Doug Kass Has Highest Net Short Position Since February

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Full article can be found at Realmoney Silver by subscription. Remember Kass took the other side of the bull in 2006-7?
Slipping Away From the Herd (RealMoney Silver $)
02:30PM 10/12/09

By Doug Kass

"I see an imbalance of rewards on numerous short positions and an imbalance of risk on the long side.~I am now [am] at my largest net short position since February."

Kudlow vs. Kass 11/27/2006

XLF November 16 Calls Active, 162,000 Contracts Traded (10/12/09)

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Big volume on the XLF (Financial ETF) November 16 Call today. Over 162,000 calls traded with 27,206 open. You can see blocks of 48,000+ at both 0.46 and 0.49 from my OptionsXpress screen shot. Will the big banks benefit from yield curve induced net interest margins with lower than expected write downs? Possibly security write ups? We'll see. Traders can cash out with profits if XLF goes above 16.46-16.49, or if call volatility spikes by November expiration. Implied volatility is at 39 and historical is at 31.35 from the ISE.

XLF November 16 Call (Source: Optionsxpress)

Technically XLF is testing the downtrend started in October 2007. If the market buys the numbers and guidance, it could break out of the official downtrend and test $17.5+. If it fails...

XLF (Courtesy of

I'm not sure of the DNA makeup of the trade but Jon Najarian thinks institutions are betting on higher prices. It's funny that our financial system collapsed less than a year ago... But I guess follow the dough! At some point there has to be a volume explosion, good luck.

More information:
Bullish traders pile into financial ETF (OptionMonster)
Monday Options Recap: Fred Ruffy on SeekingAlpha
Options Update: XLF, ENER, NBR, MGM, QCOM, AYE & TIBX (OptionsInsider)

Latvia's Budget, Mortgage Plan, CDS, EUR/LVL etc (10/12/09 Updates)

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Thought I'd update you with links on Latvia situation (10/12/09) and provide a live Euro/Lat currency chart.

Latvia default risk jumps to month high on donor budget dispute (BalticBusinessNews)
Swedish banks downplay Latvian threat (
UPDATE 2-Latvia says agreed to cut budget deficit for EU/IMF (Reuters)
Latvia agrees budget cut goal (
Latvia Mulls Budget Cuts to Appease Bailout Donors (Bloomberg)
Latvia – The Insanity Continues (iStockAnalyst)
Latvian Employers' Confederation: economy yet to reach the lowest point (

EUR/LVL (via

ForexProsForex Charts Powered by - The Forex Trading Portal.

QQQQ-to-SPY Underperformed IWM-to-SPY Late July-October 2009 (Chart)

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I'm comparing the 2 Month and 20 day performance between QQQQ/SPY and IWM/SPY as ratios. From Yahoo Finance QQQQ has a 5 year beta of 1.12 and IWM 1.24. The beta (β) of a stock or index is a number describing the relation of its returns with that of the financial market as a whole or S&P 500 and in this case SPY (more at Wikipedia). When the breadth thrust launched the market in early March, QQQQ dominated the market technically and pulled up SPY and DIA (Dow Industrials ETF) during moments of indecision. Examples:

QQQQ Testing 200 Day Moving Average $33.69, Bulls Are Not Backing Down
(May 12)
SPY, DIA Hanging Onto QQQQs 200 Day Support Level (May 27)

Now I'm adding IWM (Russell 2000 Small Cap ETF). I charted out the performance of QQQQ/SPY and IWM/SPY from the most recent QQQQ/SPY peak in late July, or 2 months and 20 days ago. I saw a divergence between QQQQ/SPY and IWM/SPY performance since IWM/SPY made a higher high and QQQQ/SPY made a lower high. In numbers, QQQQ underperformed SPY by -2.08% while IWM outperformed SPY by 2.31%. Why didn't QQQQ's beta give it powers to overpower SPY during the past 3 months? Does Tech know something? How will the IWM:SPY:QQQQ gap close.. It's a conspiracy.

QQQQ-SPY & IWM-SPY (Courtesy of

David Tice: S&P Going to 400, US Dollar Going Below 65!

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Every bull's best friend, David Tice, was on Bloomberg a couple days ago. Not only does he think the market will tank, he also thinks the US Dollar Index is headed below 65. It's interesting that he thinks the US Dollar will fall with deflation. But a Dollar crisis could kill it.
"The stock market has a long way to fall because GDP is going to fall, we're going to have to work off debt, unfortunately we see a funding crisis down the road, interest rates are going to have to go higher, the Dollar is likely to go lower. We're in a heck of a mess here, and in fact we're in a mess globally."

"I think stated unemployment could easily go to 14-15% or so. GDP could decline potentially 10-15% down the road."

LCCMX Chart Testing 50 Day, Diverging With RSI, MACD (10/09/09)

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My last post was "Leader Capital's John Lekas Sees Dow 6,300, Municipal Mergers" so why not chart out his mutual fund: LCCMX (Leader Short Term Bond Fund). It is up 13% from the March lows. It is now on the 50 day moving average and RSI and MACD are near the mid points waiting for direction. What is interesting is the divergence between price and RSI and MACD .

LCCMX (Leader Short Term Bond Fund) Courtesy of

Current Yield is 4.23%, Annual Turnover: 211%, Net Expenses 1.93% (*looks like 1.35 see comments) and the top 10 holdings (mostly floating rate notes it looks like) with % allocation and maturity are as follows (data as of 8/31 from Morningstar):

Freeport-Mcmoran Copper & Gold FRN: 3.25%, 4/1/2015
Amer Honda Fin Corp Mtn Be144a 144A FRN: 2.80%, 6/2/2011
Natl City Bk Cleve Sub Mtn Be FRN: 2.44%, 6/7/2017
BANK AMER CHRLT NC MTN: 2.32%, 6/15/2016
Fifth Third Bancorp FRN: 2.26%, 12/20/2016
HSBC FINANCE CORP: 2.15%, 4/24/2012
Goldman Sachs Grp FRN: 2.05%, 3/22/2016
General Elec Cap FRN: 1.89%, 12/20/2016
Principal Life Income Fd Mtn FRN: 1.78%, 11/15/2010
GOLDMAN SACHS GROUP: 1.62%, 9/29/2014

The guy is betting on the short end of the curve and against Muni's and the equity markets. The fund is heavily weighted toward financials and it's floating, a hedge on interest rates? Read his July conference call summary.

