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2020-01-16 09:46 by Karl Denninger
in Federal Reserve , 140 references Ignore this thread
Followup On Repo...
[Comments enabled]

In follow-up to my previous post on the Repo mess, here's another thing to consider: Negative rate bonds.

Remember that these are guaranteed loss-making instruments if held to maturity.  That is, you give a government $100,000, they give you back $99,000 (as an example) one year later.  And so on.

The only way to make money on them is for rates to go more negative by enough that you can sell them for more than you paid because the new bond is even worse.

Now economists thought these could never be sold to anyone, anywhere, for that reason.  They are a literal intentional cash bonfire with the only possible redemption being the continued stupidity of the issuer and people's willingness to buy them.  Note that in the US at least "Primary Dealers" in exchange for being the sole source of non-direct purchases are obligated to buy at the auctions.

So what happens if you, as one of these banks, are stuffed full of this garbage?  Somehow you have to make that capital back.  One way to do it is for The Fed to have alleged "Excess Reserves" which they pay for 1.5% interest on.  Heh, now we could have a -1% bond, 1.5% IOER, and, well, that nets to 0.5%, right?  Sort of.  Except that the two things are disjoint; excess reserves come from deposits of cash or sales of securities (you have to have the cash first) while negative bonds are purchased.

Hmmm... not so linked, are they?

But the ECB and others arm-twisted and indeed these bonds got sold, and bought.  Then the ECB monetized a bunch of them and issued Euros.  Heh wait -- that's a flat-out intentional currency devaluation, isn't it?  Uh huh.

So now all this trash is laying around, and suddenly there's a problem -- rumblings on the horizon about the ECB and Euro zone generally may be basically forced to exit negative rates.

Well what if they do?  What happens to the value of all the ones currently out there?  They get bushwhacked!

What if that happens while you have these allegedly-safe "bonds" in a Repo transaction somewhere?  Oh, that would be bad.

Who's got a crap-ton of this stuff?  Good question -- but there's about $13 trillion, by the last guess I saw, of this garbage out there, and I think it's fair to bet that the ordinary retail dude or the holder of a bond fund wouldn't be buying them on purpose.  So does he have them?  Probably not.

Oh, and one final question: Is the Fed's more-or-less, it appears, "permanent" Repo attempting to act as a sink for these, and if so, under exactly what authority did The Fed act (and why does Congress and the American public permit) to transfer the negative yield implication -- that is, the capital loss on a foreign government bond to the US Taxpayer?

I mean, it's not like the Citizens of the United States might decide to demand a declaration of war on a nation that conspired with our own Federal Government and Federal Reserve (along with maybe even on our own government and Fed) if they were to determine that said Fed and Government did indeed conspire to transfer a foreign government's intentional capital loss that it incurred for the benefit of itself to US tax rolls, right?

Oh, they might?

Well that's damned inconvenient.

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Jal
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" Negative rate bonds.
Remember that these are guaranteed loss-making instruments if held to maturity. "

Who own these bonds? USA friend OR USA enemies? Who will lose money?
Tickerguy
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Someone already lost money. Now they're trying to figure out who to stick with said loss.

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Winding it down.
Aztrader
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The high yield indexes haven't moved at all in the past year and the reason must be that a lot of the junk is parked on the Feds balance sheet as collateral meaning that it's not marked to market.
This whole massive fraud by the Fed to hide bad paper will not end well. We have been seeing inflation that is a lot stronger then they will every admit.
I just got a 12% increase in my prices from Switzerland who has had negative rates for about 3 years now. Prices must increase to compensate for higher wages and the cost of goods. All those stupid people that don't think there are ramifications for this BS money printing will have to learn the hard way.
Allen090
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In a deflation scenario, these bonds will appreciate in real purchasing power. That is why someone would want to buy them.

https://www.youtube.com/watch?v=vOSAxIBr....
Tdurden
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Wall Street's favorite game: Hide The Sausage. It's all fun and games until the Rufie wears off.

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"I'd like to live just long enough to be there when they cut off your head and stick it on a pike as a warning to the next 10 generations that some favors come with too high of a price." -Vir Cotto Babylon 5
Skybluepink
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So, in this scenario, the collateral would be valued at a BS price? They could just keep on rolling it and paying the interest. Wouldn't the BS value become apparent as the collateral approached maturity? Maybe they just don't care about public scrutiny anymore. After all, no one but Karl pointed out the crap they pulled when they drained liquidity going into the crisis in '08.
Redjack
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I do mass balances for a living. When rates go negative, something sucks. Either you're leaking, or your levels were never what you originally thought.

