Submitted by James Bianco of Bianco Research

•    The Wall Street Journal - Fed Proposes Tool to Drain Extra Cash
The Federal Reserve on Monday proposed selling interest-bearing term deposits to banks, a move the U.S. central bank would make when it decides to drain some of the liquidity it pumped into the economy during the financial crisis. The new facility is intended to help ensure that the Fed can implement an exit strategy before a banking system awash with Fed money triggers inflation. Fed Chairman Ben Bernanke has described term deposits as “roughly analogous to the certificates of deposit that banks offer to their customers.” Under the plan, the Fed would issue the term deposits to banks, potentially at several maturities up to one year. That would encourage banks to park reserves at the Fed rather than lending them out, taking money out of the lending stream.The central bank said the proposal “has no implications for monetary policy decisions in the near term.” “The Federal Reserve has addressed the financial market turmoil of the past two years in part by greatly expanding its balance sheet and by supplying an unprecedented volume of reserves to the banking system,” it said. “Term deposits could be part of the Federal Reserve’s tool kit to drain reserves, if necessary, and thus support the implementation of monetary policy.” Michael Feroli, an economist at J.P. Morgan Chase, said “it’s another step forward in the exit-strategy infrastructure, but it’s been well flagged in advance, so it’s not a surprise.” When Fed officials decide to tighten credit, they would likely use the term-deposits program ahead of — or in conjunction with — adjusting their traditional policy lever, the target for the federal funds interest rate at which banks lend to each other overnight. The Fed also said Monday that its balance sheet rose slightly to $2.2 trillion in the week ending Dec. 23. The Fed’s total portfolio of loans and securities has more than doubled since the beginning of the financial crisis. As part of its efforts to fight the downturn, the central bank is buying $1.25 trillion in mortgage-backed securities, a program it says will end in March. The Fed now holds $910.43 billion in mortgage-backed securities, it said Monday.

•    Bloomberg.com - Fed Proposes Term-Deposit Program to Drain Reserves
The Federal Reserve today proposed a program to sell term deposits to banks to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  The plan, subject to a 30-day comment period, “has no implications for monetary policy decisions in the near term,” the central bank said in a statement released in Washington. Fed Chairman Ben S. Bernanke is preparing tools and strategies to shrink or neutralize the inflationary impact from the biggest monetary expansion in U.S. history. Central bankers are also conducting tests of reverse repurchase agreements and discussing the possibility of asset sales. Term deposits may help the central bank “assert operational control over the federal funds rate” once officials decide to lift the overnight bank lending rate from the current range of zero to 0.25 percent, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Excess cash “would be locked up” rather than put downward pressure on the federal funds rate, he said.The Fed won’t begin raising interest rates until the third quarter of 2010, according to the median estimate of 62 economists surveyed by Bloomberg News in the first week of December.

•    The Financial Times - Fed to offer term deposits to banks
The US Federal Reserve plans to offer term deposits to banks as part of its “exit strategy” from the exceptionally loose monetary policy used to fight the recession. In a consultation paper released on Monday the Fed said it planned to change its rules so that it could pay interest on money locked up at the central bank for a defined period. The Fed added that the well-flagged rule change - designed to allow it more influence over the $1,100bn in excess reserves held by banks - was part of “prudent planning. . . and has no implications for monetary policy decisions in the near term”. It is one of a number of measures that has been outlined over the past few months by Ben Bernanke, chairman of the Fed, as an option to drain liquidity from the financial system in a manner that protects the economic recovery while heading off the threat of inflation.

•    The Federal Reserve - Notice of proposed rulemaking; request for public comment.
The Board is requesting public comment on proposed amendments to Regulation D, Reserve Requirements of Depository Institutions, to authorize the establishment of term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances. Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks (”eligible institutions”) could hold term deposits and receive earnings at a rate that would not exceed the general level of short-term interest rates. Term deposits would be separate and distinct from those maintained in an institution’s master account at a Reserve Bank (”master account”) as well as from those maintained in an excess balance account. Term deposits would not satisfy required reserve balances or contractual clearing balances and would not be available to clear payments or to cover daylight or overnight overdrafts. The proposal also would make minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board’s Policy on Payment System Risk to address transactions associated with term deposits.

Comment

We believe the proposal of this new tool signals the Federal Reserve is still flailing around trying to look busy so everyone is assured they have a plan.  The fact is they have no plan and are still throwing everything on the wall to see what sticks. From the November 4 FOMC minutes:

Participants expressed a range of views about how the Committee might use its various tools in combination to foster most effectively its dual objectives of maximum employment and price stability. As part of the Committee’s strategy for eventual exit from the period of extraordinary policy accommodation, several participants thought that asset sales could be a useful tool to reduce the size of the Federal Reserve’s balance sheet and lower the level of reserve balances, either prior to or concurrently with increasing the policy rate. In their view, such sales would help reinforce the effectiveness of paying interest on excess reserves as an instrument for firming policy at the appropriate time and would help quicken the restoration of a balance sheet composition in which Treasury securities were the predominant asset. Other p articipants had reservations about asset sales–especially in advance of a decision to raise policy interest rates–and noted that such sales might elicit sharp increases in longer-term interest rates that could undermine attainment of the Committee’s goals. Furthermore, they believed that other reserve management tools such as reverse RPs and term deposits would likely be sufficient to implement an appropriate exit strategy and that assets could be allowed to run off over time, reflecting prepayments and the maturation of issues. Participants agreed to continue to evaluate various potential policy-implementation tools and the possible combinations and sequences in which they might be used. They also agreed that it would be important to develop communication approaches for clearly explaining to the public the use of these tools and the Committee’s exit strategy more broadly.

The Federal Reserve first hinted at term deposits almost two months ago, although exactly what they were talking about was left vague until now.