LCCMX in the news:
Fund Managers Bracing for a Sell-Off (BusinessWeek) - 10/5/09
Eight Funds That Scream 'Dump Me!' (Morningstar) - 9/7/09

Leader Capital's John Lekas Sees Dow 6,300, Municipal Mergers

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John Lekas of Leader Capital is a bear and expects the Dow to hit 6,300 by the end of 2009 and 4,200 by the end of 2011. Going "below the double dip" on weak earnings on the top and bottom line. He thinks unemployment will be a drag on the economy [mentioning that 785,000 jobs were lost using the U6 data point, not the 265,000 number promoted] and that number will get worse, "26 to 27 million people out of work, that's not going to work, and until that number gets better we will not see a recovery".

He also thinks in-organic growth from extraordinary items will drive earnings going forward (asset sales etc.) but consolidations, mergers and refinancings recently have helped. Michael Cuggino of Permanent Portfolio Funds took the opposite view. You have to give credit to the last standing bears.

I thought what John said about municipalities was the most interesting part.
"I think it will get to the point where we see Municipalities merge in order to create efficiencies."

I did chart analysis on LCCMX right after this post here.

Ht BloggingStocks

Updates On Latvia's Distressed Situation, Soros Has Words

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Soros urges EU to do more to bail out Latvia (AFP)
"STOCKHOLM — US billionaire George Soros on Saturday called on the European Union to do more to help Latvia's hard-hit economy, expected to retract by an EU-worst 18 percent this year."

Latvia Trying To Reach Agreement With Donors: PM (RTTNews)
"Latvia is working on additional measures to reach an agreement with international donors, the premier's office said Friday.."

Soros says EU "wrong" to push austerity on Latvia (Reuters)
STOCKHOLM (Reuters) - Billionaire investor George Soros blamed the European Union on Saturday for not doing enough to help Latvia, one of the bloc's most damaged economies, recover from the financial crisis and return to growth."

IMF Wraps Up Mission In Latvia, Says Talks Were 'Fruitful' (WSJ/DJ)

WASHINGTON (Dow Jones)--The International Monetary Fund said Friday its staff had "fruitful" discussions with Latvian authorities over the country's 2010 budget plans during a mission to the beleaguered Baltic country."

Latvia austerity steps and budget cuts (
Latvia's appalling currency choice (Financial Times, 10/9/09)
Latvia 'to find more budget cuts' (BBC News)
UPDATE 2-Latvia eyes cuts for agreement with lenders-PM (
WRAPUP 2-Sweden slams Latvia mortgage plan, Latvia seeks cuts (10/8, Forbes)
INTERVIEW: Latvian Home Bill Would Hurt Recovery - Swedbank (WSJ/DowJones)
CDS On Nordic Financials Widen October 07, 2009 (DerivativesWeek (subscription)
Fitch: Latvia Economy To Contract 18% In 2009, 4% In 2010 (WSJ)

Serious stuff... If it gets serious.

Santelli, Iuorio Debate The USD, Rick Mentions Latvia (10/7)

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Rick Santelli and Jim Iuorio debate about the Dollar's action on CNBC. Rick also mentions Gold and the situation in Latvia, which DiVo has been watching..

Updates On Latvia's Mortgage Plan, Budget, Currency and Sweden (10/8)
Latvian Lat: Auction Fails, Speculation of Devaluation ($LVL)

Icahn: Good Time To Short REITs, Cautious On High Yield Debt But Likes Internet Advertising and Selective Bankruptcy Plays

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Carl was featured on CNBC with Becky Quick. Some of his thoughts on shorting the REITs, mispriced high yield debt, market schizophrenia, advertising on the internet, bankruptcy opportunities and risk of double dip. More on Icahn Enterprises later ($IEP). Hopefully he was well hedged on MOT, WCI, YHOO and minted money on 2008 volatility. Looks like CI gave up on his blog.

Facebook's Mark Zuckerberg Interview With Henry Blodget (10/6/09)

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Henry Blodget of The Business Insider interviewed Mark Zuckerberg, the founder of Facebook. He talks about what he was doing in his dorm room at the time, coming to the Valley and gives three keys to personal success.

Embedded courtesy of The Business Insider.

Zero Hedge Featured in New York Magazine

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Read a 7 page article about financial blog Zero Hedge in the New York Magazine.

Link: The Dow Zero Insurgency

Bernanke Speech: Balance Sheet Update 10/8/09 (Speech, Slides, Video)

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I put the whole speech up here why not. The full speech video can be found at The long bond and $TLT sold off today. If Treasuries come under pressure it will be interesting to see how gold and the S&P react. By the way: Ron Paul Calls for Delay to Bernanke Confirmation Hearing (WSJ).

Chairman Ben S. Bernanke
At the Federal Reserve Board Conference on Key Developments in Monetary Policy, Washington, D.C.

October 8, 2009

The Federal Reserve's Balance Sheet: An Update

To fight a recession, the standard prescription for a central bank is to lower its target short-term interest rate, thereby easing financial conditions and supporting economic growth. In the current downturn, however, the Federal Reserve has faced two historically unusual constraints on policy. First, the financial crisis, by increasing credit risk spreads and inhibiting normal flows of financing and credit extension, has likely reduced the degree of monetary accommodation associated with any given level of the federal funds rate target, perhaps significantly. Second, since December, the targeted funds rate has been effectively at its zero lower bound (more precisely, in a range between 0 and 25 basis points), eliminating the possibility of further stimulating the economy through cuts in the target rate. To provide additional support to the economy despite these limits on traditional monetary policy, the Federal Open Market Committee (FOMC) and the Board of Governors have taken a number of actions and initiated a series of new programs that have increased the size and changed the composition of the Federal Reserve's balance sheet.

