By Mike Whitney
February 01, 2020 "Information
Clearing House" -
A
five-alarm fire has broken out in a little known,
but critically important area of the financial
system where high-quality bonds are swapped for
cash. The “repo” market, which is short for
repurchase agreements, is part of the nondeposit,
shadow banking system that remains largely
unregulated despite the fact that it was ground zero
in the 2008 financial crisis.
On September 17, 2019, the
repo market was whipsawed by a sudden spike in
short-term interest rates that rose from the Fed’s
target rate of roughly 2% to an eye-popping 10% in a
matter of hours. The incident, that put traders into
an immediate frenzy, sent the Fed scrambling for the
printing presses where it swiftly rolled-off $75
billion to finance additional short-term loans and
to add liquidity to a market badly in need of cash.
The Fed’s efforts did in fact bring rates back down
to the 2% target-range but at great cost to its
credibility. Despite repeated assurances that the
financial crisis was over, the Fed has resumed
pumping $60 billion per month into a market that is
liquidity-starved and dangerously out-of-whack. In
truth, the only thing preventing another spike in
rates followed by an excruciating debt cascade, is
the Central Bank’s ability to bury the problem under
a mountain of freshly-minted dollar bills. Absent
that, another cataclysmic crash would be
unavoidable. Check out this excerpt from an article
from Wall Street on Parade:
“According to the data
made available on the public website of the New
York Fed, since September 17, 2019 it has
funneled a cumulative total of $6.6 trillion to
some of the 24 trading houses on Wall Street
that are known as its “primary dealers.” The
giant sum has been sluiced to Wall Street in the
form of repurchase agreement (repo) loans
without any details being provided to the
elected representatives in Congress as to which
firms are getting the money or what it’s being
ultimately used for.” (“Fed
repos have plowed $6.6 trillion to Wall Street
in 4 months”, Wall Street on Parade)
The Fed is swapping cash for
collateral of unknown quality. The public doesn’t
know the terms under which these agreements have
been made nor do they know whether the banks are
concealing their own insolvency as they did
following the collapse of Lehman Brothers in
September 2008. What we do know, however, is that
the Fed has provided a “cumulative total of $6.6
trillion” at the discounted rate of 1.55% to the
most distrusted institutions in America without any
congressional oversight, without any independent
review of the process, and without the American
people having the slightest idea of the risks that
are involved in blindly rolling over trillions of
dollars of short-term loans to these thoroughly
corrupt and totally unreformable financial
institutions.
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The Fed has no intention of
allowing the public to know what’s really going on
behind the scenes. Remember, the Fed “battled in
court for more than two years to keep the details of
its loans a secret from Congress and the American
people”, so they’re certainly not going to do an
about-face and open up today. No, what they are
going to do is push the envelope as far as they can,
operate far beyond their legal mandate, and conceal
their inappropriate or illegal activity behind an
iron wall of obfuscation and denial. Keep in mind,
no one knew the extent of the Fed’s lavish handouts
until years after the dust had settled. Check it
out:
“When the nonpartisan
investigative arm of Congress, the General
Accountability Office (GAO), tallied up the
cumulative total that the Federal Reserve had
secretly sluiced to Wall Street from December
2007 through July 21, 2010, it came to $16.1
trillion. But the GAO did not include all of the
programs that came out of the New York Fed. When
those other programs are added, the Levy
Economics Institute, using the Fed’s own data,
arrived at the tally of $19.559 trillion to the
Wall Street trading houses and another $10
trillion in central bank liquidity swaps,
bringing the bailout figure to over $29
trillion.” (“Fed
Repos Have Plowed $6.6 Trillion to Wall Street
in Four Months”, Wall Street on Parade)
So “over $29 trillion” was
shoveled into the banking system without
congressional approval and without the American
people having any idea of how they were being
finagled. We should probably expect the same
underhanded goings on in the current crisis, in
fact, that looks to be the case. The Fed is not
going to acknowledge what it is doing and the media
is not going to publish the details. It’s a
conspiracy of silence.
Some readers may remember the
$700 billion Troubled Asset Relief Program (TARP)
that was created to purchase the “toxic assets” that
were supposedly “clogging” the financial system and
dragging the Wall Street banks towards insolvency.
