.

The Fed's unorthodox steps helped it generate record profits in 2010, allowing it to send $78.4 billion to the U.S. Treasury Department. But its swollen balance sheet leaves the central bank unusually exposed to possible credit losses that could create a major headache at a time of increasing political encroachment on the Fed's independence.

Asked about the issue of potential losses during congressional testimony on Friday, Fed Chairman Ben Bernanke suggested the risks were minimal. If liabilities on the Fed's balance sheet were to exceed its assets, it would only be so because of rising interest rates in the context of a thriving economy, he suggested.

"Under a scenario in which short-term interest rates rise very significantly, it's possible that there might come a period where we don't remit anything to the Treasury for a couple of years. That would be I think a worst-case scenario," Bernanke said. Customarily, the Fed submits surplus profits from its operations back to the Treasury's coffers.

But the Fed's newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to "recapitalize" the Fed -- economist-speak for what others might call a bail-out.

That would be a strange role reversal given the Fed's efforts to ease monetary policy by buying the Treasury's debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk.

A PAUPER ON PAPER

Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke -- at least on paper.

"The most obvious exit strategy is, when inflation starts to pick up, to stop and reverse asset purchases," he said. "That's likely to include requiring the Fed in an accounting sense to see a significant accounting loss."

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss.

"I'm sure it will have some negative political fallout," Chari said. "But not economic consequences. Their ability to print money means it (insolvency) doesn't mean anything."

Many economists argue that the potential cost to the taxpayer from the Fed's policies is far smaller than the threat of a prolonged period of economic stagnation that would result from a less proactive approach.

With the U.S. unemployment rate at 9.4 percent and only tentative signs that businesses are beefing up hiring, Fed officials, including Chairman Bernanke, see a duty to prevent a further deterioration of economic conditions -- and have signaled a readiness to use all the tools at their disposal.

Last November, as the economic recovery appeared to falter, the Fed said it would buy a new round of $600 billion in Treasury securities through June of this year. That's on top of the $1.7 trillion in Treasuries and mortgage-backed securities it had purchased in response to the financial crisis.

Still, the pitfalls of the Fed's approach are almost as numerous as the lending facilities it undertook to stem the crisis. Perhaps most daunting, the Fed's purchases of Treasury debt and mortgage-backed securities have effectively turned it into a mammoth investor -- a thoroughly undiversified one.

"The biggest risk is losses on its portfolio on long-term debt if inflation rises," said Alan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh.

QUANTITATIVE TEASING

That threat is already apparent in the Fed's latest round of bond buying, or so-called quantitative easing. According to calculations by Reuters Insider credit analyst Ed Rombach two weeks ago, the average duration of the Fed's new portfolio of bonds is just under 5 years, and every 1-basis-point rise in 5-year to 6-year Treasury yields results in a loss of about $65 million.

The Fed is sitting on paper losses of about $2.3 billion on the purchases of U.S. Treasuries it made from November 12 until late last week, according to an analysis by Reuters Insider.

The Fed is also vulnerable to losses through its so-called Maiden Lane portfolios, a collection of investments it acquired when it brokered J.P. Morgan Chase's takeover of a floundering Bear Stearns and bailed out failed insurer AIG.

The portfolio will likely generate losses, according to many analysts. Still, the total Maiden Lane portfolio amounts to just $66 billion, a small slice of the Fed's growing pie of securities.

For most Fed officials, a concern over credit losses would be a luxury compared with the risk they see as predominant: that the economy will not grow quickly enough to return more than 14 million unemployed Americans to work, and inflation so low that it leaves the country exposed to possible deflationary shocks.

"The risks are worthwhile given that the economy would be in the toilet if the Fed never did anything to expand its balance sheet," said Michael Feroli, chief economist at JP Morgan and a former New York Fed staffer.

Feroli does not believe asset sales will be a primary avenue for the Fed's exit. Indeed, Bernanke appears to think the ability to raise interest rates on bank reserves might prove the most effective way to withdraw stimulus. But even that tool is not without its mechanical difficulties.

The problem lies in the basic workings of fixed income. By definition, bond prices decline when their yields or interest rates go up. That means that as the economy recovers and pushes inflation higher, the Fed will move to increase interest rates, pushing down the value of its giant bond portfolio.

"What would the international reaction be if the Fed suddenly had to go and be recapitalized?" said Bob Eisenbeis, chief monetary economist at Cumberland Advisors and a former head of research at the Atlanta Fed. "I don't think that would bode well for Treasuries, or for the dollar, or anything else. It would be embarrassing."

[flow5]

Risk-Free Money From The Fed: Frontrunning Today's POMO
Submitted by Tyler Durden on 01/11/2011 09:37 -0500

POMORon Paul


Since the New York Fed's 20-some year olds who are in charge of the Open Market Operation desk have made it clear it is everyone's patriotic duty to frontrun the Fed, courtesy of their "complex" algorithms, below we present the full frontrunning cheat sheet for today's last for the current schedule $7-9 billion POMO focusing on bond due 2016-2017. Those who wish to take no risk whatsoever should merely buy the 10 Cheapest bonds as predicted by Morgan Stanley's treasury spline. Note that the November CUSIP is now cheapest to deliver and should therefore be on the Exclusions list. Also, not surprisingly the December 7 year auction is sufficiently underwater on a relative cheapness to sector basis, that if any PDs actually offer it for sale, then we know for a fact that the spreads on the bid/ask offered by the Fed are so large they more than offset capital losses on actual exit trades and should be sufficient for Ron Paul to demand a congressional inquiry into just how much the Fed pays the PDs in commission spreads in each and every POMO.Those wishing to make a virtually risk free profit should buy the bonds in the top 10 box to the right, and sell shortly after the end of POMO. And don't forget to thank Mr. Frost's algorithm.

[flow5]

The use of Social Security tax revenues other than paying benefits to those people who are eligible to receive them is not only morally wrong — it is also against the law.

Lately, most discussions about ways of reducing Washington's budget deficit have inevitably turned to cutting entitlements. So much so that the New York Times in a recent editorial was upset that many elected officials have pledged to "shield seniors from spending cuts, apparently to please recipients of entitlements like ... Social Security."

I would ask just what part of the word "entitlements" do the editors of the Times not understand?

According to Webster's Dictionary, an entitlement is "a right granted by law or contract, especially to financial benefits from the government." To the Times, however, an entitlement is a derisive term, a promise to be broken.