I thought it would be useful this evening to review for you the most important elements of the Federal Reserve's balance sheet, as well as some aspects of their evolution over time. As you'll see, doing so provides a convenient means of explaining the steps the Federal Reserve has taken, beyond conventional interest rate reductions, to mitigate the financial crisis and the recession, as well as how those actions will be reversed as the economy recovers. I laid out some of these points in April at a conference sponsored by the Federal Reserve Bank of Richmond, but a lot has happened in the intervening period and so an update seems timely.1

For those of you who might be interested in learning more about the Federal Reserve's policy strategy, by the way, an excellent source of information is a feature of the Board's website titled "Credit and Liquidity Programs and the Balance Sheet."2 This source provides extensive and regularly updated information on our programs and goes well beyond the basic balance sheet data that we publish every week.3

To get started, slide 1 provides a bird's eye view of the Federal Reserve's balance sheet as of September 30, the quarter end, with the corresponding data from just before the crisis for comparison. As you can see, the assets held by the Federal Reserve currently total about $2.1 trillion, up significantly from about $870 billion before the crisis. The slide shows the principal categories of assets we hold, grouped (as I will explain) so as to correspond to the various types of initiatives we've taken to address the crisis. The liability side of the balance sheet, also summarized in slide 1, primarily consists of currency (Federal Reserve notes) and bank reserve balances (funds held in accounts at the Federal Reserve by commercial banks and other depository institutions). Later in my remarks, I will discuss the relationship between Federal Reserve liabilities and broader measures of the money supply. I will also discuss ways we can manage the link between the size of the Federal Reserve's balance sheet and the broader money supply during the transition back to a more familiar framework for monetary policy. Our capital, the difference between assets and liabilities, is about $50 billion.

The Asset Side of the Federal Reserve's Balance Sheet
Let's now look at the balance sheet in more detail, beginning with the asset side. For decades, the Federal Reserve's assets consisted almost exclusively of Treasury securities. Since late 2007, however, the share of our assets made up of Treasury securities has declined, while our holdings of other financial assets have expanded dramatically. As slide 1 shows, putting aside the miscellaneous "other assets" category, which includes such diverse items as foreign exchange reserves and the buildings owned by the Federal Reserve System, the assets on the Federal Reserve's balance sheet can be usefully grouped into four categories:
  • (1) short-term lending programs that provide backstop liquidity to financial institutions such as banks, broker-dealers, and money market mutual funds;
  • (2) targeted lending programs, which include loans to nonfinancial borrowers and are intended to address dysfunctions in key credit markets;
  • (3) holdings of marketable securities, including Treasury notes and bonds, the debt of government-sponsored enterprises (GSEs) (agency debt), and agency-guaranteed mortgage-backed securities (MBS); and
  • (4) emergency lending intended to avert the disorderly collapse of systemically critical financial institutions. I will say a bit more about each of these in turn.
Short-Term Lending Programs for Financial Institutions
The breakdown of the first category of assets--short-term lending programs for financial institutions--is shown on slide 2. As you can see, these assets currently total about $264 billion, which is about 12 percent of the assets on the Federal Reserve's balance sheet. This category of assets consists mainly of loans made directly or indirectly to sound financial institutions. Such loans are fully secured by collateral and, in almost all cases, by recourse to the borrowing institution, and are for maturities no greater than 90 days. Thus, they involve very little credit risk; the Federal Reserve has suffered no losses on any of these loans.

From its beginning, the Federal Reserve, through its discount window, has provided credit to depository institutions to meet unexpected liquidity needs, usually in the form of overnight loans. The provision of short-term liquidity is, of course, a longstanding function of central banks, and--as we know from Bagehot and earlier authors--a principal tool for arresting financial panics.4 Indeed, when short-term funding markets deteriorated abruptly in August 2007, the Federal Reserve's first response was to try to increase the liquidity available to the market by lowering the rate charged for discount window loans and by making it easier for banks to borrow at term. However, as in some past episodes of financial distress, banks were reluctant to rely on discount window credit, frustrating the Federal Reserve's efforts to enhance liquidity. The banks' concern was that their recourse to the discount window, if it somehow became known, would lead market participants to infer weakness--the so-called stigma problem. To address this issue, in late 2007, the Federal Reserve established the Term Auction Facility (TAF), which, as the name implies, provides fixed quantities of term credit to depository institutions through an auction mechanism. The introduction of this facility seems largely to have solved the stigma problem, partly because the sizable number of borrowers provides a greater assurance of anonymity, and possibly also because the three-day period between the auction and auction settlement suggests that the facility's users are not using it to meet acute funding needs on a particular day. As slide 2 shows, as of September 30, conventional discount window loans totaled $29 billion, and funds auctioned through the TAF totaled $178 billion. These programs, along with similar lending by other major central banks, appear to have helped stabilize the financial system here and abroad by ensuring depository institutions access to ample liquidity. In particular, increases in Federal Reserve loans to banks have been associated with substantial improvements in interbank lending markets, as reflected, for example, in the sharp declines in the spread between the London interbank offered rate, or Libor, and measures of expected policy rates.

