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12.03.08, 02:47
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Tuesday, March 11, 2008
The Short Bus Rolls Again
Let's do The Fed's action today.
The ostensible reason was to "liquefy" agency and other "AAA"
securities. Really?
Let's talk about reality.
Reality is this:
You short something it is to sell it to someone else. One of the
ways the primary dealers make their money is by shorting Treasuries
into the market, borrowing them from The Fed and then generating
carry off the money.
Over the last six months the primary dealers have borrowed an
insane amount in Treasuries and are short in aggregate close to
$100 billion of them!
What's worse, they're long all the other debt instruments, lots of
it involuntarily! Like, for example, LBO debt and mortgage
securities they can't sell into the market.
So the primary dealers are short Treasuries, which are going up in
price, and long everything else which is going straight in the
toilet!
THE PRIMARY DEALERS WERE CAUGHT IN A CREDIT MARKET SHORT SQUEEZE!
You've seen it and might have had it happen to you. Been short home
builders in the last few months when one of the "Quant" unwinds
happens? You know what happens to the market for those stocks,
right?
The price rockets higher.
Ok, what happens to treasuries when there is a huge demand? There
is a similar rocket shot in price and down in yield.
Now think about how badly it sucks to be you if you're the idiot
who packaged up all this crap debt and are watching it dwindling
towards zero in value, while what you shorted in an attempt to earn
carry is rocketing higher as everyone you sold your crap to is
dumping it on the market and fleeing into what you're short!
So what really happened today?
We were almost certainly on the verge of the collapse of one or
more of the primary dealers AND international banks FOR THE SECOND
TIME IN JUST A FEW DAYS!
Remember, The Fed just took an "extraordinary" action in expanding
the TAF!
Their only defense the primary dealers had to being forced to buy
back those treasuries at a huge loss is to borrow even more of them
from The Fed.
BUT THEY WERE OUT OF COLLATERAL TO POST OTHER THAN THESE MORTGAGE
AND OTHER "AAA" BONDS!
What's worse, this short squeeze was being fed by people who did
NOT want agency paper at any price; they were generating it by
dumping the agencies and buying Ts. They have figured out that its
contaminated (see below) and are freaking out about the potential
for serious shortfalls or outright defaults.
Remember - "AAA" means "as safe as the US Government."
Except that lately, we've learned that its not - that the claim is
a lie.
So The Fed decides that they're going to put in place a "swap" and
let the primaries exchange Treasuries (of which they have several
hundred billion) for "Agency and other AAA" paper - mortgages. The
intent is to "pair" the two, thereby halting the spread widening
and thus stopping the short squeeze.
The action today was nothing more or less than an attempt to
stabilize Agency spreads which were blowing wide in a historic
short squeeze that was threatening to collapse major financial
institutions!
Yet if you listen to CNBS, including Fast Money, you hear these
guys saying that "The Fed Injected 200 billion in money."
NO THEY DID NOT! IN FACT, THEY EXPLICITLY INJECTED EXACTLY ZERO
DOLLARS INTO THE SYSTEM; A SWAP OF ONE SECURITY FOR ANOTHER OF
IDENTICAL SIZE AND FACE IS A BIG FAT NET ZERO IN TERMS OF BALANCE
SHEET AND MONEY SUPPLY IMPACT.
THE FX MARKETS "GOT IT" IMMEDIATELY BUT NOBODY ELSE DID!
The Fed did what it always does - try to bail out the banks.
Who's in trouble?
Who the hell knows - they won't tell us!
