One of the recent themes of the Economic Undertow blog is the observation that the Treasury Department and the Federal Reserve are both running a massive money- laundering operation for the benefit of finance insiders. The only conclusion that can be drawn from this is … all concerned are ‘voting with their feet’ on the condition of the US’ and world’s economies.

It’s not a good vote. They are all heading for the exits. They’ve been heading for the exits for a year. 

One of the characters over on the right side of this blog (not in Larry Fink’s photo-montage) is John Hussman,  a stock- picker who issues a weekly news letter ripe with insightful observations, including this gem from last week’s letter:

The Federal Reserve has taken a massive amount of mortgage-backed securities onto a balance sheet that used to be restricted to Treasury securities. The purchase of these securities is reflected by a surge in cash reserves held by banks. Not only are the banks not lending these funds, they are contracting their loan portfolios rapidly. Ultimately, in order to unwind the Fed’s position in these securities, it will have to sell them back to the public and absorb those excess reserves, so to some extent, the banking system can count on losing the deposits created by the Fed’s actions, and can’t make long-term loans with these funds anyway.

Increasingly, the Fed has decided to forgo the idea of repurchase agreements (which require the seller to repurchase the security at a later date), and is instead making outright purchases of the debt of government sponsored enterprises (GSEs such as Fannie Mae and Freddie Mac). Again, the Fed used to purchase only Treasuries outright, but it is purchasing agency securities with the excuse that these securities are implicitly backed by the U.S. government.

This strikes me as a huge mistake, because it effectively impairs the Fed’s ability to get rid of the securities at the price it paid for them, should Congress change its approach toward the GSEs. It simultaneously complicates Congress’ ability to address the problem because Bernanke has tied the integrity of our monetary base to these assets. The policy of the Fed and Treasury amounts to little more than obligating the public to defend the bondholders of mismanaged financial companies, and to absorb losses that should have been borne by irresponsible lenders. From my perspective, this is nothing short of an unconstitutional abuse of power, as the actions of the Fed (not to mention some of Geithner’s actions at the Treasury) ultimately have the effect of diverting public funds to reimburse private losses, even though spending is the specifically enumerated power of the Congress alone.

Needless to say, I emphatically support recent Congressional proposals to vastly rein in the power (both statutory and newly usurped) of the Federal Reserve. Starting with the Bear Stearns deal, the Fed under Ben Bernanke has made a sharp and distinct departure from its historical role, in violation of its charter. As I noted when the bondholders of Bear Stearns were rescued, “The troubling aspect of the Fed’s action was not that it lent to a non-bank entity. That ability is clearly authorized by Section 13(3) of the Federal Reserve Act. The problem is that it made its “loans” as “non-recourse” funding – meaning that it would not stand to be repaid if the collateral itself was to fail.” This is still what the Fed seems determined to accomplish.

Hussman really cannot believe this is a … mistake! He’s far too smart and Bear- Stearn’s demise took place over a year ago! The seminal idea is the repayment didn’t matter to the Fed and still doesn’t.

The Bear- Stearns and Lehman bailouts were minuscule, less than $100 billion, the ongoing cashing in at all levels of finance is far greater.  The Fed ‘cash- for- trash’ swap with real estate lenders who are desperate to offload toxic properties includes one- quarter trillion for Agency debt plus $1.25 trillion hosed toward banks holding (worthless) mortgage securities. How much ‘statutory recourse’ is up in the air, in practical sense it is hard to get blood – or repayment – from a stone.

I’m not making this up, here’s the Fed itself:

In line with this new policy framework, the FOMC announced it would increase the size of the balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities and up to $100 billion of agency debt this year. These actions could bring the Fed’s total purchases of agency securities to $1.25 trillion this year and agency debt to $200 billion. (“Agency” refers to the government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.) Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

Add to this is the continuing Treasury funding with spill- over to primary dealers. 

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
HSBC Securities (USA) Inc.
Jefferies & Company, Inc.
J. P. Morgan Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
Nomura Securities International, Inc.
RBC Capital Markets Corporation
RBS Securities Inc.
UBS Securities LLC.

Both funds and securities at the primary dealer level are fungible and liquid. Where did all the funds ‘arrive’ to? How much cash are we talking about? No wonder everyone but the Fed wants to audit the Fed. Every day Bernanke has more to hide. The fact of all these non- recourse, non- repurchaseable loans over a long span of time add up to exactly how much? A trillion dollars – cash – is a lot of money!