Like depository institutions in the United States, foreign banks with large dollar-funding needs have also experienced powerful liquidity pressures over the course of the crisis. This unmet demand from foreign institutions for dollars was spilling over into U.S. funding markets, including the federal funds market, leading to increased volatility and liquidity concerns. As part of its program to stabilize short-term dollar-funding markets, the Federal Reserve worked with foreign central banks--14 in all--to establish what are known as reciprocal currency arrangements, or liquidity swap lines. In exchange for foreign currency, the Federal Reserve provides dollars to foreign central banks that they, in turn, lend to financial institutions in their jurisdictions. This lending by foreign central banks has been helpful in reducing spreads and volatility in a number of dollar-funding markets and in other closely related markets, like the foreign exchange swap market. Once again, the Federal Reserve's credit risk is minimal, as the foreign central bank is the Federal Reserve's counterparty and is responsible for repayment, rather than the institutions that ultimately receive the funds; in addition, as I noted, the Federal Reserve receives foreign currency from its central bank partner of equal value to the dollars swapped. Because the loan to the foreign central bank, as well as the repayment of principal and interest, are set in advance in dollar terms, the Federal Reserve also bears no exchange rate risk in these transactions. Slide 2 shows the current value of outstanding swap lines at $57 billion, down from $554 billion at the end of last year, reflecting the marked improvement in dollar-funding markets across the globe.

In March 2008, following a sharp deterioration in funding conditions and the near failure of the investment bank Bear Stearns, the Federal Reserve opened up its short-term lending facilities to primary dealers.5 Discount window lending and swap lines are part of the Federal Reserve's standard toolkit and are recognized in the Federal Reserve Act with provisions specifically identifying and authorizing each practice. However, the extension of credit to primary dealers is not authorized by the act in routine circumstances. To make these loans, which we judged to be necessary for the stability of the financial system and of the economy, the Board of Governors invoked general emergency lending authority provided by section 13(3) of the act, which allows the Federal Reserve to make secured loans under "unusual and exigent" circumstances to any individual, partnership, or corporation. Using this authority, the Federal Reserve made short-term collateralized loans available to primary dealers through an analogue to the discount window called the Primary Dealer Credit Facility (PDCF). In serving as a lender of last resort to this important class of financial institutions, the Federal Reserve supported broader market and systemic stability. Reflecting a gradual improvement in financial markets, outstanding PDCF credit dropped to zero this past spring. For similar reasons, the Federal Reserve also invoked the 13(3) authority to provide liquidity to another type of financial institution, money market mutual funds. The money fund industry suffered a significant run in September 2008 after a prominent fund "broke the buck"--that is, was unable to maintain a net asset value of $1 per share. Together with an insurance program offered by the Treasury, the Federal Reserve's lender-of-last-resort activity helped to end the run and stabilize the money funds. The final row of slide 2 shows that credit outstanding under the Federal Reserve programs aimed at stopping the run on money funds has also dropped essentially to zero.6

The unstinting provision of liquidity by the central bank is crucial for arresting a financial panic. By the same token, the pricing and terms of central bank lending facilities should discourage usage and encourage firms to return to the private markets when the panic subsides. Slide 2 shows that this has been the case. Short-term lending to financial institutions was zero in June 2007, just before the crisis began, and exceeded $1.1 trillion at the end of last year. Currently, as I mentioned, this category has fallen to about $264 billion, a decline of more than 75 percent since the turn of the year. We expect this trend to continue as markets improve.

Targeted Lending to Address Credit Market Dysfunction
The second category of assets on the Federal Reserve's balance sheet, shown on slide 3, consists of targeted lending programs aimed at improving the functioning of certain key credit markets, thereby providing critical support to the economy. Unlike the first category of assets, some of these loans are to nonfinancial borrowers. As the slide shows, this category comprises the Commercial Paper Funding Facility (CPFF) and the Term Asset-Backed Securities Loan Facility (TALF). The current amount of credit outstanding under these programs is about $84 billion, or four percent of the assets held by the Federal Reserve.

The commercial paper market is an important source of short-term funding for both financial and nonfinancial firms in the United States. In September 2008, the collapse of the investment bank Lehman Brothers set off a chain reaction: The money fund that broke the buck, to which I just alluded, did so because of its losses on Lehman Brothers commercial paper. Because money market funds are major investors in commercial paper, the run on the money funds that ensued also severely disrupted the commercial paper market. During this period, commercial paper rates spiked, even for the highest-quality firms. Moreover, most firms were unable to borrow for terms longer than a few days, exposing both the borrowing firms and the lenders to significant rollover risk. The Federal Reserve's CPFF addressed this risk by offering to lend at a term of three months, at a rate above normal market rates plus upfront fees, to high-quality commercial paper issuers. This program appears to have been quite successful. Since the CPFF was created, commercial paper spreads have returned to near-normal levels, and--as anticipated--borrowings from the CPFF have declined sharply, from $334 billion at the turn of the year to less than $50 billion today.

Before the crisis, securitization markets were an important conduit of credit to the household and business sectors; some have referred to these markets as the "shadow banking system." Securitization markets (other than those for mortgages guaranteed by the government) were virtually shut down in the crisis, eliminating an important source of credit.7 To address this concern, the Federal Reserve, in conjunction with the Treasury, launched the TALF. Under the TALF, eligible investors may borrow to finance purchases of the AAA-rated tranches of certain classes of asset-backed securities. The program originally focused on credit for households and small businesses, including auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. More recently, we have added commercial mortgage-backed securities to the program, with the goal of mitigating a severe refinancing problem in that sector.

The TALF has had some success in restarting securitization markets. Rate spreads for asset-backed securities have declined substantially, and we are seeing some market activity that does not use the facility. Like our other programs, the TALF carries little credit risk for the Federal Reserve, because we lend investors less than the value of the collateral and because capital from the Treasury provides additional loss-absorption capacity. Unlike the other programs, TALF credit outstanding has increased over time, as the loans made under this program are for terms ranging from three to five years.

Relative to the Federal Reserve's short-term lending to financial institutions, the CPFF and the TALF are rather unconventional programs for a central bank. I believe they are justified by the extraordinary circumstances of the past year and by the need for the central bank's crisis response to reflect the evolution of financial markets. Nonbank sources of credit, such as the commercial paper market and the securitization markets, are critical to the U.S. economy, especially compared with the more bank-centric economies of many foreign countries. By backstopping these markets, the Federal Reserve has helped normalize credit flows for the benefit of the economy.

