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Banks Win, You Lose on Federal Reserve Policy

James Groth
October 28, 2011, 4:28pm

Operation Twist will officially be one-month-old next week and the results could not be further from Fed projections. After $44 billion in purchases of longer dated Treasuries, yields on the 10-year have gone from 1.7 percent when the Fed began its buying program to 2.4 percent yesterday. Ever since the Fed began buying, rates have gone straight up, and correspondingly bond prices have gone straight down. We have highlighted this fact before, but it is important to understand more clearly how it affects banks, markets and most importantly, you.

First, banks:

The above chart is of an Exchange Traded Fund (ETF) that uses derivatives sponsored by Barclays PLC, a Federal Reserve primary dealer, to track and invest in longer dated Treasuries of maturities greater than twenty years. I have highlighted on the chart significant events surrounding the speculation, announcement, and implementation of the Fed’s Operation Twist program. The exact same thing happened when the Fed first began large-scale open-market purchases in late 2008, and also during the summer and fall of 2010 in anticipation and implementation of QE2. Despite what is written in the financial press about “investors seeking safety in Treasuries pushing prices up and yields down,” in reality, it is nothing more than banks and institutions and especially primary dealers with the Federal Reserve moving money over to Treasuries – in this case to be paid off by the Fed once they begin their purchases. Why they choose to say “investors” implying you and me, I do not know.

I chose the ETF in this case to highlight also the distortions that exist and the manipulation that is possible using a derivative-backed product issued and maintained by a primary dealer of the Fed. In the three months beginning August 1 and ending October 3, this product returned 25.6 percent plus three dividends bringing the total return to 26.7 percent. A comparable index or portfolio of Treasuries over the same period would have returned around 14 or 15 percent. The largest holder of this ETF as of June 30, just before the run-up began, was Credit Suisse, another primary dealer with the Federal Reserve, which holds more than 25 percent of all shares. Clearly, as the chart shows, these banks, institutions and especially primary dealers with the Fed have successfully manipulated the market around the Fed’s actions and came away quite well.

Second, Markets:

The above chart shows just how markets have responded following the Fed’s latest program. The declining line is of course, Treasuries. The only thing the Fed is actually buying. Despite their efforts, bonds have been selling-off, namely because of the selling by the same institutions and banks mentioned above.

Yes, stocks have soared, but as we have shown before, under today’s circumstances and conditions, this has actually harmed a majority of Americans because of the wealth disparity that exists in this country and the artificial means by which these stocks are rising, including the corresponding rally in food and fuel prices which have risen much higher as a result of Fed policy.

And finally, You:

If you own a sizeable stock and bond portfolio and make a decent wage, then this Fed is like Christmas morning. It’s everything you could have asked for. Your wealth is rising.

But if you don’t have excess wealth and make an average wage, say like 80 percent of all Americans, this Fed is your worst enemy. Your food prices are rising, and your wages are not keeping pace, cutting into the money you would otherwise be able to save or spend. The Bureau of Labor Statistics (BLS) reported last month that food prices at supermarkets are 6.2 percent higher than last year, while at the same time average wages have actually fallen. They have been for the past decade.

The Fed’s policy to lower rates is not working to stimulate loan issuance and demand as their goals state, because, among other things, banks and other potential lenders are piling it back into capital markets receiving huge subsidies at the rest of America’s expense. A majority of Americans are paying a heavy price for the Federal Reserve’s policy to stave off deflation, while banks and institutions manipulate markets with their help.


James Groth is Research Associate


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