Remember that the Federal Reserve has to withdraw over a trillion dollars of excess liquidity.  The easiest way to do this is to sell hundreds of billions of MBS, Treasuries and agencies.   As the bold highlighted passage above implies, they are scared to death of doing this, so they propose complicated schemes to withdraw liquidity like reverse repos and now term deposits.

We have argued that these schemes will not work.  They cannot be done in the sizes necessary or enough to even matter.  The Federal Reserve could possibly drain tens of billions of dollars via these schemes, but collectively that will amount to a rounding error when the goal is to withdraw over a trillion in excess reserves.

The Federal Reserve does not want to admit defeat, so they continue pursuing these strategies that will not make a difference.  We believe they also do it to “look busy” as they are taking measurements and notes as to how to withdraw all the liquidity they have pumped in.  They think this will give the market comfort that someone is on the case and that inflation expectations will not get out of control.  The market is not buying this.  Inflation expectations, s measured by TIPS inflation breakeven rates, are going vertical.

Reinvestment Risk

As to term deposits, the Federal Reserve is proposing an illiquid short term instrument for banks to invest in.  Banks would buy these instruments and “lock up” the excess reserves they now have.  This would have the same effect as draining excess reverses.  The maturities of these instruments would be as long as one year.

It is unclear if there will be a secondary market for these instruments, and if so, how liquid it will be.
Without a secondary market, buyers of these instruments face huge reinvestment risk.  The future course of short term interest rates is arguably to the most uncertain it has been in decades.  Will the Federal Reserve stay near zero until 2012 or will they be forced to raise rates in the first half of 2010?  Given all this uncertainty, who wants to lock up money in something that cannot be sold before maturity?  This is especially true given the Federal Reserve’s statement that the “maximum-allowable rate for each auction of term deposits would be no higher than the general level of short- term interest rates.”

The general level of short-term interest rates is set on known instruments that have generations of history and active secondary markets.  If the Federal Reserve wants to introduce a new, and wholly unknown instrument with an uncertain secondary market and offer no interest rate premium, then we cannot see how this will work beyond a token amount after some arm twisting to get them sold.  The Federal Reserve will have to offer a premium for uncertainty and illiquidy to make this fly in any major way, something they said they will not do.

Complicated Is Simple

The Federal Reserve owns 80% of AIG.  With each passing day it looks like the Federal Reserve is adopting AIG Financial Product’s business practices.  That is, when faced with a financial problem, they create complicated tools (like CDS).  When critics says these new products will not work, tell them they do not know what they are talking about and create even more complicated tools to dazzle everyone.  Once the tools are so complicated that no one understands them, you will be hailed as an expert with no peer.  You might even be named TIME’s Person of the Year.

As everyone is engrossed by assorted groundless Christmas (and other ongoing bear market) rallies, and oblivious to the debt monsters hiding in both the closet and under the bed, Zero Hedge has decided it is about time to present the ugliest truth faced by our 'intellectual superiors' and their Wall Street henchman who succeeded in pulling off Goal #1 for 2009 - the biggest ever bonus season (forget record bonuses in 2010... in fact, scratch any bonuses next year if what is likely to transpire in the upcoming 12 months does in fact occur).

If someone asks you what happened in 2009, the answer is simple - two things. There was a huge credit and liquidity crunch, and then there was Quantitative Easing. The last is the Fed's equivalent of band-aiding a zombied and ponzied corpse, better known as the US economy. It worked for a while, but now the zombie is about to go back into critical, followed by comatose, and lastly, undead (and 401(k)-depleting) condition.

In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. This makes sense: the abovementioned crunches stopped the flow of credit from January until well into April, and generally firms were unwilling to demonstrate to the market how clothless they are by hitting the capital markets until well into Q2 if not Q3. What happened was a move so drastic by the Fed, that into November, the worst of the worst High Yield names were freely upsizing dividend recap deals (see CCU) - the very same greed and stupidity that brought us here. Luckily, so far securitization and CDOs have not made a dramatic entrance. They likely will, at which point it will be time to buy a one-way ticket for either our southern or northern neighbor, both of which, in the supremest of ironies, transact in a currency that will survive long after the dollar is dead and buried.

Back to the math... And here is the kicker. Accounting for securities purchased by the Fed, which effectively made the market in the Treasury, the agency and MBS arenas, but also served to "drain duration" from the broader US$ fixed income market, the stunning result is that net issuance in 2009 was only $200 billion. Take a second to digest that.

And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all... none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.

Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating  demand. To sum up: $200 billion in 2009; $2.1 trillion in 2010. Good luck.

As we pointed, the number one reason why 2010 is set to be a truly "interesting" year is a result of the upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was  $1.1 trillion increase from 2008. For those of you needing a primer on the exponential function, click here. But wait, there is a light in the tunnel: in 2011, gross issuance is expected to decline... to $1.9 trillion.

And while things are hair-raising in "gross" country (not Bill...at least not yet), they are not much better in netville either. Net of maturities, 2010 coupon issuance will be about $1.8 trillion, a 45% increase from the $1.3 trillion in FY 2009 (and the paltry $255 billion in 2008).

Now everyone knows that the average maturity of the UST curve has become a big problem for Tim Geithner: nearly 40% of all marketable debt matures within a year (a percentage that has kept on growing). In fact, the Treasury provided guidance in its November 2009 refunding, in which it stated that it intends "to focus on increasing the average maturity" of its debt after relying heavily on Bill issuance in H2. Once again, we wish Tim the best of luck.

