Wednesday, March 18, 2009

The Fed's Last Bullet

Good Afternoon Folks


Its official! We are now officially Financing ourselves!

That's all I can say in response to the Fed's announcement that they will be purchasing US treasuries. Here is the big news from Bloomberg:

"March 18 (Bloomberg) -- The Federal Reserve opened a new front in its battle to bring down borrowing costs across the economy, pledging to buy as much as $300 billion of Treasuries and stepping up purchases of mortgage bonds.

The announcement following the Federal Open Market Committee meeting today in Washington spurred the biggest rally in longer- dated Treasuries in decades. Officials unanimously voted to expand the Fed’s balance sheet up to $1.15 trillion, and said they may broaden a program aimed at boosting consumer loans to include other assets, today’s statement showed.

With today’s move, the Fed has committed to buy or loan against everything from corporate debt, mortgages and consumer loans to government debt, after cutting its benchmark interest rate to zero failed to end the credit crunch. The unprecedented campaign comes after a worsening recession sent the unemployment rate up to a quarter-century high of 8.1 percent."

My Take:

I am still in shock that Ben actually pulled the trigger. 10 year treasury yields collapsed on the news:

So what does this all mean?

It means the world will never be the same. Let me start with the good news. This is the refinancing opportunity of a lifetime. If your job is stable and you have equity in your house, by all means refi!.

OK, back to the grim reality of this situation:

The fact that the Ben actually decided to actually risk going down this dangerous path tells me that the Fed has seen some type of economic ghost. The dollar collapsed on the news.

The risk of "unintended consequences" is extremely high here.

Think about it folks, WE ARE NOW OFFICIALLY FINANCING OURSELVES. What type of message do you think this sends to the countries that buy our debt? Gee, do you think they might be a little nervous about the value of their treasuries as they see us wallowing in trillions of dollars in debt? The Fed's balance sheet just grew by $1.15 trillion today alone and now totals more than $3 trillion dollars.

What the Fed announced today may very well lower the demand for treasuries going forward:

You see, US treasuries have always been considered to be the safest investment on Earth. Buyers around the world crowd into US treasuries when they are looking for a "safe haven" because they are extremely confident that they will be paid back. However, after Ben's desperate expansion of the Fed's balance sheet, Investor's now gotta be asking themselves: Is this still the case?

We need to ask ourselves a few other questions here:

1. Did the Treasury decide to buy their own debt because demand began to wane worldwide?

2. If this doesn't work, then what?

3. Will the banks pass on these lower rates to customers or will they try and pocket the difference in an attempt to bail themselves out?

4. How are we ever going to pay these trillions of dollars back?

5. Is the Treasury Market turning into the biggest bubble of them all? What happens if it bursts?

6. Will China and Japan continue to buy our debt OR decide that now is the time to SELL because the Fed is now buying?

7. Where does the Fed draw the line in terms of how many treasuries they will buy?

8. Do we risk a bond market dislocation as a result of all of this? How can a Chicago trader trade bonds when there is an 800lb gorilla in the room(the Fed) that could wipe him out at any second.

Bottom Line:

As you can see, there are many risks by going down this path of quantitative easing. There WILL be unintended consequences here folks. Its going to take some time for the market to digest all of this, but when it does: Look out!

In my opinion this is a huge mistake. We are basically trying to reflate a massive debt bubble. As I have said before, BUBBLES DON'T REFLATE.

What the Fed has essentially done here is used its balance sheet to replace the investment banks Ponzi like leverage. The problem with this theory is the consumers balance sheet remains DEleveraged. No one has the money or appetite for risk that's needed in order to take advantage of all of this cheap Ponzi lending.

As a result, this can't work. You can't reinflate one side without reinflating the other. Consumer's are still up to their neck in debt and losing their jobs. This hardly sets up a scenario where they want to borrow. If anything, they would prefer to throw any extra money they have under the mattress because they are terrified they may lose their job.

The economy has been destroyed, and today's desperate actions by Bernanke confirms this. The Fed is trying to temporarily use its balance sheet to "triage" a patient that's already dead.

Remember folks, we have seen this show before in Japan:

As you can see above, lending COLLAPSED after its bubble burst in the early '90's. No one had any appetite for risk after getting burned so badly as a result of their deflationary spiral. The same "quantitative easing" that we announced today was also attempted in Japan in the 1990's. You can see how well that worked out.

Bernanke's now officially out of bullets. Expect this policy to fail miserably just like it did in Japan. How does this all play out in the market? Tough call. Stocks at these levels are simply too risky for my taste. I could see them heading in either direction. Stocks retraced to close up 100 points after soaring nearly 220 points following the announcement.