Originally, that program was rejected by Congress
which triggered a panic on Wall Street sending
stocks into a steep 700-plus point nosedive.
Following that bloodletting, the Fed decided to
bypass Congress in the future and, instead, usurp
extraordinary powers it was never intended to have.
And since the Fed has never been challenged on the
matter, it has made the brash assumption that it can
meddle in the markets whenever it chooses printing
as much money as it likes.
The results of the Fed’s
chronic interventions, its uber-accommodative
policy, and its perennial low interest rates, are
plain to see. Stock and bond prices have gone
through the roof soaring to record highs on an
almost daily basis. To appreciate the magnitude of
this unprecedented 11 year bull market, it helps to
know where it all began, that is, with the first
round of Quantitative Easing (QE) that was launched
in December 2008 when the Fed purchased $600 billion
in mortgage-backed securities(MBS) and $100 billion
in other debt. Naturally, when hundreds of billions
of dollars are pumped into the financial system,
prices rise. And rise they did. Take a look at the
“highs and lows” of the three main indices since the
end of the Great Recession in 2009:
On March 6, 2009, the The
Dow Jones Industrial Average (DJIA) touched a
low of 6,547. Today, (January 28, 2020) the Dow
is 28,722 points, more than 4 times higher. On
March 9, 2009, the S&P 500 hit a low of 676
points. Today it is 3,276 more than 4 times
higher. As for the NASDAQ which dropped to 1,268
on March 9, 2009. Today, the index has climbed
to 9,269 nearly 7 times its 2009 value. At the
same time, business investment remains at
historic lows, personal consumption is flat,
wages have stagnated, and the economy is still
in the throes of the weakest expansion in the
post WW2 era. Bottom line: The stock and bond
markets have not thrived because of a strong
economy but because the Fed is engaged in the
greatest bubble-blowing experiment in history.
The $60 billion per month infusions into the
repo market just adds more helium to the bubble.
So, what impact have the
Fed’s capital injections into the repo market had?
By boosting liquidity and
acting as lender of last resort in the daily
swapping of cash for collateral, the Fed has been
able to calm the markets and keep interest rates
where it wants them. But the additional flood of
cash has also ignited a stock market rally similar
to earlier incidents when the Fed used QE to
increase reserves. So, what impact have the Fed’s
injections had on stock prices? Check out this clip
from market analyst Jim Bianco at Mish Talk:
“There is no such thing
as a one-factor model to explain the stock
market. Metrics such as the Fed’s balance sheet,
repo, etc. cannot explain the stock market’s
movements in isolation.
That said, when the Fed
injects money, funds generally flow to the
best-returning market. During the financial
crisis, it was the bond market. Today, as was
the case in 1999, it is the stock market….. a
big part of this year nearly 30% stock market
gain has come on the heels of Fed moves, much
like last year’s 20% decline was coincident with
the Fed’s hawkish rhetoric.” (“Jim
Bianco Says This Is QE, Like Y2K”, Mish
Talk)
For more clarity on this
point, we turn to a brief clip of an interview with
economist David Rosenberg who explains that, when
the Fed pumps liquidity into markets, stocks rally.
“This is a liquidity and
momentum driven market. It’s been that way for
the past four months where the correlation
between the S&P 500 and the Fed’s balance sheet
has expanded to a 95% relationship. This is
a case of a very accommodative Fed policy. The
double-digit growth in the money supply is
bypassing the real economy and has entered into
asset markets broadly, and specifically into
equities. So as long as the Fed is in the game
priming the monetary pump, shorting stocks is
going to be a very dangerous game to play….
The power of the Fed has
become so acute that it has replaced the economy
as a principle influence over the stock market
to the point where there is only a 7%
correlation between GDP and the S&P 500.
Historically, in any given cycle that
relationship was anywhere between 30% and 70%.”
(“David
Rosenberg Warns “We’re Going To Have Helicopter
Money”, Zero Hedge)
The scale of the Fed’s
manipulation is truly breathtaking. Stocks are not
rising on the strength of the economy, but on the
jet-fuel from digitally-generated money produced
with the flip of a switch in the basement of the
Eccles Building. Has there ever been a bigger fraud
perpetrated on the American people?