Purchases of Longer-Term, Marketable Securities
The third major category of assets on the Federal Reserve's balance sheet is holdings of high-quality, marketable securities--specifically, Treasury securities, agency debt, and agency-backed MBS. As shown by slide 4, these holdings currently total about $1.6 trillion, or about 75 percent of Federal Reserve assets. By way of comparison, slide 4 also shows that, prior to the crisis, the Federal Reserve held $791 billion in securities, which was about 90 percent of its assets, and that all of these securities were Treasury obligations.

Even as other categories of assets shrink, Federal Reserve holdings of longer-term securities are set to continue to rise in the near term and will increasingly dominate the asset side of the balance sheet. As slide 4 shows, our holdings of securities declined from the period before the crisis to the beginning of this year. The Federal Reserve announced in November 2008 that it would begin to purchase agency debt and agency MBS; then in March, it announced plans to increase such purchases to as much as $1.25 trillion in agency-backed MBS and $200 billion in agency debt, and also announced plans to buy up to $300 billion in Treasury securities.8 We recently indicated that we expect to purchase the full $1.25 trillion of agency-backed MBS announced in March.9 The Treasury purchase program is being completed this month, while the purchases of agency securities will be executed by the end of the first quarter of 2010. Note, incidentally, that the Federal Reserve's purchases of Treasury securities have served only to bring its holdings of U.S. Treasury debt back to roughly the level of before the crisis. The principal goals of our recent security purchases are to lower the cost and improve the availability of credit for households and businesses. As best we can tell, the programs appear to be having their intended effect. Most notably, 30-year fixed mortgage rates, which responded very little to our cuts in the target federal funds rate, have declined about 1-1/2 percentage points since we first announced MBS purchases in November, helping to support the housing market.

Support for Specific Institutions
In addition to the programs I have discussed, the Federal Reserve has provided financing directly to specific systemically important institutions. In particular, with the full support of the Treasury, we used our emergency lending powers to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Co. and also to prevent the imminent default of the insurance company AIG. Slide 5 summarizes the amount of credit outstanding from these episodes.

From a credit perspective, these emergency loans obviously carry more risk than traditional provisions of central bank liquidity. Two observations on this point are worth making: First, these loans amount to less than five percent of the Federal Reserve's balance sheet. Thus, Federal Reserve loans that are collateralized by riskier securities are quite small compared with our holdings of assets with little or no credit risk. Second, and more important, these financial risks were the result of actions taken to avert what likely would have been a substantial further intensification of the financial crisis, with potentially dire economic consequences.

All that said, we undertook these operations with great discomfort and only because the United States has no workable legal framework for winding down systemically critical financial institutions in a way that would allow firms to fail and their creditors to lose money without inflicting massive damage on the financial system. The Administration and other regulatory agencies have joined the Federal Reserve in calling on the Congress to develop a special resolution regime for systemically critical nonbank financial institutions, analogous to one already in place for banks, that could be invoked when the impending failure of such institutions threatens financial stability. The rules governing such a regime should spell out as precisely as possible the role that the Congress expects the Federal Reserve to play in such resolutions.

The Liability Side of the Federal Reserve's Balance Sheet
Having reviewed the main categories of assets on the Federal Reserve's balance sheet, let me touch briefly on the liability side (slide 6). The two main components of our liabilities are Federal Reserve notes (that is, paper currency) and reserves held at the Federal Reserve by depository institutions. In addition, as the government's fiscal agent, the Federal Reserve holds Treasury deposits.

The amount of currency in circulation is determined by the public's demand. The "public" here includes non-U.S. residents, as, by some estimates, more than one-half of U.S. currency by value is held outside the country. Banks are required to deposit with the Federal Reserve a certain quantity of reserves, which depends on the amount of customer deposits that the banks hold.10 Reserves exceeding the required amounts are called excess reserves. As you can see from slide 6, the large majority of bank reserves are currently excess reserves.

Effectively, the Federal Reserve funds its lending and securities purchases primarily through the creation of bank reserves. As you can see, the quantity of bank reserves held at the Federal Reserve has risen dramatically as the Federal Reserve's balance sheet has expanded, and reserves are likely to continue to grow as the Federal Reserve purchases additional agency-backed securities. Currency and bank reserves together are known as the monetary base; as reserves have grown, therefore, the monetary base has grown as well. However, because banks are reluctant to lend in current economic and financial circumstances, growth in broader measures of money has not picked up by anything remotely like the growth in the base. For example, M2, which comprises currency, checking accounts, savings deposits, small time deposits, and retail money fund shares, is estimated to have been roughly flat over the past six months.

Large increases in bank reserves brought about through central bank loans or purchases of securities are a characteristic feature of the unconventional policy approach known as quantitative easing. The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy nonmoney assets or to spend more on goods and services. In a quantitative-easing regime, the quantity of central bank liabilities (or the quantity of bank reserves, which should vary closely with total liabilities) is sufficient to describe the degree of policy accommodation.

Although the Federal Reserve's approach also entails substantial increases in bank liquidity, it is motivated less by the desire to increase the liabilities of the Federal Reserve than by the need to address dysfunction in specific credit markets through the types of programs I have discussed. For lack of a better term, I have called this approach "credit easing."11 In a credit-easing regime, policies are tied more closely to the asset side of the balance sheet than the liability side, and the effectiveness of policy support is measured by indicators of market functioning, such as interest rate spreads, volatility, and market liquidity. In particular, the Federal Reserve has not attempted to achieve a smooth growth path for the size of its balance sheet, a common feature of the quantitative-easing approach.

Exit Strategy
My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. Looking at the Federal Reserve's balance sheet is useful, once again, in helping to understand key elements of the Federal Reserve's exit strategy from its current policies (slide 7).

As we just saw in slide 6, banks currently hold large amounts of excess reserves at the Federal Reserve. As the economy recovers, banks could find it profitable to be more aggressive in lending out their reserves, which in turn would produce faster growth in broader money and credit measures and, ultimately, lead to inflation pressures. As such, when the time comes to tighten monetary policy, we must either substantially reduce excess reserve balances or, if they remain, neutralize their potential effects on broader measures of money and credit and thus on aggregate demand and inflation.

