Monday, August 16, 2010

Is Bernanke Engaging In Covert QE?

One theory I've been thinking about with regard to the Fed's attempt to reinflate the economy is that Bernanke would attempt to inject money into the system in ways which go largely undetected.  One way in which this is occurring is happening right in front of our eyes with very little commentary about it. You will see from the graphs below that the amount of Treasury securities held by banks has gone parabolic since the Fed has set the Fed funds target rate at basically zero.  But not only does this allow the Fed to inject free liquidity into the banking system, it gives the Government a very low cost source of funding - near-zero in the case of T-bill issuance.  This is pretty much the definition of a printing press.

With the Fed funds rate at essentially zero, banks are borrowing money at little or no cost and using the proceeds to load up on longer-dated Treasury bonds at a substantial yield pick-up, especially when considering the leverage banks can utilize at which to do this.  In other words, with a zero Fed funds rate, banks are literally printing their own cash flow by taking free money and earning a "carry" income by borrowing for free and clipping Treasury bond coupons. Isn't this the definition of a printing press? 

Why do the banks require this source of liquidity if they are posting huge income every quarter now?  Simple.  Most of that income is derived from the non-cash source of marking up their toxic, untradeable securities like mortgage-backed securities and off-balance-sheet securities like CDOs and OTC derivatives.  The banks are recognizing large "income" gains, but this does not generate cash flow. 

However, if Bernanke sets the Fed funds at level at 0-.25 (current posted Fed funds is .25), banks can borrow at a 10:1 leverage ratio at .25 and purchase last week's 30yr. Treasury bond at 3.9% and generate essentially free cash flow.  What a fabulous way to inject cash into the banking system in what can be viewed as a covert QE operation.

Just to put some numbers behind my theory, take a look at the two charts below.  The charts show the amount of Treasury bonds/notes/bills held by banks and the Fed funds rate.  Note the acceleration in bank holdings of Treausries that correlates with Ben "Buzz Lighyear" Bernanke's move to take Fed fund to essentially zero. 
(click on charts to enlarge)

If the banks were not buying these securities, thereby giving the Government very low cost funding, who would be buying them and at what interest rate would this massive volumn of Treasury issuance clear the market? This "covert" QE both keeps the banks solvent by generating risk-free cash cash flow (as opposed to non-cash accounting income) and allows the Government to fund its ever-expanding deficit at a cost this is well below that which would be set by a free market. At the end of the day, the eventual cost burden will accrue to the Taxpayer in the form of much higher inflation.


  1. It will truly be something to see when, whatever the catalyst, something causes all these institutions that are loaded to the gills with long term dated Treasuries attempt-in a state of panic- to get out of the aforesaid bonds.

  2. And gold is in a bubble! ROFLMAO. Some people are so f****** stupid!

  3. LOL. Take a look at the daily silver chart JK. Holy shit. That inverse HnS formation looks ready to burst to the upside.

  4. If you have not seen this video you are missing out, too funny:

  5. LOL. I wonder if the "hat tip" to Jesse is the Cafe Americain Jesse...

  6. gyc

    Particularly liked the bit at the end when he said he wouold open an and buy GLD. LOL

  7. Hey Dave,
    Sorry to change the subject. Any comments on ECU's latest results and financials? Also curious about your reaction to this older analysis (from 09) that was pretty harsh. Thanks in advance! OBXDave

  8. Ya. Eccelstone is a complete fraud. I don't have time to elaborate here cuz I'm running late for a tennis date, but suffice it to say that we believe he fronts for a Chicago-based hedge fund who is short ECU. He is one of the slimiest characters I have ever run into.

    If you want, you contact Wistar Holt - his firm is the 2nd or 3rd largest shareholder and he will fill you in on Eccelstone. Contact me a if you want Wistar's email address.