But breaking this particular promise would break the law — which, I would hope, the New York Times respects. The law that I am referring to is the FICA Act of 1935, which specifically stated that revenues raised under that act can be used only to pay Social Security benefits.

Over the years, the provisions of this act have been reinforced a number of times.

For example, Public Law 101-508, title XIII, Sec 13301 (a) dated Nov. 5, 1990, stipulated that "... receipts and disbursements of the Federal Old-Age and Survivors Insurance Trust Fund shall not be counted as new budget authority, outlays, receipts, deficits or surplus for purposes of the budget of the U.S. Government ..."

On May 26, 1999, the House passed H.R. 1259, the "Social Security and Medicare Safe Deposit Box Act of 1999," commonly referred to as the "Lock Box" for excess trust-fund money. It was made famous by Al Gore in one of his presidential debates with George W. Bush, back in 2000.

For years, if not decades, the Social Security Trust Fund was considered sacrosanct. Then it was brought into Washington's budget, ostensibly to show the markets the government's total financial impact, and that is when its troubles began.

The Trust Fund's surplus soon became fair game for money-hungry politicians looking for ways to pay for their pet programs without busting the government's budget. In short, it was a cash cow.

To add insult to injury the pols — aided and abetted by some in the media — now want to grab even more money from seniors in order to reduce Washington's humongous budget deficit.

This is on top of denying seniors their annual cost-of-living increases for the past two years — even though prices of food, energy and health care, their market basket, have been soaring.

The voters may have sent a number of signals by voting the way they did in the November election, but I am sure that mugging Grandma and Grandpa was not one of them.

Irwin Kellner is MarketWatch's chief economist.

[flow5]

BANK investors cheered the announcement last week that Bank of America would pay $2.6 billion to buy back mortgages it had improperly sold during the housing bubble to Fannie Mae and Freddie Mac, the beleaguered mortgage finance giants. It seemed a sweet deal for the bank, whose Countrywide Home Loans unit had peddled tens of billions of dollars in risky loans to the taxpayer-owned companies.

While it is unfortunate that the Bank of America deal won’t recoup much for taxpayers, the resolution could have one important benefit. It might just open the door to a much-needed reckoning of the liabilities created by questionable mortgage practices at the nation’s largest banks. These institutions have not yet made a full and realistic accounting of their liabilities.

It seems clear, after all, that Bank of America will not be the only institution forced to buy back billions of dollars’ worth of loans because it did not meet the lending standards promised to buyers. Costs associated with foreclosure improprieties that have come to light in courts across the country — robosigners, forged legal documents — are also likely to be substantial.

But you’ll find precious little clarity on these liabilities in the financial statements of Bank of America, Citigroup, JPMorgan Chase and Wells Fargo. The amounts that these banks, the nation’s four largest, have reserved for possible mortgage repurchases — about $10 billion as of the third quarter of 2010 — is microscopic when compared with the more than $5 trillion in mortgage securities issued from 2005 through 2007.

For some investors, this is the accounting equivalent of whistling past the graveyard. And they are demanding that the audit committees of the banks’ boards step up their scrutiny of these institutions’ practices.

Last Thursday, officials overseeing 11 large public pension funds that own shares in the big four banks sent a letter to the directors who head each board’s audit committee. The investors are asking that the audit committees conduct in-depth and independent reviews of all the internal controls related to the banks’ mortgage operations.

Once the review has been completed — by a different accounting firm from the one currently signing off on the bank’s books — the investors want the audit committees to report their findings to shareholders.

John C. Liu, the New York City comptroller and overseer of five city pension funds, instigated the campaign to focus the banks’ audit committees on mortgage problems. “There is a fundamental problem in the banks’ procedures that endangers not just homeowners, but shareholders, and local economies,” he said in a statement on Thursday. “Given the risks involved, only a swift and unbiased audit can reassure shareholders that the pension funds of 700,000 working and retired New Yorkers are in safe hands.”

Joining him in signing the letters were the heads of the Connecticut Retirement Plans, the Illinois State Board of Investment and its State Universities Retirement System, the North Carolina Retirement System, the Oregon State Treasury and the New York State Common Retirement Fund. Together, the funds own $5.6 billion of stock in the top four banks and oversee $430 billion in assets.

THE New York City pension funds have also put forward a shareholder proposal asking for an independent audit of the top four banks’ mortgage operations. Mr. Liu hopes that the proposal will be put to a stockholder vote at the banks’ annual meetings this year.

It is unclear whether the proposal will be subject to such a vote. Citigroup doesn’t want it considered and has already asked the Securities and Exchange Commission to allow it to exclude the proposal from matters to be voted on at its coming meeting. The other banks will probably follow suit.

An official at JPMorgan Chase declined to comment on the shareholders’ request for an independent audit of its mortgage operations. Officials at Bank of America, Citigroup and Wells Fargo said that they were reviewing the letter but that they had confidence in their internal controls and audit committees’ vigilance. The Bank of America spokesman added that it had hired external auditors to review its foreclosure processes, which led it to enhance its practices.

But Robert L. Christensen, an authority on financial services accounting, says it is high time that investors — and regulators, for that matter — scrutinize the banks’ auditing processes. “I believe there is an avalanche of liabilities that has not been recorded in their reserves,” Mr. Christensen said. “They say it’s not estimable, but the question is, are they really accounting for it properly and are regulators pushing them hard enough to do it?”

He thinks they haven’t. Mr. Christensen, a certified public accountant who spent 24 years as an auditor at Arthur Andersen, is a senior adviser to Natoma Partners, a forensic accounting and litigation consulting firm. He says the banks have understated the liabilities for possible loan repurchases that they were supposed to have recorded in recent years.

Under accounting rules, when a bank sells a loan or a pool of them to investors, the gain on that sale is supposed to be reduced by an amount reflecting the possibility that some loans will have to be bought back later. These amounts are estimates.

It wasn’t until 2009 that banks began to discuss in their filings the reserves they had set aside for these potential liabilities. Mr. Christensen said reserves should have been set aside much earlier, given that the banks selling these loans were in position to know that underwriting standards were slipping and that forced buybacks could rise.

“Where were these banks’ internal controls?” Mr. Christensen asked. “Somebody inside knew that they were lowering their underwriting standards. They should have had processes that told them if these loans ever go bad, they will be put back because we are not meeting our representations and warranties.”