Why our generous best intentions to the US Treasury? Because unless the US consumer decides to forgo the purchase of the 4th sequential Kindle and buy some Treasuries (and not just any: 30 Year Bonds or bust), the presumption that the Bond printer will have the option of finding vast foreign appetite for its spewage is a very myopic one. We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of Uncle Sam's - at some point the return on investment in its own middle class will surpass that of funding the rapidly disappearing US middle class. That tipping point could be as soon as 2010.

As for Japan - the country has plunged into its n^th consecutive deflationary period. Whether or not the finance minister announces yet another affair with the Quantitative Easing whore on any given day, depends merely on what side of the bed he wakes up on. The country will have its hands full monetizing its own sovereign issuance, let alone ours.

Lastly, the UK - well, with the country set to have zero bankers left in a few months, we don't think the traditionally third largest purchaser of US debt will be doing much purchasing any time soon.

None of this is merely speculation: October TIC data confirmed these preliminary observations. It will only become more pronounced in upcoming months.

How about that great globalization dynamo: emerging markets? Alas, they have their hands full with issuing their own record amounts of both sovereign and corporate debt as well: in 2009 gross EM debt issuance reached an astounding $217 billion, $29 billion higher than the previous record in 2007. Gross EM issuance was particularly high in the last quarter at $73 billion, with October breaking the record for the largest ever monthly gross issuance of emerging market global bonds at $38 billion (January is traditionally the busiest month of the year.) With $81 billion, 2009 was notably a record year for sovereign bonds, while gross issuance of corporate bonds amounted to $136 billion, the second highest level after that of 2007 with $155 billion.

Bottom line: everyone has major problems at home, and is more focused on the supply than the demand side of th e equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke's complete lack of preparation from a monetary standpoint (we are surprised the Fed's $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke's forced intervention in bond and equity markets. Yet the President's Working Group is fully aware that when the time comes to hitting the "reverse" button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors. Then again, as Eric Sprott has been pointing out for quite some time, it could very well be that the US economy has become merely one huge Ponzi, and as such, its expansion or reduction on the margin is uncontrollable. We very well may have passed into the stage where blind growth is the only alternative to a complete collapse. We hope that is not the case.

Merry Christmas and Happy Holidays to all readers.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Henny Sender of the FT reports that top hedge funds bet on big rise in yields:

The recent rise in long-term US interest rates comes as good news for several leading hedge fund managers, including John Paulson, who have positioned their trading books to benefit from higher yields on US Treasury securities.

 

Mr Paulson, who made big gains earlier this decade by betting against the subprime mortgage market and whose firm, Paulson & Co, manages $33bn, has said he believes that government stimulus efforts would inevitably lead to higher inflation and a corresponding rise in rates.

 

“It will be difficult for the government to withdraw the economic stimulus,” Mr Paulson said in a speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.”

 

Bond prices fall as yields rise, and Mr Paulson told the Financial Times last week that he has been hoping to benefit in the Treasury market by buying options that would become profitable if rates headed higher. TPG-Axon’s Dinakar Singh has been making similar options trades, according to a person familiar with the matter.

 

Julian Robertson, the hedge fund manager, has pursued a related strategy, hoping to benefit from a bigger difference between short-term and long-term interest rates, known as a steeper yield curve, a person familiar with his trades said.

 

The yield on the 10-year Treasury, which hit a crisis low of 2.055 per cent last year, has moved from 3.2 per cent last month to 3.75 per cent on Tuesday.

 

Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

 

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

 

Some traders are cautious because many peers lost large sums betting that rates would rise in Japan in the 1990s – as yields fell to less than half a percentage point. The trade was termed the “black widow” because it left so many victims.

 

“Nobody understood the extent of deflation and economic weakness in Japan,” said Dino Kos of Portales Partners, a research consultancy, who was then a Fed official. “More money was lost on that trade than on any other single trade. Everyone piled in when rates were at 3 per cent and then at 2.5 per cent and then at 2 per cent.”

So is it time to place big bets on rising yields? I could easily see a backup in yields in the near term as economic reports surprise to the upside, but I don't believe that bonds have entered a long-term secular bear market. I think the hedgies are right, best to play interest rate directional calls though options.

Also, given the increase in liability-driven investing by pension funds worried about their funding status, there is an upper cap on bond yields. I don't know what the exact magic number is, but at a certain level (say 7%), you'll have pensions scambling to lock in rates. Bond bears tend to ignore this when predicting doom and gloom on bonds. All they do is focus on the "pending collapse" of the US dollar, which won't happen.

Could the next black/green/dark gray swan be so obvious that it has avoided everyone? Well, except for the deputy governor of the Bank of China, who just gave the world a startling reminder of economics 101, when he said that it is "getting harder for governments to buy United States Treasuries because the US's shrinking current-account gap is reducing the supply of dollars overseas." Oops.

The funny thing about natural (and economic) systems: they can only be pushed so far before they snap back to default state. With the entire world embarking on an unprecedented spree of domestic bubble blowing to mask the collapse in global GDP, everyone forgot to trade. Zero Hedge has long emphasized that the drop in world trade can only sustain for so long before it brings the current destabilized system back to some form of equilibrium. Because with every country intent on merely printing more of its own currency, whether it is to build bridges or to make the stock of electronic book fads trade at 100x earnings, said countries ran out of non-domestic cash. Alas, this is most critical for the United States, now that Treasury monetization is over, as the US needs to constantly find foreign buyers of its debt to fund unsustainable deficits. Foreign buyers who have US dollars. And according to Shanghai Daily, this could be a big, big problem.

Here is what the BOC's Zhu Min said earlier:

"The United States cannot force foreign governments to increase their holdings of Treasuries," Zhu said, according to an audio recording of his remarks. "Double the holdings? It is definitely impossible."

"The US current account deficit is falling as residents' savings increase, so its trade turnover is falling, which means the US is supplying fewer dollars to the rest of the world," he added. "The world does not have so much money to buy more US Treasuries."