In this case, I am left wondering why someone would buy a negative bond. Heck, I am holding more cash than I have ever in my life (both in specie and tender) because I don't understand why you would put it in a savings account that has a neutral or net negative rate.

Something stinks. The economy either has a leek, or was never as full as we were led to believe. But I am just an engineer. The laws of nature tend to be a bit more concrete than finance.
Tickerguy
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@Tdurden -
Quote:
Wall Street's favorite game: Hide The Sausage. It's all fun and games until the Rufie wears off.

And you wake up with a very sore *******, half the skin from your knees is spread all over the carpet and you're laying in a mess on the bed.

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Winding it down.

Tdurden
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Sam Kinison, the late, great relationship specialist, refereed to his version of break-up sex as leaving them sticky, broke and confused. I'll let the readers find their own youtube links for that routine, but I think that is how a lot of people are going to end up once this math problem is solved for "x"

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"I'd like to live just long enough to be there when they cut off your head and stick it on a pike as a warning to the next 10 generations that some favors come with too high of a price." -Vir Cotto Babylon 5
Asimov
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Karl: Reminds me of the politician in Unintended Consequences. Add in a little coke and the semen from multiple men and you've got yourself a party! Well. Except for the waking up part.

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It's justifiably immoral to deal morally with an immoral entity.

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Flappingeagle
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Quote:
Car debt has grown an astonishing 75 percent since 2009 to about $1.26 trillion

https://usa.streetsblog.org/2019/02/13/a....

What about junk car loans? That gets bundled and resold as I understand it. Is that market big enough to be contributing substantially to the problem? Entities with this junk on the books can't use it as collateral?

One of the videos that was posted yesterday(?) in another thread also brought up a good point, rehypothecation. What if various entities are beginning to question whether or not borrowers actually own the collateral that they are posting?

Flap


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Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave the Rat Race to the rats...
Jduwaldt
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Our Host wrote..
What if that happens while you have these allegedly-safe "bonds" in a Repo transaction somewhere?
But is it not true that the person exchanging cash for the negative bonds knows their final worth? And that final worth does not change? That is, I loan someone $0.990M dollars for a bond that cost them $1.1M that I *know* matures at $1M and the other party defaults, I should still be good.

I may be kicking myself later if interest rates pop and shorter-duration bonds (that happen to mature on the same date) are a better buy so I can't sell my bond before maturity but I'm still getting my $1M on someone else's $1.1M purchase at my cost of $0.990M. But I shouldn't be going broke, UNLESS the whole purpose of buying a bond is to sell it, the devil take the maturity value.

But if that's the case then the rate of the bond itself does not really matter? The only question is, if I think rates are going up then I sell my current bond holdings. If I think they are going down, then I buy already-issued bonds from someone who thinks rates are going up or will be steady!

Context I discovered as wrote this: Repo agreements can last up to two years, and the majority is said to be three months. I was under the impression the "overnight repo market" was in trouble. Are financial reporters mixing water and oil here?

[url https://www.investopedia.com/terms/t/term-repurchase-agreement.asp wrote..
Term] repurchase agreements, on the other hand, can be as long as one year with a majority of term repos having a duration of 3 months or less. However, it is not unusual to see term repos with a maturity as long as two years. The financial institution that purchases the security cannot sell them to another party, unless the seller defaults on its obligation to repurchase the security.


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Ahhz
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As Jal said in the other repo thread: "The elite enablers all went to the same school and are all playing the same game."

Yep, that game seems to be Hot Potato. The school motto is "No honor among Thieves" and the primary lunch menu item will soon be Eat your Own.

Aztrader
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Henryfrapp
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I've seen some speculation this, effectively a bank bail out, is related to derivative exposure. I have noted over the past five weeks the option activity in the SPY has seen a closing price on expiration day that has wiped out almost all puts positions while leaving the vast majority of calls in the money. Normally, price tends to gravitate to the "Max Pain" price...this has not been the case. Over a week ago I noted a relatively huge (6X typical) call position expiring tomorrow at the 330 strike...and here we are. Meanwhile, about 500K - 600k puts will expire worthless, and only about 8k in the money (assuming we close tomorrow at 330). This has been ongoing.

Meanwhile here are the following assets to derivatives exposure for the top ten derivative players: JPM .0503, GS .0201, C .0408, BAC .0617, MS .0249, WFC .1511, HSBC .0329, Mizuho .0074, SMBC(Sumitomo).0045, STT .1000

All of those numbers above mean if those companies were to see a loss of 5% the entire market cap of most of those companies disappears. As for the negative interest rate speculation, look at the leverage of the Japanese banks...they take a mere 1% write down and they, in theory, go belly up.