Banks are beginning to disclose more about their reserves in this area, but investors deserve far more, Mr. Christensen said. Regulators seem to agree. Last October, the S.E.C. sent letters to chief financial officers of public companies reminding them of their obligation to disclose the potential pitfalls in their mortgage operations. For example, the letter tells them to detail the risks associated with potentially higher loan repurchase requests and defects in the loan securitization process.

Mr. Christensen welcomes the regulatory interest, especially because the banks have set aside so little to repurchase loans sold to investors other than Fannie and Freddie. “They still haven’t taken any significant reserves for private-label deals, which were very large and probably contained lower-quality loans,” he said.

For example, JPMorgan Chase said in its third-quarter 2010 filings that it had set aside $3.3 billion in reserves for potential loan repurchases. But most of this applies to the roughly $380 billion of loans sold to Fannie and Freddie from 2005 through 2008, the bank said. Reserves to cover any potential putbacks from purchasers of the $450 billion in private-label securitizations the bank sold during that period are unspecified. They are included in a bucket designated for litigation costs, which consisted of $5.2 billion in the third quarter.

The bank said that because repurchase demands from private-label buyers had been limited thus far, it is tough to estimate future requests. Analysts in JPMorgan Chase’s own research unit published a report last fall stating that possible mortgage repurchase liabilities for the overall banking industry ranged from a best case of $20 billion to a worst case of $90 billion.

IT is unclear whether regulators or auditors will require the banks to increase reserves for the questionable loans they sold to private investors. The banks say investors will have a tough time proving the buybacks are warrented. Still, it is becoming more obvious by the day that these reserves are probably too low.

“There may be a reluctance to challenge the banks because of the overall fragility of the financial system,” Mr. Christensen speculated. “But I don’t think it’s a good thing to mix politics and accounting. That’s not a legitimate reason not to enforce the rules.”

[bimetalaupt]

Flow5,
Why does the Federal Reserve system not put into the equation reserves for lose of principle due to interest rate change??

Just a question,
Bruce

[flow5]

Right. Tell Ron Paul (on the U.S. House Financial Services Subcommittee on Domestic Monetary Policy and Technology).

The Reserve banks have no capital requirements, no bank regulatory oversight, no Basel II restrictions, no FASB guidelines, no provisions for loan losses according to GAAP, The FED doesn't report to its stockholders (the 3% capital & surplus owned by the member banks in their District), the SEC, nor is subject to audits by the FDIC & its examiners,

The investing stakeholders are the taxpayers, who are represented by their legislators (the U.S. Congress), which is controlled by the banking lobby & its PACs.

[flow5]

Today's POMO Confirms Fed Continues To Shower Primary Dealers With Billions In Commission-Based Profits
Submitted by Tyler Durden on 01/11/2011 11:40 -0500

Bill DudleyGoldman SachsNew York FedPOMOSteve Liesman


While commenting on yesterday's NYT joke of a profile of the New York Fed POMO group, we openly mocked the claim by one Mr. Frost who said that when monetizing debt "We are looking to get the best price we can for the taxpayer.” We politely suggested that this is a blatant, tendentious lie, and that in fact the New York Fed merely cares to gift the Primary Dealers with any price it can for their bonds just so it stays on their good side (think Primary Dealer Auction take down over 50%), and after all - it is only money that according to Steve Liesman appears out of thin air. Earlier today, we suggested a simple experiment that would confirm whether or not this is the case: specifically, if any of the monetized bonds by the Fed ended up being on the part of the curve seen as rich to the spline, it would immediately become obvious that PDs, instead of monetizing the "cheap to sector" bonds, or those on which the PDs are making a capital gains profit, are making up for capital losses through side arrangements with the Fed, specifically in the form of wide bid/ask spreads resulting in taxpayer funded commission gifting. Sure enough, this is exactly what has transpired.

As the chart below shows, while the 10 bonds suggested to be monetized were all in fact tendered, leading to a hit rate of 100%, the notional represented by this sample which was all "cheap to sector" was just 70% of the total. Of the balance, a whopping 78% (or 23.5% of the total) was accounted for by CUSIPs which were rich to the sector, meaning the PDs were at a relative disadvantage when submitting these for Fed buybacks, and likely ended up losing money on the transaction.

What made up for this P&L mismatch and incentivized the PDs to sell to the Fed at a capital loss? Why cumulative commissions of course. Which means that it is now up to those few uncorrupt congressional critters to immediately submit a letter to Messrs Frost, Sack and, of course, Goldman liaison Bill Dudley (not forgeting to cc: the Chairman himself) and demand to find out just what is the fuzzy logic in the algorithm used by the 20 year olds NYU student at the FRBNY POMO desk, and just how much in taxpayer funds does each and every POMO transaction gift to the 18 Primary Dealers, whose bonuses per banker, as far as we understand, will be the second highest in history for 2009. Surely we can commiserate with the Fed's desire to create a wealth effect at such impoverished institutions as Goldman Sachs and fund billions in commissions directly to the govvie traders, but doing so at the expense of more billions in bond issuance which will never be repaid anyway, is something that we believe is time for Congress to have some say on.

[flow5]

Meet The Fed's POMO Desk... Which Doesn't Even Have Bloomberg Terminals
Submitted by Tyler Durden on 01/10/2011 21:43 -0500

Bank of New YorkBen BernankeFederal ReserveFederal Reserve BankFederal Reserve Bank of New YorkNew York FedObama AdministrationOpen Market OperationsPOMOQuantitative EasingrecoveryTransparency


Over one year after Zero Hedge made POMO, and the Fed's open market operations group a household name, and Brian Sack a household curse, the NYT has finally decided to write an expose on the people who are charged with enforcing America's transition to central planning. And they just happen to be the grizzled 40 year old Mr. Sack, a 34 year old supervisor, two 29-year olds and a 26 year old ... who goes to NYU. Yes, ladies and gentlemen, these are the people who are gifting billions in commissions to the Primary Dealers on a daily basis. You see, the FRBNY whiz-kids have a "computer algorithm that works out which [offers] to [lift]. The computer compares the offers from Wall Street against market prices and the Fed’s own calculation of what constitutes a “fair value” price." In other words, taxpayers are getting raped during each and every single POMO but that's ok - the Fed's algorithm, probably created by yet another ex-Goldmanite, determines that said raping is "fair" and with absolutely no transparency anywhere in the process, except of course the Fed telegraphing in advance what bonds will be monetized, there is no way to ever check... Because that kind of mutually assured destructive disclosure would mean the financial world would promptly implode in a case study of total protonic reversal. After all, only smart people (and we are talking Wall Street smart) can handle the responsible truth... of daily Primary Dealer Subsidies.