In a nutshell, in printing trillions of assorted securities, the Treasury has soaked up the world's dollars, which due to US banks not lending, is sitting and collecting dust in the form of bank excess reserves. These excess reserves can not be used to buy Treasuries and MBS as that would be literal monetization (as opposed to the figurative one which is what QE has been). And the world is running out of dollars with which to buy Treasuries.

Does this mean that the "world" will be forced to buy dollars, and thus spike the value of the greenback? Not necessarily:

In a discussion on the global role of the dollar, Zhu told an academic audience that it was inevitable that the dollar would continue to fall in value because Washington continued to issue more Treasuries to finance its deficit spending.

Submitted by Greg Simmons and Brett Buchanan of Scope Labs

Are financial markets a direct reflection of the overall health of a nation? I wish they were not, but I fear they are.

I wonder at times if our nation has entered a state of purgatory – all of us mulling around in the waiting room to Hell, anxiously counting the minutes until the grim reaper saunters through the door sickle in hand his mission to send us off to eternal damnation. Unfortunately, there is little time to close this door so that we may stave off this potential fate that looms so near. What we need to alter this course is a procession of men who possess moral fortitude and common sense, men of rationality and reason. Men of action who will set in motion the dismantling of institutions that bleed this nation dry.

Hope is not a strategy. This present state of manufactured optimism emanating from the White House and our news outlets is contemptible. We are in dire need of new reformist leadership and of new voices that will speak the truth. A national purification is long overdue. Time is not on our side. Look at the track record this nation has racked up over the last few decades and this economic and moral purgatory in which we find ourselves might very well mark the beginning of our walk of death down the long road to Hell.

I make this analogy of a national state of purgatory not in jest, but rather in practical terms. This nation has gone the way of an absolute meltdown of morality and ethics. We’ve reverted to a sort of Wild West where anything goes. From the halls of congress to our corporate boardrooms our collective morality bar has sunk so low we cannot go any lower without disconnecting from the great past this nation is starved to regain. We stand dangerously close to the point where immorality begets our undoing.

Personally, I am father to a daughter of fourteen years. Brett, my co-author, is father to a twenty-month old daughter and an eighteen-year old son. We desperately want to create for our children a better world. But we are fallible men, and certainly not saints. The paragraphs you are about to read are not written from some moral high ground, or a Holier-than-thou pulpit, but rather from saddened hearts when we see that by walking our own moral tightrope, if we were to allow ourselves to slip below the bar, however slightly, we would be just as guilty as the worst perpetrators of our nation’s moral destruction. Also, when witness to greater moral transgressions, by our own inaction, we become part of the problem. And we are just two men. Amplify this by fifty million, one hundred million, or three hundred million fold and it is no wonder immorality permeates our society.

This article is our personal effort to call people’s attention to the truth. The brevity of our circumstance is immeasurable by past reference. Economically, we have never been so challenged. Over the past few decades a gullible US population cheered the halls of congress and the Oval Office alike as the incestuous bedfellows of money and politics ushered in a financial Coup d’état – co-opting our public trusts with the greed and excess of Wall Street. Profits are now had at any cost – damn the long-term consequences. Instead of being exposed as the obvious fraud he was, Bernie Maddoff was coddled by the SEC – an institution whose role as regulator is a complete failure. As Wall Street and Washington raped an entire nation, employees of the SEC were too busy surfing porn on the Internet and running private businesses instead of doing the jobs taxpayers pay them to do. All the while, young girls were selling their virginity to the highest bidder in public cyber-forums where grown men (not hormonally charged teenage boys) seek out their sexual fantasies in the netherworld of Internet pornography. What of the wives, children, and even parents of these men? Do they approve of such questionable actions?

Think of our children turning on the television to see people eating bile, cow blood, and live bugs for money on game shows like Fear Factor, or Flavor Flav and his hit reality show where he maintains a stable of women all of whom physically fight each other to have sex with him because he’s a celebrity – and a damn ugly one at that. And finally, there’s always Survivor, the ultimate demonstration of all things wrong with modern human interaction. A reality show that pits person against person in a deceitful game of moral destruction where lack of ethics are rewarded, instead of punished. Survivor, this is what our nation’s leadership has become. Win at any cost. Damn the future of anyone but myself.

Morality is in great part the measure of a nation. Have we unlearned morality? Is this why we find ourselves staring down the abyss?

We are allowing ourselves to become more corrupt by the minute. We stare into the face of our future being raped, but we do nothing. We are as corrupt as the corrupters. We accept the unacceptable. We fail to understand that absolute power, corrupts absolutely. In what will go down as the greatest financial heist in history our leaders have chosen to reward corrupt individuals and their hollow corporations for what are arguably criminal levels of risk behavior by the moneyed elite of this country. What message does that send to our children, or to anyone for that matter? Be as corrupt as possible in the US and you will be rewarded? Be the biggest failure jeopardizing the fate of others then stand in the corporate welfare line with all the other wealthiest institutions of the world, your greedy hand extended for a government bailout check while you simultaneously foreclose on an entire nation? Talk about the rich corralling the masses. It’s no wonder someone coined the term “The Sheeple.”

The path we traveled to this purgatorial limbo is both easily understood and misunderstood. The answers to understanding are sometimes right in front of us. What are seemingly benign things or actions, those everyday judgments or decisions we make to do one thing or another, are not always benign. Tell a little white lie to make that one sale that will put us into our bonus. Rig the game in our favor so that we might enjoy a little more opulence for the few decades we have remaining on this planet. Look the other way while the Federal Reserve and Wall Street blow economic bubble after economic bubble and in the process create a six-hundred trillion dollar shadow banking system that plays by no one’s rules but its own. In the case of Goldman Sachs, and Wall Street in general, lie, cheat, and steal their way to profitability at the expense of three hundred million taxpayers. The fact is that we have become an uncooperative nation willing to take advantage of anyone for the sake of profit. The idea of building a cooperative future where everyone wins has been sacrificed at the altar of short-mindedness.

