"Economists are pessimists: they've predicted 8 of the last 3 depressions."
--Barry Asmus

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Tuesday, January 18, 2011

T-Note Flash Crash, Federal Reserve May Need A Bailout, And WikiLeaks Outs Tax Evaders

You might have missed it, but the Treasury bonds were crushed earlier today by a roughly $6 billion trade in 30-year Treasuries..Yes, billion.  With a "b".  In Treasuries.  At one point, the 30-year Treasury was down 1 6/32, bringing the yield to 4.61%[1].  Early reports were that it was a "fat-finger trade", but Tradeweb - the electronic platform that processed the trade - denies this.  "Reports of a multibillion dollar customer trade error on Tradeweb this morning are completely false.  Indeed, Tradeweb has a number of safeguards and warnings incorporated into its electronic markets to prevent 'fat-finger' errors of this type," was the official word from the company.
The 30-year Treasury has recovered somewhat, closing with a yield of 4.56%.  Still, with the "flash crash" a distant but still bad taste in the mouths of most investors, this won't do much to improve the confidence of an investing public that is already skittish about bonds in general.
Speaking of debt, there's some interesting analysis showing that the Federal Reserve could find itself in a position where it needs to recapitalize[2].  Here's the theory:  the fed has purchased right around $2 trillion (yes, with a "t" this time)) in mortgage-backed securities, US Treasuries, and "toxic assets", and still holds about $1 trillion.  Now, a general rule is that as prevailing interest rates go up then the value of existing bonds goes down.  So, according to Varadarajan Chari[3], if inflation goes up 2%-3%, it could cut the value of the Fed's holdings by around 10%, giving the Fed a $100 billion loss.  On paper, at least.  Of course, as we all know, paper losses only matter if your forced to realize them.  But the Fed could be left holding some of these securities for 20 to 30 years, showing a loss on their books the whole time.  While it wouldn't disrupt the Fed's activities (the Fed funds rate and the printing press don't care about paper losses), it would certainly result in a significant political backlash.
And in WikiLeaks news, Rudolf Elmer - a former employee of Switzerland's Bank Julius Baer - has reportedly handed documents over with details by more than 2000 wealthy business leaders and lawmakers attempting to evade tax payments.  Given the other things Wikileaks has told us, this could be just the latest in a series of embarrassments for world governments.
[1]  Putting it in perspective, that nearly drove it to an eight-month high.
[2]  That's fancy talk for "get bailed out".
[3]  An economics professor at the University of Minnesota who is also a consultant to the Minneapolis Fed.

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