Behold what the nerve center of 21st century central planning looks like. Note the abundance of Bloombergs:



Blake Gwinn, left, and James White in the operations room at the Federal Reserve Bank of New York.

As for the lovely pre-cleared narrative of how a few people run the world on behalf of Wall Street, pardon, revive the economy, here is the spin, courtesy of the NYT's Graham Bowley.

In a spare, government-issue office in Lower Manhattan, behind a bank of cubicles and a scruffy copy machine, Josh Frost and a band of market specialists are making the Fed’s ultimate Wall Street trade. They are buying hundreds of billions of dollars of United States Treasury securities on the open market in a controversial attempt to keep interest rates low and, in the process, revive the economy.

To critics, it is a Hail Mary play — an admission that the economy’s persistent weakness has all but exhausted the central bank’s powers and tested the limits of its policy making. Around the world, some warn the unusual strategy will weaken the dollar and lead to crippling inflation.

But inside the Operations Room, on the ninth floor of the New York Fed’s fortresslike headquarters, there is no time for second-guessing. Here the second round of what is known as quantitative easing — QE2, as it is called on Wall Street — is being put into practice almost daily by the central bank’s powerful New York arm.

What exactly is the Operations Room task? Why to gift huge bid/ask spreads to the Primary Dealers of course, making sure that bonuses of traders in the govvie desks of the PD crew are well padded, and those same people continue to cooperate in the pumping of the ponzy pyramid. But in NYT speak, this is known as getting the "best possible price" - too bad this is the best possible price for Goldman, not for Joe Sixpack, who is unaware that the bent over Vaseline treatment proceeds daily with every single POMO, which directly funnels tens if not hundreds of millions of dollars to the Primary Dealers (we don't know - you see the Fed does not disclose the asking prices that ultimately are lifted, contrary to what the NYT will have you believe.

Each morning Mr. Frost and his team face a formidable task: they must try to buy Treasuries at the best possible price from the savviest bond traders in the business.

The smallest miscalculation, a few one-hundredths of a percentage point here or there, could unsettle the markets and cost taxpayers dearly. It could also embolden critics at home and abroad who say QE2 represents a dangerous expansion of the Fed’s role in the markets.

“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses.

Unfortunately, the best price for the taxpayer is one which results in billions in commissions to Primary Dealers at the end of any given QE program (and there will be many after the current one is done).

Louis V. Crandall, the chief economist at the research firm Wrightson ICAP, said Wall Street bond traders were driving hard bargains. The Fed has tipped its hand by laying out which Treasuries it intends to buy and when, giving the bond houses an edge.

“A buyer of $100 billion a month is always going to be paying top prices,” Mr. Crandall said of the Fed. “You can’t be a known buyer of $100 billion a month and get a good price.”

Nevertheless, Mr. Frost and his team have been praised on Wall Street for creating a simple, transparent program. Neither the Fed nor Wall Street want any surprises. The central bank is even disclosing the prices at which it buys.

Mr. Frost and his team work out of a small, beige corner office with arched windows that used to be a library. There, at about 10:15 most workday mornings, one of them pushes a button on a computer. Across Wall Street, three musical notes — an F, an E and a D — sound on trading terminals, alerting traders that the Fed is in the market.

On one recent Tuesday morning, what Mr. Frost and his five young colleagues did over a 45-minute period might have unsettled even a seasoned Wall Street hand: they bought $7.8 billion of Treasuries.

As for the actual people who push the buttons to see of this symphony of taxpayer rape, meet 26 year old Tiffany Wilding (who will graduated from NYU in 2013), 29 year old Blake Gwinn and 29 year old James White. These are the people who every day (and in some cases twice daily) proceed to monetize billions in bonds.

The real work is done by three traders who are referred to during the operation as trader one, trader two and trader three. They sit at a long table against the wall, tapping at seven screens.

On one recent morning, trader one was Tiffany Wilding, 26. While she reviewed the stream of offers and then the prices finally accepted by the algorithm, trader two, Blake Gwinn, 29, double-checked her decisions and trader three, James White, 29, made a duplicate of everything in case the computers crashed.

All the while, Mr. Frost stood behind his colleagues, ready to intervene — and even cancel the Fed’s purchases — at any sign of trouble.

Too bad the only sign of trouble is if the Primary Dealers are not extracting their daily allotted ten/hundred million pounds of flesh.

And between the talented Mr. Sack, and the NYU students who actually execute the billions in dollars, there is the mysterious Mr. Frost:

Mr. Frost — a Rutgers math grad who has worked at the Fed for 12 years, lives in the Borough Hall area of Brooklyn and takes the subway each day to work — is fairly well known within the dealer community. He and his team talk to the big banks most days.

The job carries great responsibility and is prominent within the Fed.

So prominent and so responsible... yet his entire QE2 operation has been an abysmal failure - note the rates on the 10 Year today, and 2 months ago when QE2 started. Oops...

Mr. Frost, and his boss, Brian P. Sack, insist the program has succeeded. Mr. Sack, 40, joined the Fed 18 months ago to run the entire markets group. He has a Ph.D. from M.I.T. and worked most recently for a Washington consulting firm. In 2004, he wrote a paper with Ben S. Bernanke, the future chairman of the Federal Reserve, and another economist about unconventional measures for stimulating the economy in extraordinary times — just like large-scale purchases of Treasuries.

“We didn’t know then that the Fed would be putting it to the test,” he said.

He said the Obama administration’s $858 billion tax compromise with Congressional Republicans in December complicated the macroeconomic picture.

But the biggest reason for the rise in interest rates was probably that the economy was, at last, growing faster. And that’s good news.

“Rates have risen for the reasons we were hoping for: investors are more optimistic about the recovery,” said Mr. Sack. “It is a good sign.”

And there you have it: to "prominent and respected" puppets within the Fed, evidence of the the adverse outcome is proof that the desired outcome has been achieved.

With lunatics such as this who needs Kool Aid... and who cares if teenagers with a penchant for Jersey Shore push the "Buy" buttons (also known as Any Key) at the heart of US central planning. After all it is more than clear by now that even Snooki knows to BTFD.

[flow5]

So while the headline buzz will no doubt be used to say the great Bankster bail out of the financial crisis is now making the taxpayer money, not so fast. Now that the the Federal Reserve is the great investor on toxic assets in chief, what happens when they really try to sell them or go through an audit?