To some extent, excess reserves will automatically contract as improving financial conditions lead to reduced use of our special lending facilities and, ultimately, to their closure. Indeed, as I have already noted, the amount of credit outstanding in the first two categories of assets (short-term lending to financial institutions and targeted lending programs) has already declined substantially, from about $1.5 trillion at the beginning of the year to about $350 billion. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Federal Reserve mature or are prepaid.

However, even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time--paying interest on reserve balances and taking various actions that reduce the stock of reserves. In principle, we could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.

The Congress granted us authority last fall to pay interest on banks' balances at the Federal Reserve. Currently, we pay banks an interest rate of 1/4 percent. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate. In general, banks will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk. Thus, the interest rate that the Federal Reserve pays should tend to put a floor under short-term market rates. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed. Considerable international experience suggests that paying interest on reserves is an effective means of managing short-term market rates. For example, the European Central Bank (ECB) allows banks to place excess reserves in an interest-paying deposit facility. Even as the ECB's liquidity operations have substantially increased its balance sheet, the overnight interbank rate has remained at or above the ECB's deposit rate. The Bank of Japan, the Bank of Canada, and several other foreign central banks have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

Although, in principle, the ability to pay interest on reserves should be sufficient to allow the Federal Reserve to raise interest rates and control money growth, this approach is likely to be more effective if combined with steps to reduce excess reserves. I will mention three options for achieving such an outcome.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements (reverse repos) with financial market participants, including banks, the GSEs, and other institutions. Reverse repos, which are a traditional and well-understood tool of monetary policy implementation, involve the sale by the Federal Reserve of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date. Reverse repos drain reserves as purchasers transfer cash from banks to the Fed. Second, using the authority the Congress gave us to pay interest on banks' balances at the Federal Reserve, we can offer term deposits to banks, roughly analogous to the certificates of deposit that banks offer to their customers. Bank funds held in term deposits at the Federal Reserve would not be available to be supplied to the federal funds market. Third, the Federal Reserve could reduce reserves by selling a portion of its holdings of long-term securities in the open market. Each of these policy options would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has a wide range of tools for tightening monetary policy when the economic outlook requires us to do so. We will calibrate the timing and pace of any future tightening, together with the mix of tools, to best foster our dual objectives of maximum employment and price stability.

By using our balance sheet, the Federal Reserve has been able to overcome, at least partially, the constraints on policy posed by dysfunctional credit markets and by the zero lower bound on the federal funds rate target. By improving credit market functioning and adding liquidity to the system, our programs have provided critical support to the financial system and the economy. Moreover, we have carried out these programs responsibly, with minimal credit risk and with close attention to the exit strategy. Our activities have resulted in substantial changes to the size and composition of our balance sheet. When the economic outlook has improved sufficiently, we will be prepared to tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration.

Source: Federal

Related articles:
Dollar Rises as Bernanke Says Fed Set to Tighten Upon Recovery (Bloomberg)
2nd UPDATE: Bernanke: Fed Ready To Tighten As Economy Heals (Dow Jones)
FOREX-Dollar gets a reprieve after Bernanke remarks (Reuters)
Treasuries Decline, Head for Weekly Loss, on Fed Policy Outlook (Bloomberg)
Fed's Hoenig: Fed Funds Rate Can't Remain Low Indefinitely (Dow Jones)

Interest Rate Differentials Are Dollar Bearish UNTIL Fed Rate Hike Speculation

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Win Thin, senior currency strategist at Brown Brothers Harriman & Co talks with Bloomberg. He believes that interest rate differentials will work against the US Dollar in the near term however Fed rate hikes in 2010 will bring a Dollar rebound.

Ken Fisher Thinks We Need More Debt, Return On Assets Too High

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I forgot to put this up! Bring out the Dupont ratios for this one folks. On Tech Ticker on 9/17, Ken Fisher said that our "total balance sheet" needs more debt to boost ROA (GDP/Total Assets).
"I created this total balance sheet for all sectors of the United States (business, personal and Government) and then you look at our income which we call GDP (that's our return), our return on our total assets is very high compared to our after tax borrowing cost. The way you would know you are over-levered was when your after tax borrowing cost would start to approximate your return on assets. But our return on assets is still very high therefore you know we will have more people finding ways to borrow money to avail themselves of"
What if rates spike??? Aaron Task and Henry Blodget challenge his view.

Option and Volatility Links for 10/8/09: IYR, EWH, TBT, BRCD, COP

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UBS vs. Goldman on Wells Fargo Target, $20 or $35 ($WFC)

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Basically moving my disqus comments from here onto this blog post. I feel like a Google Wave would have been easier. Who will be right on Wells Fargo (WFC) going forward? Place yo bets... I provided a real time chart of $WFC below.

Goldman: Upgraded Wells Fargo to "buy" with $35 target. They said it trades at a 6x multiple with the average large cap banks trading at 7x so there is upside. Read full article at Barron's ("A Bullish Wells Fargo Trade").

UBS: Initiated Wells Fargo at "sell" with a $20 target.
"Both Wells Fargo and PNC face "meaningful" credit problems in the near term that make them likely to disappoint the Street's 2010 and 2011 earnings forecasts, UBS said. UBS set a $20 price target for Wells Fargo"
Regional Banks Facing Bigger Credit Headwinds, UBS Says (DJ via WSJ)

Chris Whalen Warns Of Rough Q4 For Bank Earnings

Updates On Latvia's Mortgage Plan, Budget, Currency and Sweden (10/8)

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Updates on the debacle in Latvia..