It might be this purgatorial limbo I speak of is simpler than it appears. It could be that we are collectively suffering the consequences of the “Peter Principle”, or getting to the job of failure. This principle supposes that an individual rises in a corporate hierarchy to their first level of incompetence. An assembly worker gets promoted to supervisor then to assistant manager, then manager, until he next gets promoted to an upper management job for which he is ill equipped and subsequently gets promoted no further as he can no longer demonstrate the competence required for the task at hand. He rather relies on subordinates who are then stuck with an upper manager who cannot carry out his own duties. Could this be the state of our nation? Have we been promoted as far as our competence allows? Are we in fact incompetent to handle our future? Have we now elected a man just incompetent enough for the Presidency who is being manipulated by Goldman Sachs, the Federal Reserve, and a circle of (previous) Wall Street insiders now on the government payroll as cabinet members and high-ranking advisors? The saddest thing is that we sit idly by whilst our virtue is being stolen. We do nothing.

A view of the world through rose-colored glasses does no one, any good. We are not as resilient as we think we are. Instead, we exist in a world of synthetic productivity where multi-tasking renders us incapable of doing anything effectively or with any level of competence. Multi-tasking, that art of simultaneous ineffectiveness is a counter productive weapon that to a large degree has contributed to the potential failure of this nation. If you were to listen to Alan Greenspan however, you would believe that multi-tasking through technological gains by way of the “new paradigm” was the gold at the end of the Information Superhighway and that exotic mortgages and the burgeoning spending class paved the road to riches. We now know these premises to be empirically wrong.

It can now be argued that what would seemingly be advancements in productivity are proving to be setbacks. The Information Superhighway has led us to an era of technological arrogance. In reality all we have accomplished is to dilute our ability to carry out simple tasks as we click from a quarterly sales report due in an hour, to Facebook, to on-line solitaire, to writing an email explaining to our boss why the quarterly report will be delayed this day. We are a nation of excuse makers. We look for someone else to keep us one step ahead of our accumulating debt that smothers the potential of what could have been an equitable future. Ironically, it is our technological arrogance that impedes our ability to produce and manufacture our way to prosperity.

Craftsmen who used to flock to this country to fulfill the needs of a manufacturing base flock here no more. “Made in the USA” used to mean something. It meant quality. It was the definition of industrial capitalism. But now through the wonders of globalization we have exported our craftsmanship through an outflow of jobs to China and India as we turned everyone in the USA into real estate agents, mortgage brokers, and web designers – a perfect playground for bankers to ply their craft, lending money in every creative manner both thinkable, and unthinkable. “Made in the USA” has been reduced to the status of punch-line – synonymous only with “Mortgage Backed Securities” and other “Toxic Derivatives.”

Is it any wonder we have evolved into the ‘entitled society’? If we weren’t on the government payroll, or subsidized by the US taxpayer through social welfare then we were borrowing our way to prosperity. Enter the God-fearing middle class. Just dumb enough to buy into the scam a couple hundred million people began signing over their paychecks, selling their future for the enjoyment of having things now. We were transformed into non-productive Sheeple, selling our souls for an easier life in lieu of a better future for our children. At our current rate of productive attrition we will soon be a nation of declawed housecats, possessing no skill-set whatsoever to survive in a world where the ability to produce real goods still reins supreme. Yet we remain the ‘entitled society’, when we are entitled to nothing.

We forget (through economic amnesia) that throughout history all societies fail. Nicolaus Copernicus maintained that civilizations failed when bad money, controlled and understood by an elite few, drove out good money. The same can be said for morality. Bad, drives out good. This is a reality of which we should all be acutely aware but rather are immune to its possibility. We dangerously believe we cannot fail. That, in fact, is the greatest gamble of all. A roll of the dice against history, a bet against all natural laws of the universe, all things are in a state of entropy. All things eventually wither away to nothing. To possess longevity is to be ahead of the universe. Sadly, we have constructed a fragile world that produces material things that do not last. The fiat money we use as the currency of our production is by design, destructive itself. The Federal Reserve prints greed, nothing more. But still we covet it. We pursue it as if it had value. And in this pursuit we destroy earth’s resources as if the laws of nature have no relevance. We believe there is only now.

We, the entitled society, morally and fiscally bankrupt have borrowed, spent, and bailed our way into a historical corner. Nero should be so proud. Our public trusts are nothing more than government sanctioned check-kiting operations shifting liabilities from one credit card to another faster than our creditors can say “Federal Reserve.” The Ponzi-scheme that is our fiat currency system is about to go the way of what was for a time the symbol of American superiority, General Motors. It used to be said that what was good for General Motors was good for our nation. As I claimed in 2005 that GM would go bankrupt I will now guarantee that the US government is soon to follow. How our ultimate entropy will take form I cannot say, but form it will. We will default. We will restructure. It will be at this point our arrogance will end.

Tomorrow at 10 am the House Oversight Committee will hold a hearing with SEC's Robert Khuzami (oddly Mary Schapiro, together with Chris Cox, had been scheduled to appear initially, however "in a series of last minute negotiations, members settled on Khuzami") to discuss what the SEC has already found to be a criminal transaction (and attempted to promptly bury under the rug if only if it weren't for one Judge Jef Rakoff). Details of the hearing below:

Washington, DC – House Oversight and Government Reform Committee Chairman Edolphus “Ed” Towns (D-NY) and Domestic Policy Subcommittee Chairman Dennis Kucinich (D-OH) will convene a joint hearing entitled: “Bank of America and Merrill Lynch: How Did a Private Deal Turn Into a Federal Bailout?  Part V?”  The hearing will examine the events surrounding Bank of America’s acquisition of Merrill Lynch and its receipt of Federal financial assistance. 

