Hyper-Speculative Psycho-Facsistic Parabolic Blow-Off
Much has been written about the Fed's Permanent Open Market Operations, or the technical name for Quantitative Easing's Bond Repurchase, aka Monetization, program. What has been largely left out is the true cost in the form of a call premium that the Fed has paid out due to what amounts to an early redemption of $300 billion in par securities. From a basic bond standpoint, the Fed's buybacks of Treasuries at market prices simply represent premium redemptions as a substantial amount of the bonds bought back had been issued (at par) when interest rates were materially higher. Therefore the differential from par to market has to be considered when evaluating the actual cost to US taxpayers, and by implication, early paydown benefit to bondholders. The surprising result: after $300 billion in par repurchases (or $295 billion ex-TIPS to be precise), a whopping $27 billion has been paid by the Fed over par to account for declining interest rates over the past three decades. As the actual price paid by the Fed is known only to the Fed itself, despite claims to transparency and openness, this is at best an exercise in extended bond math. Only when the Fed is truly audited will we get a full glimpse into just how much the Treasury portion of QE has truly cost US taxpayers in order to provide a quick and lucrative "out" to all those bondholders, especially the ones who purchased bonds at lofty interest levels (and thus very discounted prices) in the early to mid 80's. In sum, even though the Fed has purchased a nominal $300 billion in assorted government securities, its actual cash outlay has likely been in the $325 billion+ ballpark. Keep in mind this analysis excludes the roughly $1.4 trillion in MBS and Agencies that Bernanke is still actively gobbling up to prevent the housing market from collapsing. A comparable exercise performed in that part of the POMO market would likely yield even more distributing results.
On March 18th of 2009, the FOMC released a statement outlining the purchase of $300 Billion in U.S. Treasury securities. However, all reporting on these purchases were released in Par terminology, with no detail given regarding the market price of these securities. This brings up the question, what was the actual price paid for these securities? It would most certainly not be at par, so one must automatically assume that it was the market price. Unfortunately, without accurate reporting due to the Fed's unwillingness to disclose any actually relevant cashflows to the broader public, the exact amount spent on this program must be estimated. This further complicates the matter since the value depends on the rate of interest used for each security and few of these securities mature at the discrete intervals used in the construction of the yield curve.
First, let’s take a look at the facts:
Individual Securities: 143
Number of Transactions: 553
Total Par: $295,448,000,000
Weighted Average Coupon: 3.7213
Weighted Average Maturity (From 11/30/09): 6.02 years
Tips are irrelevant to this study, but the total par of 13 TIP Securities purchased is $4,552,000,000 or 1.52% of the total Par Purchase amount (combined, one gets the $300 billion par total for the Treasury portion of QE). The important item to note here is that after a large period of inflation, a small number of TIP securities were purchased at deflated prices.
Now for the Treasury Bonds/Notes, there are multiple methods to estimate the approximate rate of interest used, but for the sake of not overestimating the impact, the information being reported uses the higher of the two rates surrounding the actual maturity. For example, if a note matured 4 years, it is then bounded by 3 and 5 year rates for that particular day and thus the 5 year rate was utilized to estimate a purchase price. It must be noted then that the estimate being reported MUST be less than the actual price paid, by how much can not by determined unless the Federal Reserve decides to publish the actual values. To compensate for irregularities on the curve, valuations were then calculated using continuous formulas to provide for the most accurate values.
Upon completion of this study, multiple important questions became readily apparent. These will be outlined at the end. First, let us look at a security which was issued in 2009 that was subsequently purchased by the New York Fed.
912828KN9 – 5 year note, 1.875 Coupon
Issue date: April 30th, 2009
Maturity Date: April 30th, 2014
Average Price paid at Auction: 99.6917
Total Issuance: $35,000,000,000
Average Sale Price: 99.167
Amount Repurchased by POMO at PAR: $5,961,000,000
% of Total Issuance: 17.03%
Approx Sale Price: $5,942,621,462
Number of POMO transactions: 6
Approximate Market Price Paid (total): $5,791,441,102
Approximated Gain: $169,558,897.75
Approx % Gain from Sale: 2.31%
Approx % Gain from Par: 2.84%
Issue Notification: http://www.treasurydirect.gov/instit/ann....
Well, that appears to have gone well. But unfortunately out of the 143 individual securities purchased a gain was registered (from Par) for 15 of these securities or a mere 10% of the total. The total gain from Par pricing would be $533 million or so. But that’s not what should concern you. What should concern you is the larger number of securities where we paid $28 billion in excess of par. Let’s take a look at the security which would have the largest gain over par, which was issued on August 15th, 1989.
912810ED6 – 20 year bond,
Issue date: August 15th, 1989
Maturity Date: August 15th, 2019
Total Issuance Size: 20,214,000,000
Amount Repurchased by POMO at PAR: $3,788,000,000
Percent of original issuance: 18.74%
Number of POMO transactions: 5
Approximate Market Price Paid (total): $5,356,587,487
Approximated Gain: $1,568,587,486
Approx % Gain from Par: 41.41%
In fact, when you look at the distribution of these securities, the largest gains over par ALL come from bonds issued from the late 1970’s to the early 1990’s, when they were issued with larger coupons. The plot gets thicker however when you do a Google search for each of these securities. When you research 912810ED6 you find out that in fact THIS SECURITY WAS ALSO PURCHASED IN 2001 DURING THE EARLY DAYS OF THE MELTDOWN. http://www.treasuryhunt.gov/instit/annce....
This brings up a larger issue…. Are Market Crashes the result of liquidity problems or are market crashes ENGINEERED to help solve liquidity problems? In effect, is the debt cycle the ultimate cycle? This simple exercise demonstrates that the total cost of the $295.5 billion in Treasury Purchases (not including TIPS) hypothetically would have cost the American taxpayer $322.8 billion, or rather $27.4 billion in excess of stated. This amount to roughly $100 per US citizen. How many hungry, homeless people would that feed?
And just what is the comparable "call" premium that the government has paid the likes of PIMCO and China in purchasing their MBS and Agency securities at prices exponentially over fair value? That is another exercise that we are currently conducting, but we can tell you now, dear taxpayers, your tax dollars were put to good use to pad the pockets of Mr. Gross, and all those others (all of them) who were selling MBS at market prices directly to the Fed over the past year. And with Wellington and BlackRock being completely phased out as agents in the MBS POMO program, very soon there will be absolutely no information leakage as to just how far the Fed has perverted the true state of the mortgage backed market. Which in these days of rampant and wholly accepted and endorsed bubble recreation, is a "very good thing." As Dan Aykroyd pointed out so many years ago in Spies Like Us, "Chem men'she znaesh', tem luchshe." The Chairman wholeheartedly agrees.
( For a Summary of QE Treasury purchases at market please use the link at the top of the posting to go to Zero Hedge. )
Last modified: 2009-12-23 09:18:09 by throxxofvron