There are huge risks if inflation rears it's ugly head and these U.S. treasuries the Fed bought and then makes some profit on, drop in value.

According to calculations by Reuters Insider credit analyst Ed Rombach two weeks ago, the average duration of the Fed's new portfolio of bonds is just under 5 years, and every 1-basis-point rise in 5-year to 6-year Treasury yields results in a loss of about $65 million.

The Fed is sitting on paper losses of about $2.3 billion on the purchases of U.S. Treasuries it made from November 12 until late last week, according to an analysis by Reuters Insider.

The Fed is also vulnerable to losses through its so-called Maiden Lane portfolios, a collection of investments it acquired when it brokered J.P. Morgan Chase's takeover of a floundering Bear Stearns and bailed out failed insurer AIG.

The portfolio will likely generate losses, according to many analysts. Still, the total Maiden Lane portfolio amounts to just $66 billion, a small slice of the Fed's growing pie of securities.

[flow5]

lis.virginia.gov/cgi-bin/legp604.exe?111+ful+HJ557+pdf

Virginia contemplates a new currency to replace the Federal Reserve Note

[flow5]

What is rising faster?

(1) interest rates
(2) crb index
(3) gold
(4) exchange value of the U.S. dollar
(5) stocks
(6) jobs
(7) excess reserves

[flow5]

The Long Swim ¨C How the Fed Could Become Insolvent

By Terry Coxon, Editor, The Casey Report


You¡¯ve seen the proof in real time. Once-dominant industrial companies, e.g., General Motors, can run out of money. The biggest banks, e.g., Bank of America, can run out of money. Even sovereign governments, e.g., Greece, can run out of money. Yes, all those organizations are still limping along, but only after being rescued by other giant institutions, such as the U.S. government, the less unhealthy European governments, the European Central Bank, and the International Monetary Fund.

So far, it¡¯s been easy to get rescued. The people who run giant institutions seem to shudder at the thought of other giant institutions being shown up as anything less than indestructible. Of course, the rescues weaken the rescuers and push them toward the day when they, too, may join the ranks of the desperate.

By now it¡¯s clear that neither big, Bigger, nor BIGGEST implies unlimited resources. But how about central banks? In a world of fiat money, a central bank can always print more of its own currency. So unless it takes on debt or other obligations denominated in something other than its own currency, it¡¯s impossible for a central bank to become formally insolvent. Nonetheless, it can become functionally insolvent, void of any ability to command resources or influence markets. That¡¯s what happened in Zimbabwe, with a hyperinflation.

As of today, we¡¯re nowhere near such a catastrophe. But there is another way, long before hyperinflation destroys its currency, for a central bank to become functionally insolvent. It¡¯s a trap into which our own Federal Reserve System has already stuck its foot and now seems to be getting ready to stick its neck.

The Federal Reserve has come a long way since it was conjured by Congress in 1913. From the beginning, it was authorized to issue Federal Reserve notes with the status of legal tender and to issue demand deposits, redeemable in Federal Reserve notes or other ¡°lawful money,¡± to member banks. But there were constraints. Among them was a requirement for the Federal Reserve to hold a gold reserve equal to 35% of the deposits it owed to member banks plus 40% of the total Federal Reserve notes outstanding. In addition, being legal tender, Federal Reserve notes were redeemable in gold. Those restraining factors didn¡¯t last.

The 1933 prohibition on gold ownership by U.S. citizens weakened the constraint of gold redeemability, but not by much, since foreigners (whom governments normally treat better than their own citizens) could still redeem dollars for gold. Next, in 1944, in conjunction with the Bretton Woods agreement, the gold reserve requirements were lowered to 25%. In the late 1960s, through a series of steps, the requirements for a gold reserve were eliminated altogether. Then, in 1971, the U.S. government told all foreigners, ¡°If you haven¡¯t redeemed your dollars for gold already, it¡¯s too late, ha-ha-ha.¡± The era of Central Bankers Gone Wild had arrived.

The Federal Reserve was not long in using its new license. In the 37 years that followed the abandonment of the last tie to gold, successive waves of printing reduced the dollar¡¯s purchasing power by 81%. That was mischief enough, but nothing like the danger the Fed embraced in the fall of 2008. Determined to rescue the country¡¯s largest banks from their subprime lending and derivative investing blunders, the Federal Reserve in effect swapped more than $1 trillion in newly created cash for the low-quality loans and debt securities that commercial banks wanted badly to be rid of.

For the banks, the swap was like waking up on Christmas morning and finding that Santa had taken out the trash and left a big sack of money in its place. But the exchange gave the Fed a new problem ¨C how to keep all the new cash that banks were sitting on from fueling a doubling in the public¡¯s money supply (M1) and the unprecedented rates of price inflation that such a doubling would cause. The solution was to give commercial banks an incentive to keep sitting on the excess reserves rather than lending or investing them. The incentive the Fed offered was to pay interest on the reserve that commercial banks keep on deposit at Federal Reserve banks, so that the money would stay there.

The Federal Reserve is now paying interest on nearly $1 trillion in deposited reserves. The interest rate is only 0.25% per year, but with open market interest rates so low, it¡¯s more than banks can earn elsewhere, so it¡¯s enough to keep the excess reserves sequestered. And at that low interest rate, the expense is easy for the Fed to manage, only about $2.5 billion per year.

But what happens when interest rates start rising from today¡¯s abnormally and artificially low levels? To prevent an explosion, roughly a doubling, in the M1 money supply, the Fed will need to raise the rate it pays banks on their deposits, so the Fed¡¯s interest expense will start growing.

Could it grow into a problem?

Below is a summary of the asset side of the Federal Reserve¡¯s balance sheet. Those are the assets that generate income for the Fed, income that currently runs about $65 billion per year. Most of the income-earning assets ¨C chiefly the Treasury securities, agency securities, and mortgage-backed securities ¨C have long maturities (short-term T-bills make up only a small portion of the total).

www.themarketfinancial.com/how-the-fed-could-soon-become-insolvent-thanks-to-qe/121591

Given the composition of the Fed¡¯s assets, when interest rates start rising, the immediate effect on the Fed¡¯s income will be negligible. But the Fed¡¯s interest expense will respond immediately, because the interest it is paying is interest on deposits that commercial banks are free to withdraw without notice. That¡¯s not a healthy combination. Short-term rates would only need to rise above 6.5% for the cost of keeping the $1 trillion sequestered to exceed all of the Fed¡¯s income. The Federal Reserve would be operating at a loss.

