Dec 11, 2010
With the Federal Reserve now actively participating in capital markets, it should be noted that just like every other asset manager, the Fed has to be held accountable for its trading efficacy. After all, the Treasury takes every opportunity to remind the US public how courtesy of record amounts of new government debt, it has managed to make “profits” on its assorted investments, which are merely transfers of risk from one entity to another, and the “another” being the US taxpayer, although not directly, but indirectly via the now ludicrous amount of US debt which will never be repaid. Which is why the US taxpayer may want to know that in just the most recent POMO schedule – that from early November to December - the Federal Reserve has lost $2.4 billion in taxpayer capital by its mistimed market operations, primarily due to the recent rise in interest rates. This is $2.4 billion that has not evaporated, but instead has been transferred to Primary Dealers under the “profit on trade” category. This is also money that will be used to determine, and fund, banker bonuses.
John Lohman breaks down the specifics of the P&L calculation:
Announced par purchases: $106,300,000,000
Actual Market Value Paid: $116,457,219,800
Market Value 12/10/10 : $114,032,149,219
Taxpayer Profit/(Loss): ($2,425,070,661)
The money transfer continues, but much more concerning, the Fed continues to assume ridiculous amounts of interest rate risk on behalf of taxpayers with absolutely no Plan B should it lose control of the situation.
As Zero Hedge readers known by know, the DV01 on the Fed’s total rate holdings was recently estimated at about $1 billion. This number refers to a Fed balance sheet as of April 2010: extending the calculation for the Fed’s current ballooning holdings, means that the DV01, or the P&L impact from every basis point move up or down, is now about $1.5 billion. In simple terms, a 1% move in rates will result in a $150 billion loss to taxpayers! And so on: 2% – $300 billion, 3% – $450, although technically not in a linear fashion, as by then the convexity impact will make losses progressively larger. And that’s not all – by the time QE2 is over, and the Fed’s balance sheet is about $3.5 trillion, DV01 will be just under $3 billion!
Basically what this confirms is that should the Fed lose control of interest rates, the losses to Americans will be in the hundreds of billions, if not trillions, wiping out any imaginary profit from TARP repayments and other marginal optical illusions.
And two more thoughts: strike any thoughts that QE2 is just $900 billion of fund transfers to Primary Dealers. As we have said before, this is the notional amount of debt bought back. Adjusting for market values, means that the Fed will actually transfer well over $1 trillion in actual cash to Primary Dealers.
Second: the Fed is blasting headlong into a potential inflationary situation with absolutely no rate hedes. When will the Fed actually start managing the downside risk on its SOMA portfolio? When will Ben Bernanke or Brian Sack finally direct BlackRock to buy some upside rates protection. Of course, should the Fed do that, the move in the market predicated by the need to hedge a $2.5 trillion rate portfolio would itself start a massive sell off in rates instruments due to the feedback loop nature of modern “efficient” and volumeless markets.
This article was posted: Saturday, December 11, 2010 at 6:16 am