The hearing will take place at 10:00 a.m. on Friday, December 11, 2009 in room 2154 Rayburn House Office Building.  A webcast of the hearing will be available on the Committee’s website: http://oversight.house.gov.

As for the actual hearing, Dow Jones presents this advance look of how Dennis Kucinich will approach the interrogation:

[Kucinich] plans to present Khuzami with a financial forecast that had been prepared by Merrill Lynch a few weeks ahead of the December 2008 shareholder vote on the merger, according to subcommittee documents obtained by Dow Jones. The forecast omits projected losses from Merrill Lynch's illiquid assets for the month of December and underestimates by almost half the roughly $15 billion after-tax fourth quarter loss, the documents say. Based on the subcommittee's investigations, Kucinich says he believes Bank of America executives were aware of the red flags raised by Merrill Lynch's forecast. But that didn't stop them from presenting the document to their lawyers at Wachtell, Lipton, Rosen & Katz.

Kucinich says Bank of America's decision not to investigate the Merrill Lynch document and notify shareholders of any change in expectations amounts to "an egregious violation of securities laws."

Referring specifically to the Merrill Lynch forecast, [BofA spokesman Lawrence] Di Rita said, "The matter of Merrill's projected fourth-quarter 2008 losses was considered carefully and the decisions were made in good faith at a time of unprecedented economic and market upheaval."

And while committtee chairman Edolphus Towns is allegedly satisfied with BofA's behavior in the last year, "since it paid the last of its $45 billion debt to taxpayers" even though it does not have the ready sources for this outflow, and even though the deal was merely a front to allow BofA traders to scalp exorbitant bonuses one last time before everything collapses, Judge Rakoff may not share Towns' utter lack of interest with due process and punsihment of criminal behavior, especially where said criminal behavior has already been proven.

Treasury Department Releases Text of Letter from Secretary Geithner
to Hill Leadership on Administration’s Exit Strategy for TARP

WASHINGTON – The U.S. Department of the Treasury released the text of identical letters sent today from Secretary Tim Geithner to Speaker Nancy Pelosi and Senator Harry Reid outlining the Administration's exit strategy for the Troubled Asset Relief Program (TARP) established by the Emergency Economic Stabilization Act of 2008 (EESA). The text of the letter to Speaker Pelosi follows.

December 9, 2009

The Honorable Nancy Pelosi
Speaker          
U.S. House of Representatives
Washington, DC 20515

Dear Madam Speaker:

I am writing to update you on the status of the Obama Administration's financial policies, including programs initiated under the Troubled Asset Relief Program (TARP) established by the Emergency Economic Stabilization Act of 2008 (EESA), the results they have achieved, the challenges ahead, and our plan for exiting TARP.

These policies are working.  When the Obama Administration took office, the financial system was extremely fragile and the economy was contracting sharply.  The Administration's financial and economic policies have helped to shore up confidence in our financial system.  Credit is starting to flow again to consumers and businesses, and the economy is growing.  Further, private capital is replacing public capital in our major institutions.

As a result of improved financial conditions and careful stewardship of the program, losses on TARP investments are likely to be significantly lower than previously expected.  We now expect a positive return from the government's investments in banks.  These banks will soon have repaid nearly half of the TARP funds they received.  We also expect to recover all but $42 billion of the $364 billion in TARP funds disbursed in FY2009.  Further, we plan to use significantly less than the full $700 billion in EESA authority.  As a result, we expect that TARP will cost taxpayers at least $200 billion less than was projected in the August Mid-Session Review of the President's Budget.

But significant challenges remain.  Too many American families, homeowners, and small businesses still face severe financial pressure.  Although the economy is recovering, foreclosures are increasing, and unemployment is unacceptably high.  Businesses are still cautious in the face of uncertainty about the strength of the recovery, and many small businesses face very difficult credit conditions.  Although bank lending standards are starting to ease, many categories of bank lending continue to contract.  This contraction has hit small businesses very hard because they rely heavily on such lending, and do not have the ability to substitute credit from securities issuance.  Commercial real estate losses also weigh heavily on many small banks, impairing their ability to extend new loans.

Further, the recovery of our financial system remains incomplete.  And near-term shocks to that system could undermine the economic recovery we have seen to date.

Exit Strategy for TARP

Our exit strategy for TARP balances the mandate of EESA to address these challenges with the need to exercise fiscal discipline and reduce the burden on current and future taxpayers.  There are four broad elements to our strategy.

First, we will continue terminating and winding down many of the government programs put in place last fall.  In September, Treasury ended its Money Market Fund Guarantee Program, which guaranteed at its peak over $3 trillion of assets.  The program incurred no losses, and generated $1.2 billion in fees.  The Capital Purchase Program, through which the majority of TARP investments in banks have been made, is effectively closed.  Before this Administration took office, nearly $240 billion in TARP funds had been committed to banks.  Since January 20, we have committed about $7 billion to banks, much of which went to small institutions.  Major U.S. banks subject to the "stress test" conducted last spring have raised over $110 billion in high-quality capital from the private sector.  And banks will soon have repaid $116 billion of TARP funds

Second, we will limit new commitments in 2010 to three areas.