A rate of 6.5% is higher than the historical average for short-term rates, but it¡¯s not extraordinary. The fed funds rate was higher than that for most of the 20 years from 1969 to 1989. (It peaked at 19% in 1981.) And it will move back up to the 6.5% neighborhood when, as I expect, the rate of price inflation picks up substantially.

And the crossover rate, at which the Federal Reserve starts losing money, may be about to come down. The Fed is about to begin round 2 of ¡°quantitative easing,¡± in which it creates still more reserves to buy still more long-term Treasury bonds. Suppose that QE2, regardless of what details are initially announced, adds up to a purchase of another $1 trillion of 30-year T-bonds, at the current yield of 3.9%. That will add $39 billion per year to the Fed¡¯s income. But it will double the effect that any rise in short-term rates has on the Fed¡¯s interest expense. The net effect would be to lower the crossover fed funds rate, at which the Federal Reserve starts operating at a loss, to 5.3%.

When the Fed does start operating at a loss, it won¡¯t be broke, but its hands will be tied. It won¡¯t have the latitude to influence markets that it had just a few years ago. Its choices for covering its operating loss will be:

¡öSell assets to cover the loss. It has plenty of assets to sell, but selling them would put upward pressure on interest rates.
¡öPrint the money to cover the loss but continue to pay interest at a sufficiently high rate to keep the new reserves sequestered. That, of course, would add to the rate at which the Fed would be losing money.
¡öPrint the money to cover the loss and simply let the new reserves have their inflationary effect. But that, too, would add to future operating losses, since higher inflation means higher interest rates, which means higher interest expense for the Fed.

If short-term rates bob up to the 5% to 7% neighborhood and stay there, all this will happen in slow motion. Mr. Bernanke and company can still hope to find a way out. But the higher rates go, the less real hope there will be. Even without QE2, if the fed funds rate returns to its historic peak of 19% (price inflation running at a similar rate would get it there), the Federal Reserve will be losing $125 billion per year. In that case, things would move rapidly. Then we would find out what happens when the last lifeguard has swum out so far that he hasn¡¯t the strength to get back to shore.

[bimetalaupt]

Jan 11, 2011 16:21:19 GMT -5 flow5 said:

What is rising faster?

(1) interest rates
(2) crb index
(3) gold
(4) exchange value of the U.S. dollar
(5) stocks
(6) jobs
(7) excess reserves

Flow5,
It has to be #7.. Reserves are going to the moon and M2 and M3 are stuck in neutral.

James Ballard from SLFRB hold to increasing M2 will require more interest paid.
That will Decrease bond prices IE the Federal Reserve could be insolvent..
Increase cost for the UST to sell bonds.. WE will pay more taxes...
slow inflation (#2)
Stall refinance of large Real Estate Deals...
Make America better then the EUB as far as solvent Banking..

Just a thought,'
Bi Metal Au Pt

[scaredshirtless]

Jan 11, 2011 9:47:00 GMT -5 flow5 said:

Yeah, but I hear they have heated toliets?

Not the ones I've sat on! (TMI???)

7 degrees C today. At least the taxi had a heater.

[flow5]

Bi Metal Au Pt:


Hal Stewart has a post on Seeking Alpha "A Closer Look at Money Supply: MZM" which attributes the slow growth of M2 to the unattractive returns from money market funds - which now pay very little in interest to their holders.
===

The definition of money doesn't change, but the current classifications do:

From the standpoint of monetary authorities, charged with the responsibility of regulating the money supply, none of the current definitions of money make sense. The definitions include numerous items over which the Fed has little or no control (e.g., M2), including many the Fed need not and should not control (currency).

The definitions also assume there are numerous degrees of “moneyness”, thus confusing liquidity with money (money is the “yardstick” by which the liquidity of all other assets is measured).

The definitions also ignore the fact that some liquid assets (time deposits) have a direct one-to-one, unvarying , relationship to the volume of demand deposits (DDs), while others affect only the velocity of DDs. The former requires direct regulation; the latter simply is important data for the Fed to use in regulating the money supply.

[flow5]

States still facing big budget gaps after two tough years
.
Tami Luhby, senior writer, On Wednesday January 12, 2011, 1:39 pm EST
The nation's battered state governments face a collective $41 billion budget gap next fiscal year, a survey released Wednesday found.

State officials will have to contend with slow revenue growth, increased spending demands and the end of federal stimulus assistance next year, according to the semi-annual Fiscal Survey of States, released by the National Governors Association and the National Association of State Budget Officers.

"Many budget and governor's offices are telling us that fiscal 2012 could be even worse because so many painful choices have already been taken and more need to be taken as we go further," said Scott Pattison, head of the state budget officers' group.

The start of the 2012 fiscal year is still seven months away for most states, but the gaps are already appearing.

Some 23 states are reporting a total of $41 billion in budget shortfalls. And 11 states must close $10 billion in deficits before the current fiscal year ends.Total revenues this year are forecast to be $636 billion.

The cutting has already begun even though the current fiscal year is not even half over: 14 states have already slashed $4 billion.

States are also hiking taxes and fees to the tune of $6 billion in fiscal 2011, after increasing them by nearly $24 billion in the previous year. And they relied on $43 billion in federal Recovery Act funds, primarily to help cover the costs of Medicaid and education.

"The significant wind down of this support will result in a continuation of extremely tight fiscal conditions for states and could lead to further state spending cuts," the report said.

Third tough year

The Great Recession has hit state governments hard. Over the past three fiscal years, states have closed $230 billion in budget gaps. They have slashed spending for education, social services and public safety. They've cut the state workforce and reduced aid to local governments.

And they've raided their rainy day funds, drawing them down to a total 2.4% of expenditures when the flush states of Alaska and Texas are excluded. Budget experts recommend states hold 5% of expenditures in reserve.

State revenues are expected to pick up a little this year as the national economy slowly recovers. Sales, personal income and corporate income taxes are projected to rise 5% in fiscal 2011. That's a welcome change from the revenue drops of recent years. In fiscal 2010, for instance, collections were 2.7% lower than the year before.

But general fund revenues have a long way to go before they return to pre-recession levels. The total expected fiscal 2011 revenues are 6.5% below fiscal 2008 levels.

Spending is also expected to rise. State general fund expenditures are budgeted to increase 5.3% this fiscal year.

Still, the future doesn't look bright for states, which typically recover two years after the nation's economy. Seventeen states are already reporting nearly $41 billion in budget gaps for fiscal 2013.