The primary dealer cast of characters is the same bunch that has gotten the US public up in arms about misuse of taxpayer largess and customer abuse. Hussman argues the Fed’s commitments sandbag Congress, which is now loathe to modify programs as they would then strand these funds. Hussman is being gracious; I’m sure the funds are likely long gone, repayment is a bygone conclusion. Hussman is also being generous regarding the repo agreements. The Fed did not simply ‘forgo’ the attempt, there was push- back from primary dealers. This is from Zero Hedge:

On Monday the Federal Reserve held a major reverse repo test, as was announced by the NY Fed and by Zero Hedge. We have subsequently received several unconfirmed reports that the conducted test has been a disaster (we have calls into the Federal Reserve to confirm or deny this, we are eagerly awaiting their reply). Presumably, after conducting various repos last year, a typical transaction would be in the $1 to $5 billion range. At around the time the financial system was being pulled apart, were two separate $50 billion repo transactions on September 18, 2008, a day when as Paul Kanjorski had highlighted earlier in the year the money market system nearly collapsed as a result of Lehman and AIG’s failure, and the Reserve Fund breaking the buck. Notable about Monday’s reverse repo “test” was that it was quite sizable: in the $100 billion ballpark, on parallel with the biggest liquidity extraction from 2008. The outcome was the discovery that the dealer community does not have the capacity to do reverse transactions of this magnitude. As a result the Fed was forced to go directly to the money market industry, which has been speculated as a key source of excess liquidity withdrawals, another topic we discussed previously.

This sets a dangerous precedent on two levels. First, if the dealer community, recently expanded to consist of such middle-market banks as Jefferies which allegedly has over $20 billion on its balance sheet compliments of various Fed repo actions, is unable to satisfy reverse repos of this size, a big question mark appears as to what is the illiquid collateral backing the Dealer community, if it is unable to comply with a $100 billion liquidity withdrawal. Second, it indicates that reverse repos as a source of liquidity extraction by the Fed will be contained to the very precarious money market industry. All that is needed, in today’s hair-trigger mindset on liquidity, is for another systemic glitch to be made apparent to all market participants, before yet another run on money markets occurs. As readers will recall, money markets were recently stripped of their implicit Federal guarantees: as such, this is the biggest potential threat to a nascent “recovery.”

A bigger potential threat to the nascent recovery would be the general realization that the same finance elite the citizens are counting on to lead the way out of depression is instead commandeering the lifeboats.

Where are these elites all going to go, by the way?

The actions of the Federal Reserve invite scrutiny, to this mind the attention of a special prosecutor.  The one sure way to turn this economy around from its date with destiny is indictments unsealed, followed by FBI raids. 

An advantage finance holds over the rest of the citizenry is its fundamental and unswerving dishonesty against the willingness of the public to give finance the benefit of the doubt. Such status quo has been held in place by various, timely ‘buy- offs’. Occasionally, some otherwise normal person has been allowed by the powers- that- be to morph into a millionaire – to be chosen, to be a winner. Thus created is the illusion the system ‘works’. The system does indeed work, in ways that pull public attention awat from finance’s primary business of outright theft. Hussman’s critique is seminal in this way; he’s finally asking the right questions; looking under the right door. The Wall Street Illusion is starting to crack among its practitioners. 

Here’s yet another example of the process in action, courtesy Wall Street Manna:

Bloomberg had this story on PIMCO:

Nov. 24 (Bloomberg) — Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., increased his holdings of government-related debt to 63 percent, the highest proportion since July 2004.

Gross boosted his $192.6 billion Total Return Fund’s investment in Treasuries, so-called agency debt and other U.S. government-linked bonds from 48 percent of assets in September while reducing his position in mortgages to the smallest since May 2004, according to data on Pimco’s Web site yesterday.

What the story didn’t say was this:

PIMCO dumped their mortgage holdings for shorter term Government paper. Over $80 billion worth. That the taxpayer picked up. PIMCO front ran the QE from Bernanke, who willy nilly bought hundreds of billion worth of mortgage paper. And Gentle Ben, bought it from PIMCO, who got his willy in front of the taxpayer, to take another piece on the Government bailout of those institutions closest to the Fed.

All Bloomberg had in their story was this line:

The fund’s holdings of mortgage debt fell to 16 percent of the portfolio by market weight from 22 percent the month before, matching their smallest percentage of the assets since May 2004.

Go back to March, and you’ll then have a clearer picture:

Gross also boosted the world’s biggest bond fund’s holdings in mortgage-backed securities to 86 percent of total assets, up from 83 percent last month, according to the Newport Beach, California-based company’s Web site.

Graphically, it looks like this courtesy of ZH. The red line is PIMCO’s mortgage holdings, the blue line is the newly purchased shorter term Government debt.

This is what it looks like, the red line and the blue line … rats abandoning a sinking ship.

The ship that you are on.

Hussman’s conclusion disappointingly aims at more woe for the dollar’s value. His argument is dressed up with nowhere to go, the dollar is debased against a dollar- denominated cultural gestalt that is becoming debased even faster. Our culture is now fantasies, these being more of the tired, old same, more free lunches with the finger of fate creating more and more no- cost winners out of endless cheap energy. 

Perhaps it’s ‘better luck next time’ for Mr. Hussman as cynicism is an art that grows slowly in the mind. Then again, the audacity of finance’s ambition is perhaps too grand to accommodate at one sitting. Mindful of Lord Grey’s remark in 1914; “The lamps are going out all over Europe; we shall not see them lit again in our lifetime.” It’s hard to contemplate the end of your world even when it stares you in the face.