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Note how we barely see
the hand of the ‘mystery’ rider [Geithner]. Note the conduit
[crop] through which the force is applied. Now note the animal that does the
heavy lifting….
Interest Rate Swaps and the Long End of the Interest Rate Curve
The rest of the world has
been a net seller of U.S. Treasuries for a number of years now. It has been
the U.S. Treasury – exercising / implementing Imperialist U.S. monetary
policy through the trading desks of the magnificent five [J.P. M., BofA, Citi, Goldy and MS]
– IN THE LONG END OF THE INTEREST RATE CURVE by selling tens upon tens
of Trillions of Interest Rate Swaps [IRS] – deals between the banks
[payers of fixed] with the Exchange Stabilization Fund [ESF] brokered by the
N.Y. Fed trading desk. This is what has kept things “appearing somewhat
normal” in the long end of the interest rate curve.
Forward Rate
Agreements [FRA’s] and the Short End of the Curve
Getting banks to purchase
U.S. Government paper in the short end of the interest rate curve [< 1
yr.] – creating the cascades in T-Bill rates depicted in C and D below
– is not solely the product of lowering the Fed Funds [over-night] rate
– and requires a different tact:
 
Zeroing in on
“C” above, we can see how Government T-Bill yields plunged down
in Q3/07 EVEN AS BANKS initial reaction was to RAISE Libor rates:
So, the plunge in rates
was CLEARLY NOT INTER-BANK TRADING
INDUCED – higher Libor rates means that banks think rates are going
higher. So what, or who, caused the plunge in short term rates????
We find the answer to
this question when we analyze the composition of J.P. Morgan’s
derivatives book [particularly the OTC Swap component of their book] from a
control period Q2/07 through Q3/07 and on to Q4/07:
Here
we see the less than 1 year Swap component of Morgan’s book grow from
25.2 Trillion in Q2/07 to 32.8 Trillion in Q3/07 before reverting back to
24.7 Trillion in Q4/07. Morgan’s < than 1 yr. OTC Swap component of
their derivatives book BLOATED by 7.5 Trillion - an insidious disgrace - in
Q3/07 before recoiling back in Q4/07. Here’s how that happened:
The less than 1 yr.
component of a derivatives book INCLUDES instruments known as FRA’s
which “settle” against 3 and 6 month U.S. Dollar Libor. OTC FRA contracts are all tailor made between
counterparties and like IRS – they require two-way credit lines between
counterparties.
Near term 3 month FRA’s would be described as:
- 0 x 3 FRA over a
specified date in the current month [basically a bet on what 3 month Libor
will be on a specific date before the current month ends.
- 1 x 4 FRA would be a bet
– between two counterparties – on what 3 month Libor will be at a
specific date in the next calendar month.
- 2 x 5 FRA would be a bet
– between two counterparties – on what 3 month Libor will be at a
specific date two months from now
The same thing applies with six month FRA’s:
- 0 x 6 FRA over a
specified date in the current month [basically a bet on what 6 month Libor
will be on a specific date before the current month ends…
- 1 x 7 FRA would be a bet
– between two counterparties – on what 6 month Libor will be at a
specific date in the next calendar month.
- Etc…
What happened in 2007 and
2008 is that the ESF acting through the N.Y. Fed trading desk – had Fed
traders call J.P. Morgan’s trading desk and ask them where they
“pay” for hundreds-upon-hundreds of billions [totalling
Trillions] worth of these 0 x 3, 1 x 4, 2 x 5, 0 x 6, 1 x 7 etc… When
Morgan posted their prices their bids were “hit” NECESSITATING
them to immediately “hedge” or purchase ungodly amounts of U.S. 3 and 6 month T-bills.
The beauty of this type
of operation, from the Treasury/Fed point of view – is that these
trades HORSE-WHIP short term rates
LOWER in a hurry, make the U.S. Dollar look strong and they mature within 3
months [the FRA’s settle vs. Libor and the T-bills mature at par]. This
is the only reason WHY J.P.
Morgan’s derivatives book could “bloat” and then
“recoil” to the tune of 7.5 Trillion in a 3 month time period.
The bad part – they leave a “paper trail” – which
exposes what they did - in the Office of the Comptroller of the Currency quarterly derivatives reports.
One of the side-effects
of this INTERVENTION on the part of the U.S. Treasury’s ESF – is
that Libor “appeared” to BREAK DOWN. The reason for the apparent
break-down in Libor was that the U.S. Treasury was trying to fix a problem of
“insolvency” [caused by too much debt] with massive additions of
“liquidity” [more debt].
The same process occurred
in 2008 when short term rates once again plunged from approximately 2.00 % to
ZERO. This time a roughly 8 Trillion “bloat” showed up in
Morgan’s < 1 yr. swap book – but not until Q1/09 – and
has, more-or-less, remained at this elevated level to this day.
Banks like Barclays
initially recognized the problem in the financial system as being an issue of
insolvency – and hence started raising rates to conserve/preserve
capital. This put them “at odds” with the ESF [via the Fed and
J.P.M.] intervention making “Libor” appear broken – as
expressed by the dramatic widening of the TED spread.
The
problem[s] with Libor are not
Barclays or Bank of England centric. This is an American [U.S. Treasury], Fed
and a J.P. Morgan centric issue. This is why no one from officialdom will
DARE speak about the size and composition of derivatives books like J.P.
Morgan [70 Trillion] et al – regularly making “adds” in
given quarters of 10+ Trillion in the “swap” components of their
books.
Ladies and gentlemen, the
ENTIRE interest rate curve has been horse-whipped to ZERO. This has been done
in the name of U.S. national security, preservation of the global U.S. Dollar
Standard, bailing out insolvent banks and at the expense of savers, pensions,
pensioners and the capital stock.
And in case any of you
are left wondering how captive banks with MONSTER derivatives books REALLY
make their dough – it’s mainly because they have privileged
insider information they glean [can you say front-run?] from being the
“go to” horses of the horse-whipping elite. Trading treasury
bonds and T-bills profitably isn’t really that difficult when you know
in advance which way interest rates are going.
And we’ve all been
horse-bleeped into thinking it was because they were the brightest and the
best.
What a let-down [or
trip-up, perhaps?].
Happy trails!
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