And states are likely to suffer $175 billion in gaps over the next three years, said Raymond Scheppach, executive director of the governors association.

The federal government is not expected to step in to help the states, as it did in 2009 with the Recovery Act. While governors successfully lobbied their representatives for more Medicaid assistance, they are not asking for additional funding and Congress is not likely to provide any, Scheppach said

[flow5]

Tentative Outright Treasury Operation Schedule

Across all operations in the schedule listed below, the Desk plans to purchase approximately $112 billion. This represents $80 billion in purchases of the announced $600 billion purchase program and $32 billion in purchases associated with principal payments from agency debt and agency MBS expected to be received between mid-January and mid-February.

Operation Date1 Settlement Date Operation Type2 Maturity
Range Expected Purchase Size

January 13, 2011 January 14, 2011 Outright Treasury Coupon Purchase 07/31/2016 – 12/31/2017 $7 – $9 billion

January 14, 2011 January 18, 2011 Outright Treasury Coupon Purchase 01/31/2015 – 06/30/2016 $6 – $8 billion

January 18, 2011 January 19, 2011 Outright TIPS Purchase 04/15/2013 – 02/15/2040 $1 – $2 billion

January 19, 2011 January 20, 2011 Outright Treasury Coupon Purchase 07/31/2013 – 12/31/2014 $6 – $8 billion

January 20, 2011 January 21, 2011 Outright Treasury Coupon Purchase 08/15/2028 – 11/15/2040 $1.5 – $2.5 billion

January 21, 2011 January 24, 2011 Outright Treasury Coupon Purchase 02/15/2018 – 11/15/2020 $7 – $9 billion

January 24, 2011 January 25, 2011 Outright Treasury Coupon Purchase 07/31/2016 – 12/31/2017 $7 – $9 billion

January 25, 2011 January 26, 2011 Outright Treasury Coupon Purchase 01/31/2015 – 06/30/2016 $6 – $8 billion

January 27, 2011 January 28, 2011 Outright Treasury Coupon Purchase 07/31/2012 – 07/15/2013 $4 – $6 billion

January 28, 2011 January 31, 2011 Outright Treasury Coupon Purchase 02/15/2018 – 11/15/2020 $7 – $9 billion

January 31, 2011 February 1, 2011 Outright Treasury Coupon Purchase 08/15/2013 – 12/31/2014 $6 – $8 billion

February 1, 2011 February 2, 2011 Outright TIPS Purchase 04/15/2013 – 02/15/2040 $1 – $2 billion

February 2, 2011 February 3, 2011 Outright Treasury Coupon Purchase 02/15/2021 – 11/15/2027 $1.5 – $2.5 billion

February 3, 2011 February 4, 2011 Outright Treasury Coupon Purchase 08/15/2016 – 01/31/2018 $7 – $9 billion

February 4, 2011 February 7, 2011 Outright Treasury Coupon Purchase 08/15/2013 – 01/31/2015 $6 – $8 billion

February 7, 2011 February 8, 2011 Outright Treasury Coupon Purchase 02/15/2018 – 11/15/2020 $7 – $9 billion

February 8, 2011 February 9, 2011 Outright Treasury Coupon Purchase 08/15/2028 – 11/15/2040 $1.5 – $2.5 billion

February 9, 2011 February 10, 2011 Outright Treasury Coupon Purchase 02/15/2015 – 07/31/2016 $6 – $8 billion



The next release of the approximate purchase amount and tentative outright Treasury operation schedule will be at 2 p.m. on February 10, 2011. At that time, the Desk will also publish information on prices paid for securities included in the operations listed above.

[flow5]

FAQs: Purchases of Longer-term Treasury Securities

Effective January 12, 2011

Why is the Desk purchasing longer-term Treasury securities?
Purchases are being conducted in connection with a directive from the Federal Open Market Committee (FOMC) to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, and to continue to reinvest principal payments from agency debt and agency mortgage-backed securities (MBS) holdings into longer-term Treasury securities. Together, these purchases are anticipated to bring total SOMA holdings of domestic securities to about $2.654 trillion by the end of the second quarter of 2011.

What Treasury securities will the Desk purchase?
Beginning with the operations included in the November 10 schedule, the Desk plans to distribute purchases across the following eight maturity sectors based on the approximate weights below:

Nominal Coupon Securities by Maturity Range*
TIPS**

1½ -2½
Years
2½-4 Years
4-5½
Years
5½-7
Years
7-10
Years
10-17
Years
17-30
Years
1½-30
Years

5%
20%
20%
23%
23%
2%
4%
3%


*The on-the-run 7-year note will be considered part of the 5½- to 7-year sector, and the on-the-run 10-year note will be considered part of the 7- to 10-year sector.
**TIPS weights are based on unadjusted par amounts.
Under this distribution, the Desk anticipates that the assets purchased will have an average duration of between 5 and 6 years. The distribution of purchases could change if market conditions warrant, but such changes would be designed to not significantly alter the average duration of the assets purchased.

The Desk will continue to refrain from purchasing securities that are trading with heightened scarcity value in the repo market for specific collateral, or that are cheapest to deliver into the front-month Treasury futures contracts.

Specific issues that will be excluded from consideration will be announced at the start of each operation. Currently, the Desk does not plan to purchase Treasury bills, STRIPS, or securities trading in the when-issued market.

How much will the Desk purchase in each issue?
To provide operational flexibility and to ensure that it is able to purchase the most attractive securities on a relative-value basis, effective November 10, 2010, the Desk temporarily relaxed the 35 percent per-issue limit on System Open Market Account (SOMA) holdings under which it had been operating. However, SOMA holdings of an individual security will be allowed to rise above the 35 percent threshold only in modest increments, as specified in the table below. Subject to market conditions, the Desk may further limit the size of additional purchases in certain issues or otherwise change the stated limits as needed.

