The Market Ticker

Up front: Thanks to Pat over on the forum for the "heads up" on this one.

This is only half-way into the tinfoil range.

Last week some $75 million of "fed funds" (that is, interbank overnight credit) was transacted at a rate of 15%, and "a bunch" went through in the low to mid 7s.

No, I didn't mistype that. You can find the actual data at this link.

Originally I, and everyone else, assumed that the "high" was an error. A bad print. That there was no chance this was "real".

It was.

Yes, "EFF" (effective fedfunds) was right where "it should be" according to The Fed - across all transactions.

Now let's think about this one for a minute here folks.

"Someone" transacted a $75 million overnight loan that they needed to meet reserve requirements at an absolutely outrageous interest rate - about what you pay for credit card money. A bunch of "someone else's" transacted a bunch at 7-7.5%.

They had the discount window available to them at 50 bips of penalty to EFF, which is a direct overnight loan from The Fed, but didn't use it.

Are you going to try to tell me that some banks actually paid nearly 10% more as an interest rate than they had to?

On what planet are we having this discussion?

There is only one possible explanation for this particular behavior - The Fed would not take the alleged "collateral" these institutions tried to put up, and the market didn't think it was worth much either, even on an overnight basis, and as such "the market" priced the interest rate similar to how Guido would for your "short-term" loan!

This raises the spectre of something truly terrifying in the credit markets -

The Fed may be inches away from losing control over the FF Rate entirely!

Indeed, for those transactions, they already have!

The implications of this, if it spreads, are truly terrifying. We are not talking about a three sigma event, a four sigma, or a five sigma.

We are talking about the equivalent of Financial Armageddon in the credit markets.

Sensing this possibility, a whole bunch of someones put on a bunch of options on the FF Futures contracts that are so far out of the "mainstream" of conventional thinking that they have zero chance of paying off unless a major dislocation event occurs.

These weren't just "idle speculators" either - they were risk management desks, repo desks and, of course, once they started to get bought hard, speculators who piled in behind them.

This sort of trade is so far out of the realm of "normal" that it deserves notice.

Unlike the options trades on the SPY (and other markets) - aka the "Bin Laden" trades that I wrote about - this is not some wild "unnamed" person putting these on.

These are the risk managers and repo desks that handle transactions in the credit markets every single day.

When they start freaking out like this, you goddamn well better sit up and take notice!

Note that back in August we didn't see shit like this. Yeah, that was bad. But even in the worst moments of August, nobody got such a wild hair up their ass that they thought The Fed would lose control of the overnight lending rate!

The little press that this did get put it out there as a "no ease" play. Uh uh.

That is a dislocation play guys and gals.

Think about this for a minute. If you think the Fed is going to cut rates, you wouldn't want to be on that side of the trade. It doesn't pay well enough. You want to be on the other side. So if the belief here is simply that someone is in big trouble and "Ben will ride to the rescue", you take the opposite position.

This bet is more akin to "The Fed loses control entirely and Effective Fed Funds trades radically higher irrespective of what Bernanke does, because nobody trusts anyone anymore - not even overnight."

In other words, this bet is one that the credit markets will go supercritical.

And it wasn't made by just one firm, one speculator, or one guy.

A few months ago I pointed out that every big equity market dump - every last one of them - has started in the credit markets. It always starts there, simply because of the volume of business transacted and the sensitivity to problems. In the equity markets one company can go "boom" and it doesn't mean much. But in the credit markets "systemic risk" - that is, a refusal to trust people as a foundational principle - once it takes hold is very, very difficult to tamp back down.

There is only one way to fix this in the credit world, and that is to force ALL of the off-balance sheet bullshit back ON balance sheets, to force ALL credit derivatives and structured credit to trade through public exchanges and to force ALL marks to be to market - anything less simply must be recorded as a "zero" until you can get an actual transaction to mark against!

That, by the way, is what I've been calling for - in the petition, in my letter to Bush, in my writings for months.

Unfortunately Hank Paulson, Ben Bernanke, The Fed as an institution and everyone else are going in exactly the opposite direction - more obfuscation, more mendacity, more myth.

We are at extreme risk here.

I do not have a way to assign a potential time, day, or event to an impending supercritical dislocation.

All I can do is note that there are market participants out there who are deathly afraid that it is going to happen and soon; they have placed their bets and spent a goodly amount of money doing it.

They smell it, and they're the ones that are close enough to the action to know about it.

What you do, with your own risk exposure, given the upcoming Fed Meeting, is up to you.