The bulls will attempt to keep the momo going by playing the "reflation" trade following the Fed's spending orgy. Expect energy and commodity stocks to move higher if the market continues to bounce. I could also see a scenario here where the market asks itself "now what?" and then proceeds to sell off.

Remember, the market hates uncertainty. I don't see how things could get more uncertain with the Fed now officially involved in the treasury market.

Watch the 800 area on the S&P. If the market fails to move higher from these levels I will be inclined to jump in on the short side. IMO, Don't try and front run this freight train. Let the market sort this all out first before you get too bold.

Stay tuned folks and god help us all if this doesn't work.


@home said...

may god help us all. At least I got all my money back and am in the process of raising as much cash as I can. It's just pure gambling now Jeff.

Jeff said...


Here here.

Cash will be king when this is all said and done.

Its a sad day when there is no "safe haven" from an investment standpoint.

Whats scary is the treasury bubble may be the biggest one of all!

Anonymous said...

Thanks for the blog...always informative.

Do you think the fed is now acting like a "bad bank"? how does this play for the financial stocks? thanks.

Jeff said...



Actually it appears AIG is acting more like the bad bank after paying out $100 billion in CDS contracts at 100% thanks to the taxpayer.

The Treaasury would be the ones setting up the bad bank.

The Fed's balance sheet is basically replacing the consumer until we get back on our feet.

Our economic system would have collapsed without their "triage". The problem is this can only be a temporary fix because they can't afford to do this forever.

The problem here is the consumer will never consume like they did because the housing bubble burst. This stops the housing ATM right in its tracks. Throw in massive unemployment and a deleveraged banking system and you have an economic nightmare consumerwise.

The Fed will be waiting for a consumer that never comes back because they don't have the ability to consume like they did when Ponzi lending was available.

We need an economic reset where assets become affordable again. The problem is the banks can't afford for assets like housing to drop to the levels at where they need to be in order to be affordable.

This gap between what the bank wants homes to be worth and what the consumer can afford is huge. This is why the bad bank is having a hard time getting off the ground.

The banks can't afford to price homes where they need to be because they would go under.

This is a disaster without a solution. the only answer is an economic reset to affordability.

I would avoid financials right now until some solution(if ever) is carved out.


Anonymous said...

Today the market shows no love toward the Fed last bullet. I read that Bernanke studied the Great Depression in great details. I am sure he had studied Japan last housing bubble well too.

Yet he decided to act on plans that have failed in history. So why repeat it given his extensive background on the subject? I am just wondering if he sees something that we don't?

Jeff said...


If I had to guess, I don't think he had much of a choice.

The economic numbers must be so bad that he saw no alternative.

You don't QE unless you have seen a ghost. The "get out of the recession" playbook that they typically used has failed so now its time to take drastic measures. This is something much much worse.

Don't be blinded by this rally. Things are not improving. They must be getting much worse. Bernanke NEVER would have done this if things were getting better.

Raise cash for the short term! Buy hard assets for the long term as a hedge. Where we go from here is unclear. The dollar is very much at risk here. An economic collapse is very much on the table.

Anonymous said...

I am completely out of the stock market since last summer. Like you, I agree that we are heading toward a huge disaster and possibly social chaos.

For a speedy recovery, we need to take out all the trashes. The dirty Wall Street executives and corrupted politicians must be thrown in the slammer. Their assets have to be taken away to pay for the losses. Crappy banks and poorly run companies such as GM or AIG should just die. There are better companies out there to to take over the businesses. The bailout madness must be stopped NOW!

Consumers need to spend less and save more. Granted that will slow down the GDP. Granted there will be financial hardship for many due to loss of jobs. But eventually the country will recover.

Unfortunately there are too many crooks running the country. So I don't know how we can get rid of this ponzi scheme unless there is a social revolution.

Jeff said...


Couldn't have said it better myself.

I think we are close to seeing the social chaos. This AIG bonus nightmare might be the start of it.

There was a protest planned in front of GS tonight. I think people are going to eventually freak out as the economy gets worse and more people suffer.

The pigmen and the other elites must be stopped before they destroy this country!

Anonymous said...

The AIG bonus might just be the final straw in the heist of the century against the American people.

Jeff said...



The more details I read about how the AIG thing went down the more pissed I get.

The taxpayer was flat out robbed!

It was the perfect "back door" for the FED to throw money into the banks.

The corruption and rot in DC and on Wall St has never been so out of control.

The torches better come out quick or this country is toast