SOMA Security Ownership Prior to Operation as a Percentage of Outstanding Issuance
Maximum Purchase Amount per Security in Operation is the Lesser of:

(A)
(B)

0-30%
N/A
(35% of Outstanding Issuance) minus SOMA Holdings

30%-47.5%
5% of Outstanding Issuance
(50% of Outstanding Issuance) minus SOMA Holdings

47.5%-59%
2.5% of Outstanding Issuance
(60% of Outstanding Issuance) minus SOMA Holdings

59%-70%
1% of Outstanding Issuance
(70% of Outstanding Issuance) minus SOMA Holdings

Above 70%
Not Eligible for Purchase



How much will the Desk purchase each month in Treasury securities and how will this be communicated?
On or around the eighth business day of each month, the Desk will publish an anticipated amount of purchases expected to take place between the middle of the current month and the middle of the following month. This number is subject to change, should the FOMC choose to alter its guidance to the Desk during the monthly period or if market conditions warrant. This amount will be determined by:

the amount of the $600 billion in announced purchases that are planned to be completed over the coming monthly period, and
the sum of the approximate amount of principal payments from agency MBS expected to be received over the monthly period, and the amount of agency debt maturing between the seventh business day of the current month and the sixth business day of the following month.
The FOMC statement indicated that the $600 billion in purchases would proceed at a pace of "about $75 billion per month." The monthly amount of purchases announced by the Desk that are associated with these purchases may deviate modestly from $75 billion in order to ensure that the Desk remains on pace to purchase $600 billion by the end of the second quarter of 2011.

How would a change in the FOMC directive be reflected in the Desk’s published schedule?
Schedules published by the Desk are based on already announced FOMC decisions, and make no assumptions about future policy actions. Accordingly, if the FOMC announced a modification to its policy stance with a new policy directive, the Desk would release an updated schedule of operations for the remainder of the month.

Will purchases of longer-term Treasuries representing the reinvestment of principal payments from agency debt and agency MBS be managed separately from the additional longer-term Treasury purchases in any way?
No, from an operational perspective, the Desk will conduct all purchases as one consolidated purchase program.

How will the Desk adjust for any unexpected deviations between anticipated and actual longer-term Treasury purchases over a given monthly period?
An adjustment for any deviation will be made by modifying the following month’s Treasury purchases. For example, if actual Treasury purchases were $1 billion smaller (larger) than previously announced, the Desk would increase (decrease) the following month’s anticipated Treasury purchases by $1 billion.

Will these purchases impact the existing policy for reinvesting the proceeds from maturing Treasury securities held in the SOMA?
No, the Desk’s existing Treasury reinvestment policy of reinvesting the proceeds from maturing Treasury securities in Treasury auctions will not be altered.

Who is eligible to sell Treasury securities to the Federal Reserve under this program?
The Federal Reserve Bank of New York’s primary dealers are eligible to transact directly with the Federal Reserve. Dealers are encouraged to submit offers both for themselves and their customers.

Will the Federal Reserve lend the Treasury securities it purchases through this program?
Yes, Treasury securities purchased through this program will be available to borrow through SOMA’s securities lending facility.

Will purchases be adjusted for the effect of inflation on the original face value of TIPS securities held in the SOMA?
Inflation compensation for the SOMA’s holdings of TIPS securities results in an increase in outright holdings of domestic securities. Accordingly, the total amount of purchases of longer-term Treasury securities conducted in association with the reinvestment of principal payments from agency debt and agency MBS will be reduced over time by the amount of inflation accrual.

Operation

How will the purchases be conducted?
Consistent with its prior outright purchases of Treasury securities, the Desk will arrange these purchases with primary dealers through a series of multiple-price competitive auctions using the Desk’s FedTrade system.

How will the Desk communicate the operation results?
Operation results will be posted on the Federal Reserve Bank of New York website following each operation. The information posted will include the total amount of offers received, total amount of offers accepted, and the amount purchased per issue. In addition, participating dealers will receive the operation results, including their accepted propositions, via FedTrade.

Will the Desk release operation pricing results?
Yes, the Desk will begin to publish information on prices paid in individual operations at the end of each scheduled period, coinciding with the release of the next period’s schedule. The Desk plans to publish the first pricing information on December 10, 2010, which will cover the operations included in the November 10, 2010 schedule. For each security purchased in each operation, the Desk will release the weighted-average accepted price, the highest accepted price, and the proportion accepted of each proposition submitted at the highest accepted price.

How often will the Desk conduct operations to purchase longer-term Treasuries?
The Desk will conduct one operation per day on most business days, but will occasionally conduct either no operations or multiple operations.

How many offers can a dealer submit during an operation?
Beginning with the first operation associated with the November 10 schedule, dealers will be limited to nine offers per issue. This represents an increase from the prior limit of five offers per issue to facilitate greater participation by customers through dealer counterparties.

What is the minimum amount for which a dealer may submit offers?
The minimum offer size is $1 million, with a minimum increment of $1 million.

Whom do dealers call if they experience difficulties during the operation?
Primary dealers may call the Federal Reserve Bank of New York Trading Desk with submission and verification questions. For system related problems, dealers may call Federal Reserve Bank of New York Primary Dealer Support.

Settlement

When and how does Treasury security settlement take place?
Treasury security settlement will occur on a T+1 basis, i.e. one business day after the day of the operation, via the Fedwire Securities System.

FAQS: December 20, 2010 »

[flow5]

Trade Date
Par Amount Purchased
Weighted Average Accepted
Highest Accepted Price
% Allotted of Each Proposition
Submitted at the Highest Accepted Price



www.newyorkfed.org/markets/pomo_landing.html



2All securities eligible for purchase during a given operation are included, whether or not the issue was purchased.
3Weighted average accepted prices are based on all propositions accepted and are rounded to the nearest $0.001 per $100 par.
4Prices are submitted using standard U.S. Treasury trading convention in increments of $0.00390625 per $100 par.
5Percentages are rounded to the nearest percent. Propositions submitted at the highest price accepted may have received partial allocations. Partial allocations are allotted in $1 million par increments which may have resulted in some rounding differences between individual propositions. All propositions submitted below the highest accepted price were allotted at 100%.

[flow5]

Plosser also took issue with those who say the Fed faces essentially the same challenges it always faces when making a policy shift.

The sheer size of the balance sheet "is the difference," he said. "The question of timing always faces us: do we get the timing right? That's not a new problem."

"The problem is the execution of an exit strategy when you've got a balance sheet as big as the one we have," he went on. "And what will that mean for interest on reserves?"

"How high will interest on reserves have to go to hold those excess reserves?" he asked. "How rapidly will they have to increase? will we have to sell assets?"

"We will never get the funds rate above the interest on reserves (rate) , never, as long as our balance sheet is as big as it is," Plosser asserted. "It's got to shrink."

"Ultimately we all realize we have to get that balance sheet down," he said. "The challenge we face is how do we do that in a timely way and do it in a way that preserves both stability, inflation credibility and an exit strategy that doesn't end up introducing more instability."

"We've never had to do that before," he added.

====

The money supply can never be managed by any attempt to control the cost of credit.