But what are the downside
risks of such an operation?
Once again, Wall Street on
Parade helps to answer this question in a recent
article. Here’s an excerpt:
“On Monday, a member of
the New York Fed’s own Investor Advisory
Committee on Financial Markets, Scott Minerd,
published a critique which he headlined as
follows: “Global Central Banks Fueling a Ponzi
Market,” with this scary subhead: “Ultimately,
investors will awaken to the rising tide of
defaults and downgrades.”
The thrust of the article is
that central banks (which include the New York Fed’s
Wall Street money spigot that was launched on
September 17, 2019) are creating a Ponzi scheme of
liquidity that is hiding the true state of risk in
both the stock and bond markets. The implication is
that without the Fed’s cheap money flooding markets,
interest rates on questionable debt would be much
higher, thus providing a red flag for investors.
Minerd develops his thesis as follows:
“The disturbing trend is
that despite the rally in risk assets in the
prior year, the number of defaults rose by
approximately 50 percent, according to data
compiled by J.P. Morgan. Additionally, the
number of distressed exchanges increased by 400
percent.
“This correlates well
with our observation that the number of
idiosyncratic defaults has been increasing. …
However, that day of reckoning when spreads rise
is being held off by the flood of central bank
liquidity and international investors fleeing
negative yields overseas.” (“The
Man Who Advises the New York Fed Says It and
Other Central Banks Are “Fueling a Ponzi Market”
Wall Street on Parade)
Defaults are rising because
corporations and financial institutions can no
longer roll over the prodigious pile of debt they’ve
accumulated in the last few years due to the Fed’s
easy money policies. So even though stocks continue
to steadily climb higher, the rot at the foundation
of the system is becoming more and more apparent. As
defaults increase, more liquidity will be sucked
from the system, deflationary pressures will build,
the economy will stall, and stocks will fall back to
earth.
But the greatest threat posed
by the Fed’s reckless “repo” policy is not the
threat of another giant asset bubble but the
possibility that US Treasuries will lose their
exalted role as the world’s preeminent “risk free”
asset of choice. Keep in mind, that the way the Fed
finances these repos, is identical to the way it
conducted QE, by buying U.S. Treasury bills and
other high-rated securities from the banks for cash.
These securities serve as collateral for the
underlying loan, and the banks buy them back with
interest. This unconventional expansion of the Fed’s
balance sheet calls into question the true value of
USTs which are increasingly used as a tool for
preventing crises. Former Fed governor Kevin Warsh
pointed out the pitfalls of the Fed’s strategy in an
article in the Wall Street Journal titled “The New
Malaise”. Here’s what he said:
“The Fed’s increased
presence in the market for long-term Treasury
securities also poses nontrivial risks. The
Treasury market is special. It plays a unique
role in the global financial system. It is a
corollary to the dollar’s role as the world’s
reserve currency. The prices assigned to
Treasury securities–the risk-free rate–are the
foundation from which the price of virtually
every asset in the world is calculated. As the
Fed’s balance sheet expands, it becomes more of
a price maker than a price taker in the Treasury
market. And if market participants come to
doubt these prices–or their reliance on these
prices proves fleeting–risk premiums across
asset classes and geographies could move
unexpectedly. The shock that hit the financial
markets in 2008 upon the imminent failures of
Fannie Mae and Freddie Mac gives some indication
of the harm that can be done when assets
perceived to be relatively riskless turn out not
to be.” (“The New Malaise”, Kevin Warsh, Wall
Street Journal.)
With the National Debt
hovering at $23 trillion, one would think the Fed
would be more cautious in its misuse of USTs to
shore up transactions in the repo market. If present
trends continue, it’s only a matter of time before
foreign central banks trim their stockpiles of USTs
and seek a more reliable source of value. Any
significant shift away from risk free US debt will
send shock-waves through the global economy. It
would portend an abrupt changing of the guard and
the onset of a new order.
Mike lives in Washington
state. He can be reached at fergiewhitney@msn.com.
Do you agree or disagree? Post
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