• We will continue to mitigate foreclosure for responsible American homeowners as we take the steps necessary to stabilize our housing market.
• We recently launched initiatives to provide capital to small and community banks, which are important sources of credit for small businesses.  We are also reserving funds for additional efforts to facilitate small business lending.
• Finally, we may increase our commitment to the Term Asset-Backed Securities Loan Facility (TALF), which is improving securitization markets that facilitate consumer and small business loans, as well as commercial mortgage loans.  We expect that increasing our commitment to TALF would not result in additional cost to taxpayers.

Beyond these limited new commitments, we will not use remaining EESA funds unless necessary to respond to an immediate and substantial threat to the economy stemming from financial instability.  As a nation we must maintain capacity to respond to such a threat.  Banks are still experiencing significant new credit losses, and the pace of bank failures, which tend to lag economic cycles, remains elevated.  At the same time, many of the Federal Reserve and FDIC programs that have complemented TARP investments are ending.  This creates a financial environment in which new shocks could have an outsized effect – especially if an adequate financial stability reserve is not maintained.  As we wind down many of the government programs launched initially to address the crisis, it is imperative that we maintain this capacity to respond if financial conditions worsen and threaten our economy.  However, before using EESA funds to respond to new financial threats, I would consult with the President and Chairman of the Federal Reserve Board and submit written notification to the Congress.  This capacity will bolster confidence and improve financial stability, thereby decreasing the probability that it will need to be used.  This is the third element of our exit strategy.

In order to accomplish these goals, pursuant to Section 120(b) of EESA, I certify that I am hereby extending the authority provided under the Act to October 3, 2010.  This extension is necessary to assist American families and stabilize financial markets because it will, among other things, enable us to continue to implement programs that address housing markets and the needs of small businesses, and to maintain the capacity to respond to unforeseen threats, as described above.

While we are extending the $700 billion program, we do not expect to deploy more than $550 billion.  We also expect up to $175 billion in repayments by the end of next year, and substantial additional repayments thereafter.  The combination of the reduced scale of TARP commitments and substantial repayments should allow us to commit significant resources to pay down the federal debt over time and slow its growth rate.

Even with this extension, we expect that TARP will cost taxpayers at least $200 billion less than was projected in the August Mid-Session Review of the President's Budget, including $25 billion in potential costs from new TARP commitments in 2010.  We expect that the vast majority of these potential costs would come from mitigating foreclosure for responsible American homeowners as we take the steps necessary to stabilize our housing market.

The final element to our exit strategy is how we manage equity investments acquired through EESA while protecting taxpayers.  We will continue to manage those investments in a commercial manner and seek to dispose of them as soon as practicable.  We will exercise our voting rights only on core issues such as election of directors, and we will not interfere in the day-to-day management of individual companies.  In addition, as the steward of taxpayers' funds, Treasury will continue to manage investments in a manner that ensures accountability, transparency and oversight.  And we will work with recipients of EESA funds and their supervisors to accelerate repayment where appropriate.  We want to see the capital base of our financial system return to private hands as quickly as possible, while preserving financial stability and promoting economic recovery.

History suggests that exiting prematurely from policies designed to contain a financial crisis can significantly prolong an economic downturn.  We must not waver in our resolve to ensure the stability of the financial system and to support the nascent recovery that the Administration and the Congress have worked so hard to achieve.  Improvements in the financial performance of EESA programs put us in a better position to address the economic and financial challenges many Americans still face.  I look forward to continuing to work with you to achieve these goals.                                                               

Sincerely,

Timothy F. Geithner

Identical copy of this letter sent to:
            The Honorable Harry Reid

cc:       The Honorable Barney Frank
           The Honorable Spencer Bachus
           The Honorable David Obey
           The Honorable Jerry Lewis

I have written hundreds of articles documenting that unregulated, speculative derivatives (especially credit default swaps) are a primary cause of the economic crisis.

And I have pointed out that (1) the giant banks will make a killing on carbon trading, (2) while the leading scientist crusading against global warming says it won't work, and (3) there is a very high probability of massive fraud and insider trading in the carbon trading markets.

Now, Bloomberg notes that the carbon trading scheme will be centered around derivatives:

The banks are preparing to do with carbon what they’ve done before: design and market derivatives contracts that will help client companies hedge their price risk over the long term. They’re also ready to sell carbon-related financial products to outside investors.

 

[Blythe] Masters says banks must be allowed to lead the way if a mandatory carbon-trading system is going to help save the planet at the lowest possible cost. And derivatives related to carbon must be part of the mix, she says. Derivatives are securities whose value is derived from the value of an underlying commodity -- in this case, CO2 and other greenhouse gases...

 

 

Who is Blythe Masters?

She is the JP Morgan employee who invented credit default swaps, and is now heading JPM's carbon trading efforts. As Bloomberg notes (this and all remaining quotes are from the above-linked Bloomberg article):

Masters, 40, oversees the New York bank’s environmental businesses as the firm’s global head of commodities...

 

As a young London banker in the early 1990s, Masters was part of JPMorgan’s team developing ideas for transferring risk to third parties. She went on to manage credit risk for JPMorgan’s investment bank.

Among the credit derivatives that grew from the bank’s early efforts was the credit-default swap.

Some in congress are fighting against carbon derivatives:

“People are going to be cutting up carbon futures, and we’ll be in trouble,” says Maria Cantwell, a Democratic senator from Washington state. “You can’t stay ahead of the next tool they’re going to create.”

 

Cantwell, 51, proposed in November that U.S. state governments be given the right to ban unregulated financial products. “The derivatives market has done so much damage to our economy and is nothing more than a very-high-stakes casino -- except that casinos have to abide by regulations,” she wrote in a press release...

However, Congress may cave in to industry pressure to let carbon derivatives trade over-the-counter:

The House cap-and-trade bill bans OTC derivatives, requiring that all carbon trading be done on exchanges...The bankers say such a ban would be a mistake...The banks and companies may get their way on carbon derivatives in separate legislation now being worked out in Congress...