Latvia looks for additional budget cuts (Forbes/AP)
Latvia Mortgage Plan No Devaluation Prelude, Commerzbank Says (Bloomberg)
Riga rules out currency devaluation (
Latvian FinMin says seeking further budget steps (Reuters)
How exposed is Sweden? ( Blogs)
WRAPUP 1-Latvia grapples to satisfy lenders, markets wary (Reuters)
Latvian currency at weak end of peg in early trade (Reuters)
ANALYSIS-Muted Latvian fallout raises risks to IMF-EU aid (Reuters)
Swedish head warns Latvia on obligations - paper (Reuters)
UPDATE 1-Better to cut budget than lose aid, Latvian PM says (Reuters, 10/7)
Bank of Latvia warns of "wave of distrust" (MarketWatch, 10/7)

I could only find a decent chart of the Lat (free) at that I could put a trend on. Here is the EUR/LVL and USD/LVL trading live via It is affecting the Euro more than the USD. So maybe this won't spread.

ForexProsForex Charts Powered by - The Forex Trading Portal.

ForexProsForex Charts Powered by - The Forex Trading Portal.

USD/LVL (Snapshot courtesy
EUR/LVL (Snapshot courtesy of

By the way Adam Hewison over at was spot on with the gold break out recently. Here is a recent video of him analyzing the gold ETF (GLD). He sees gold hitting 1200-1300 an ounce and 120-130 on the ETF.

Latvian Lat: Auction Fails, Speculation of Devaluation ($LVL)

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Could this be a catalyst for a USD carry trade unwind if fears spread throughout the Baltic region? This is nothing new though, read Latvian Lat Falls, Blondes Rally from early June. I provided a $USD/LVL chart below for you to keep an eye on the pair. From today's WSJ article:
"The criticism came as a government bond auction failed to attract buyers, and worries about the Latvian economy weighed on the currencies of Sweden -- whose banks are Latvia's major lenders -- and other countries."

"Latvia's struggle has continued for months and its current woes revived market speculation that the country could try to ease its troubles by devaluing its currency, the lat. Such a move could trigger devaluations in the region as Latvia's neighbors come under pressure from nervous markets, analysts said."
Full Article: Latvia's Woes Rise as Auction Fails (10/8/09)

ForexProsForex Charts Powered by - The Forex Trading Portal.

Hat tip: Across The Curve by way of Eco_Feed.

Conundrum: $TLT and $GLD 4 Month Chart, Someone Explain This

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We have a condundrum on our hands. Look at the 4 month chart of $TLT and $GLD move up side by side. Does this mean we are in for deflation while the USD gets pushed out of trade? If it doesn't decouple that is... Someone please explain this. Anyway read this: Which Will Blink First? (MarketWatch).

TLT vs. GLD 4 Months (Courtesy of

Gold COT Report At Extremes, 92% Bullish on 9/29/09

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Do you run with the large specs or fade them on the breakout? I remember Gregor Macdonald on MacroTwits not too long ago mentioned the extreme level on the gold commitment of traders report. You can find charts at or get the data at (US Commodity Futures Trading Commission).


$GLD Makes New High Above March 2008, Volatility and Protection (Charts 10/6)

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$GLD, the gold ETF, broke above the March 2008 intra-day high of 100.44. Good job Paulson and Pento. The Sky's the limit if no downside catalysts fuel a risk reversal. If I were to run with this, IMO, a stop under $100 and put protection would be mandatory. GLD implied volatility is at 23.55 while historical is at 15.25. When $GLD broke out of that symmetrical triangle IV hit a peak of 26 before selling off. The ISEE ratio is at 213 meaning the opening call/put ratio is at 2.13. Explanation on ISEE ratio.

Chart courtesy of

This was probably contributed to the breakout (oil traders ditching the US Dollar?)..

Be careful because Fed speak could ruin this trade at any time. Also if the market and commodities start to sell off with a stronger dollar, GLD could get crushed. Some people are hedging that risk. Reported from the VIX pit by OptionMonsterTV, someone bought 10,000 Oct 30 VIX calls which could be hedging Q3 earnings results. There was also out of the money put action on IWM (Russell Small Cap ETF): Bought: 40,000/March 2010 60 Puts, Sold: 40,00/March 2010 45 Puts (explanation at IWM closed at $60.31 today and $VIX cash closed at 25.70.

Previous posts on GLD:
Santelli vs. Pento on Gold, Charts: CRB, Gold, Dollar, 30Y Treasury 9/7/09
GLD Breaks Out, December $100 Call Up 49% (Charts: GLD, Comex Gold Futures) 9/3/09
Gold Spot Eyeing $1,000, GLD at Inflection Point (2 Year Chart) (8/6/09)
John Paulson Buys GLD, GDX. Laidi Long Gold/Oil Pair Trade (5/20/09)

Chris Whalen Warns Of Rough Q4 For Bank Earnings

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Chris Whalen of Institutional Risk Analytics was on Tech Ticker the other day. I listened to him speak to congress about credit default swaps not too long ago on CSPAN which was interesting (link).
"When you see the markets rallying when the real economy is shrinking that tells you this [recovery] is not going to be very enduring," Whalen says." (Tech Ticker)

He was "astounded" by Goldman's upgrades of Wells Fargo and Capital One this week.

Things should get VERY VERY interesting here.................

Tech Ticker sources:
"Astounded" by Goldman's Upgrade: Banks "Heading Into the Storm," Whalen Says

The "Real" Economy Is Dying: Q4 "Going to Be a Bloodbath," Whalen Says

Robert Prechter Sees 30% Decline From These Levels During Next Wave (10/5/09)

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Prechter predicted the March lows, the June-July correction and the 1,000-1,100 target. He now thinks we are going to see another wave to the downside. Get ready to surf an amazing short if the next wave can drown those freshly printed US Dollars. Watch the trend line for a break folks.