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Whitehat
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could our Fed agree to hold ECB negative rate bonds as part of a trade or other political deal?

there has been a push to get Europe to accept more of our goods as pressure on China hurts Europe's exports to them. by stabilizing the Euro, we allow for a carry trade with the new exports as Europe loses much of is Asian market. we might be creating a trade arrangement between the US and Europe that is more fair to both parties by allowing them to wash their inflation created when they had greater access to the Chinese money.

as the world reserve currency, we have the ability to dilute more. not that it is right, but it could be the cold logic.

it is now no longer, "hold our bonds or currency." it is let us control your inflation.

if any Middle East or other country is willing to modernize, we will offer the same to them. no longer do we wish to export our debt, but to be the master debtor. perhaps neg rate bonds are a form of debt as they destroy money for financial reasons with obligation. think of it this way. if one owes an entity an astonishing amount of money, one owns the entity.

yes, i am postulating that buying inflation is like going into debt which might not seem to be the cleanest logic, but is based in the fact that such in just our own economy indebts subsequent generations for the present.

so this will not crash us any time soon, but eventually grind us down until we are no longer the world reserve currency or we go to war to keep it that way.

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Amused
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Phase One of the China deal was about opening up Capital Markets.

Wanna make a bet that we are backstopping some bad Chinese paper with this?
Drifter
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Pacific Northwest
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Yet again the American taxpayer is making socialism possible in the EU: military, pharma, and now buying their bull**** paper.

Haven't we been down this road before with the Libor scandal?

Tritumi
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tokyo
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Foreplay with a chain saw. FED as Lorenna Bobbit.

So up whose poop chutes can they stuff their collection of severed members?

Volunteers please step forward.
Keenan
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Western PA
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RE; the last paragraph in the Ticker:

I suggest that a key phrase in the wording of the oath of allegiance to the United States, the Congressional oath of office, etc. is dis-ordered. It seems to me that domestic enemies, as opposed to foreign, pose the greater threat to the U.S. Constitution.
Crossthread
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Wilmington, NC
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WAG? BlackRock ???

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Lobo
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Quote:
Oh, and one final question: Is the Fed's more-or-less, it appears, "permanent" Repo attempting to act as a sink for these, and if so, under exactly what authority did The Fed act (and why does Congress and the American public permit) to transfer the negative yield implication -- that is, the capital loss on a foreign government bond to the US Taxpayer?

I mean, it's not like the Citizens of the United States might decide to demand a declaration of war on a nation that conspired with our own Federal Government and Federal Reserve (along with maybe even on our own government and Fed) if they were to determine that said Fed and Government did indeed conspire to transfer a foreign government's intentional capital loss that it incurred for the benefit of itself to US tax rolls, right?

Oh, they might?

Well that's damned inconvenient.


The spin machine would have ramp up to insanely high revs to hide/obfuscate an additional $13 trillion in US debt.I'm tempted to say it couldn't be successful, but all the **** that has happened up to now hasn't provoked much of a response from taxpayers. Eventually, critical mass will be reached and an uncontrolled reaction will start. Mobs will target a small few of the guilty and a butt load of the innocent.

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Village Idiot
Aztrader
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Scottsdale, AZ
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The real question is which hedge funds or banks are dumping bad collateral on the Fed to beef up their liquidity and then dumping said cash into the markets. When the fed lengthened the maturity on the Repo paper, the market exploded. They are being allowed to use worthless collateral that is too illiquid to sell, so the Fed is giving them an out. They are pumping the crap out of the markets knowing that the end is near. They figure that if they drive it up to 30k, the downside to 25k isn't so bad even though we know it's barely worth 12k.
Gauntlet33
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@Whitehat: Interesting theory you pose...

And excuse me if I'm wrong in my analysis, but I think that what you're saying boils down to: The US is printing a **** ton of money (by putting out money in the REPO market, which avoids calling it quantitative easing) knowing full well that it will massively devalue the dollar, but at the same time not caring because it buys the US the most amount of time, and that instead of our economy blowing up instantaneously (like other westernized capitalist nations likely will), it will be a longer drawn out decline as inflation grows more and more.

However, I tend to think that as the national debt bubble grows, it inevitably will have a snowball effect where it will accelerate as we get closer, as our national debt becomes unmanageable (because other nations stop buying our debt/treasuries), and as corporate and personal debt also do the same. In other words, I believe there's no "soft landing" scenario, but perhaps the US will have a less rocky crash than other nations.

Anyway, I'm curious on Karl's take on this...
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