Financial experts are also opposed to cap and trade:

Even George Soros, the billionaire hedge fund operator, says money managers would find ways to manipulate cap-and-trade markets. “The system can be gamed,” Soros, 79, remarked at a London School of Economics seminar in July. “That’s why financial types like me like it -- because there are financial opportunities”...

 

Hedge fund manager Michael Masters, founder of Masters Capital Management LLC, based in St. Croix, U.S. Virgin Islands [and unrelated to Blythe Masters] says speculators will end up controlling U.S. carbon prices, and their participation could trigger the same type of boom-and-bust cycles that have buffeted other commodities...

 

The hedge fund manager says that banks will attempt to inflate the carbon market by recruiting investors from hedge funds and pension funds.

 

“Wall Street is going to sell it as an investment product to people that have nothing to do with carbon,” he says. “Then suddenly investment managers are dominating the asset class, and nothing is related to actual supply and demand. We have seen this movie before.”

Indeed, as I have previously pointed out, many environmentalists are opposed to cap and trade as well. For example:

Michelle Chan, a senior policy analyst in San Francisco for Friends of the Earth, isn’t convinced.

 

“Should we really create a new $2 trillion market when we haven’t yet finished the job of revamping and testing new financial regulation?” she asks. Chan says that, given their recent history, the banks’ ability to turn climate change into a new commodities market should be curbed...

 

“What we have just been woken up to in the credit crisis -- to a jarring and shocking degree -- is what happens in the real world,” she says...

 

Friends of the Earth’s Chan is working hard to prevent the banks from adding carbon to their repertoire. She titled a March FOE report “Subprime Carbon?” In testimony on Capitol Hill, she warned, “Wall Street won’t just be brokering in plain carbon derivatives -- they’ll get creative.”

Yes, they'll get creative, and we have seen this movie before ...an inadequately-regulated carbon derivatives boom will destabilize the economy and lead to another crash.

The degree of insider trading in this market is getting ridiculous. And the strangest thing is those who are executing on blatantly obvious material, non-public insider information, are no longer concerned the least bit about getting caught as they realize that the "mighty" SEC will do nothing against them, courtesy of the example the SEC has set by finding absolutely nobody "responsible" (except, of course, the regulator's own future employers who thus get immunity from prosecution) for the greatest market heist in history in which over $5 trillion has been transferred from the middle class to the Wall Street oligarchy (future providers of paychecks for SEC staffers).

Today's grotesque example of the SEC's futility to act as even a modest deterrent to insider trading activity: New York Community Bancorp (which, just so happens, is a $602 million recipient of TLGP debt), whose stock surged in the final minutes of trading for reasons (then) unknown. As reader QevolveQ pointed out at 5:30 pm, the activity in both the stock and the calls of the company was many standard deviations away from average and raised major red flags. Those questions were quickly put to rest when it became known at 6:33 pm that NYB would in fact receive FDIC subsidies to acquire newly failed AmTrust Bank in a transaction that would be "immediately accretive to earnings." And how wouldn't it be:

Under the terms of the agreement, the Community Bank did not acquire any of AmTrust Bank’s  non-performing loans serviced by AmTrust Bank or any other real estate owned; construction, land, or development loans; private-label securities, or mortgage servicing rights, nor did it acquire any of the assets or assume any of the obligations of the holding company.

No, those would conveniently be funded by Ms. Bair herself. The cost to the FDIC, and US taxpayers, to make NYB a richer enterprise: $2 billion. This is value that will go straight to the bank's bottom line. As a result of this middle-class subsidy it was a certainty that its shares would spike.

The smoking gun here comes straight from a quick observation of NYB's intraday P/V chart: the jump at 3:24pm on statistically significant volume is a clear signal that someone was fully aware of the soon to be announced transaction:

Furthermore, as QeQ highlights, "8,933 of the Dec 12 calls traded vs. 2,244 OI, finishing +300% on the day." A very solid return for a few hours of trading. The block trades are visible below: one set of 2,500 Dec $12 calls bought at $0.20, followed promptly by two more 2,500 blocks around $0.25. With the stock poised to open much higher than its closing price, someone is sure to make a killing.

It is practically certain that the NYB stock and option transactions came courtesy of a insider tip. And as NYB is both a ward of the state, courtesy of its TLGP umbilical cord, and as the bank would soon become $2 billion richer as a result of some more middle class-to-Wall Street fund flows, it is very likely that the FDIC itself is the source of such leak. We truly hope that one of D.C.'s most ineffective and useless females (if grossly, grossly overpaid for her "work" in 2008) will analyze whether the agency headed by another such female has been responsible for yet more illegal insider trading activity. That the government is only capable of promoting unpunished criminal activity would not surprise anyone at this point. And as this will be one of those cases when everything is handed to the SEC on a silver platter, we don't doubt that some minor scapegoat will be put away to make it seem like the most worthless organization in the world earns its $1 billion annual budget fair and square. What is chilling is the complete disdain that insider traders now flaunt when it comes to fear of retribution by the "regulators." And when Ms. Mary "$3.3 Million" Schapiro is done catching any and all masterminds behind this dastardly deed, we would all be very grateful if she could leave her keys, her chauffeur, and her masseuse as she packs her banker box full of Wall Street indulgences on the way out of public office once and for all - Ms. Schapiro, the public does not want you betraying its trust any longer. Now please go work for Goldman Sachs where your continued betrayal of U.S. interests will be welcome and compensated much better than the meager $3.3 million you made at Finra. The sooner you get into a job that requires efforts more consummate with your diminished capacity, the sooner you can continue counting the $5-$25 million in cash payouts you slurped up from FINRA's defined benefit plans.