February 2009

June 2009

"At that time (March) I was looking for the biggest rally since the high and we had a target range on the S&P of 1,000-1,100. We've reached that area and all the same indicators are now on the other side of the ledger"

October 2009

Thomas Lee of JP Morgan Sticking With 1,100 S&P Target (Bloomberg Interview)

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Tom Lee (Chief US Strategist of JP Morgan) has been spot on with his 1,100 call on the S&P from this June 17, 2009 (Reuters Interview). HE IS STICKING WITH HIS CALL FOLKS. Here is the Bloomberg interview from a few days ago with a quick summary (Link: JPMorgan's Lee Interview on Stock Market Outlook). His 2010 EPS Estimate at $75/share.

Australia Raises Rates By .25 to 3.25%, AUD/USD Reaction (Charts, Articles)

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Wow, the Australian central bank increased interest rates by a quarter point to 3.25%. Up from a 49 year low. AUD/USD spiked 0.83% as of 12:45a and is testing the Sep 30 high of 0.8854. Right now it is at .8846. If that area gets taken out then 0.90 is next. Look at that clean 20 weekma/100weekma cross on the weekly to the upside which proves strong momentum. I thought we'd see a correction at the .68% retracement level, guess not. The Australian Dollar priced in US Dollars rose about 40% since the reflation trade began in February. There was a minor AUD/USD correction in June-July but that's about it. It would be very interesting to see AUD/USD retrace 100% of it's losses from the July 2008 peak to October 2008 low (during the financial crisis). I'd watch that strong uptrend and if it gets broken, hedge or position accordingly imo.

The Dollar is NOT getting much love these days. For example read this article:
The demise of the dollar (The Independent). "In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading". Here are charts and articles.

Australia's shares come off highs on surprise rate hike (Market Watch)
RBA puts housing market in jeopardy say brokers (
Australia raises rates, more expected (Reuters)
Australia Lifts Key Rate From 49-Year Low, Signals More to Come (Bloomberg)

AUD/USD Hourly (Courtesy of
AUD/USD Weekly (Courtesy of

Full statement from the Reserve Bank of Australia (Source:

No: 2009-23
Date: 6 October 2009
Embargo: For Immediate Release


At its meeting today, the Board decided to raise the cash rate by 25 basis points to 3.25 per cent, effective 7 October 2009.

The global economy is resuming growth. With economic policy settings likely to remain expansionary for some time, the recovery will likely continue during 2010 and forecasts are being revised higher. The expansion is generally expected to be modest in the major countries, due to the continuing legacy of the financial crisis. Prospects for Australia’s Asian trading partners appear to be noticeably better. Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets. For Australia’s trading partner group, growth in 2010 is likely to be close to trend.

Sentiment in global financial markets has continued to improve. Nonetheless, the state of balance sheets in some major countries remains a potential constraint on their expansion.

Economic conditions in Australia have been stronger than expected and measures of confidence have recovered. Some spending has probably been brought forward by the various policy initiatives. As those effects diminish, these areas of demand may soften somewhat. Some types of capital spending are likely to be held back for a while by financing constraints, but it now appears that private investment will not be as weak as earlier expected. Medium-term prospects for investment appear, moreover, to be strengthening. Higher dwelling activity and public infrastructure spending is also starting to provide more support to spending. Overall, growth through 2010 looks likely to be close to trend.

Unemployment has not risen as far as had been expected. The weaker demand for labour over the past year or so nonetheless has seen a moderation in labour costs. Helped by this and the earlier fall in energy and commodity prices, inflation has been declining, though measures of underlying inflation remained higher than the target on the latest reading. Underlying inflation should continue to moderate in the near term, but now will probably not fall as far as earlier thought.

Housing credit growth has been solid and dwelling prices have risen appreciably over the past six months. Business borrowing has been declining, as companies have sought to reduce leverage in an environment of tighter lending standards. But large firms have had good access to equity capital and access to debt markets appears to be improving, helped by the better-than-expected economic conditions and increased willingness on the part of investors to accept risk. Share markets have recovered significant ground.

Interest rates facing prospective borrowers on fixed-rate loans have already risen to some extent, as markets have anticipated a higher level of the cash rate. For many business borrowers, increases in risk margins will still be occurring for some time yet. In addition, the exchange rate has appreciated considerably over the past year, which will dampen pressure on prices and constrain growth in the tradeables sector. These factors have been carefully considered by the Board.

In late 2008 and early 2009, the cash rate was lowered quickly, to a very low level, in expectation of very weak economic conditions and a recognition that considerable downside risks existed. That basis for such a low interest rate setting has now passed, however. With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the Board’s view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy. This will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead." (Source)

The Alignment of Asset Reflation and a Collapsed Economy

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Great post at The Alignment of Asset Reflation and a Collapsed Economy
**"Like the prestige-performance gap, the divergence between the economy and asset prices apparently has to become even more grotesque before people will understand."

Rutgers Econ Professor: Jobs Won't Recover Until 2017 (Joseph Seneca)

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Rutgers Economics Professor Joseph Seneca thinks we won't see a jobs recovery until 2017. "It will take over 7.5 years, til the middle of 2017, to get back to those labor market conditions that existed at the end of 2007, a 4.9% unemployment rate".

A new normal?
Oct. 5 (Bloomberg) -- "Mohamed El-Erian says economists are wrong to dismiss unemployment as merely a lagging indicator, a sign of where the economy has been. For the chief executive officer of Pacific Investment Management Co., the 26-year high jobless rate is also an omen of things to come."

Recent posts:
Unemployment at 9.8%, Most Annual Job Cuts Since 1930s (BLS Report, Charts) 10/4
Q2 Household Equity Up But Asset/Liabilities Ratio At 65 Year Low 9/18

Roubini: Stocks Have Risen Too Fast, Expects U-Shaped Recovery

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Dr. Roubini is back expecting a U-shaped recovery and a stock market correction. He doesn't give a specific price target but expects a correction to occur in the 4th quarter of 2009 or 1st quarter of 2010. He also talks about the growing disconnect between financial markets and economic activity, risk of double dip recession from fiscal stimulus drag, demand lagging supply and lower dollar fueling net exports (potentially filling in as a demand component).

and Noubini's thoughts.