The Real Ponzi Scheme -
"Unreal Interest Rates"
Posted Mar 18, 2009
Recently, former chairman of
the Federal Reserve - Alan Greenspan - penned an editorial, "The
Fed Didn't Cause the Housing Bubble". It was published
in The Wall Street Journal March 11, 2009.
In the article Mr. Greenspan
attempts to blame today's global financial crisis on "too-low
mortgage rates" between 2002 and 2005 which led to a real
"There are at least two
broad and competing explanations of the origins of this crisis.
The first is that the "easy money" policies of the
Federal Reserve produced the U.S. housing bubble that is at the
core of today's financial mess.
"The second, and
far more credible, explanation agrees that it was indeed lower
interest rates that spawned the speculative euphoria. However,
the interest rate that mattered was not the federal-funds rate,
but the rate on long-term, fixed-rate mortgages. Between 2002
and 2005, home mortgage rates led U.S. home price change by 11
months. This correlation between home prices and mortgage rates
was highly significant, and a far better indicator of rising
home prices than the fed-funds rate."
Greenspan's statement that
the Federal Reserve only controls short term rates [Fed Funds
Rate] is false. So is his claim that long term rates were determined
by excess savings in foreign lands - beyond the purview of the
"As I noted on this page
in December 2007, the presumptive cause of the world-wide decline
in long-term rates was the tectonic shift in the early 1990s
by much of the developing world from heavy emphasis on central
planning to increasingly dynamic, export-led market competition.
" ...That ex ante
excess of savings propelled global long-term interest rates progressively
lower between early 2000 and 2005."
The historic low rates in the
2000 - 2005 time period as well as the rates we have today are
the direct result of activity at the Federal Reserve's proxy
bank - J.P. Morgan Chase, and their 59 Trillion [at Q3/08] notional
interest rate derivatives book:
(Click on images to
of the Currency
It was none other than Alan
Greenspan himself who lobbied to have these and other OTC derivatives
remain "unregulated" and thus beyond any sort of critical
oversight with additional false claims that doing so gave the
U.S. financial system "flexibility". The tacit acceptance
and encouragement by Greenspan of rampant growth of derivatives
by banks and dealers resulted in extraordinary systemic risk
in the financial system which is manifesting itself in the current
of the Currency
The Fed's defacto management
and control of the ENTIRE interest rate curve makes Bernie Madoff's
and AIG's frauds [Charles Ponzi - R.I.P] look like child's play.
Interest rate swaps with durations of 3 years or greater typically
have a corresponding physical government bond trade embedded
in them. Increasing outstanding notionals of interest rate swaps
INCREASES aggregate demand for bonds - forcing rates DOWN.
In prior articles I have demonstrated
the bond math showing how these interest rate derivatives were
utilized to give the Federal Reserve [through its chief agent
J.P. Morgan] effective control of the "long end" of
the interest rate curve - neutering usury - engineering long
term interest rates DOWN.
Hedging Mechanics of Interest
Rate Swaps > 3 yrs. Duration
Interest rate swaps > 3
yrs. in duration customarily trade as a "spread" -
expressed in basis points - over the current yield of a corresponding
benchmark government bond. That is to say, for example, 5 year
interest rate swaps [IRS] might be quoted in the market place
as 80 - 85 over. This means that the 5 yr. swap is "bid"
at 80 basis points over the 5 yr. government bond yield and it
is "offered" at 85 basis points over the 5 year government
bond yield. Let's assume that 5 year government bonds are yielding
1.90 % and the two counterparties in question consummate a trade
for 25 million notional at a spread of 84 basis points over.
Here are the mechanics of what happens: The payer of fixed rate
pays [1.90 % + 84 basis points =] 2.74 % annually on 25 million
for 5 years. The other side of the trade - the floating rate
payer - pays 3 month Libor on 25 million notional, reset quarterly
- typically compounding successive floating rate payments at
successive 3 month Libor rates so that actual cash exchanges
are settled "net" annually. To ensure that the trade
remains a "true spread trade" [and not a naked spec.
on rates] and to confirm that 1.90 % is a true measure of where
current 5 year government bond yields really are - the payer
of the fixed rate actually buys 25 million worth of physical
5 year government bonds - at a price exactly equal to 1.90 %
- from the receiver of the fixed rate at the front end of the
trade. So, in this regard, we can say that 25 million IRS traded
on a spread basis creates
a "need" for 25 million worth of 5 year
government bonds - because it has a 5 year bond trade
of 25 million embedded in it.
- Interest rate swaps of duration
< 3 years are typically hedged with strips of 3 month Eurodollar
futures instead of government bonds.
Interest rate swaps were originally
developed to  allow parties to exchange streams of interest
payments for another party's stream of cash flows;  manage
fixed or floating assets and liabilities and  to speculate
- replicating unfunded bond exposures to profit from changes
in interest rates. Growth in the first two of these activities
are dependent on their being increased end-user-demand for these
products - graph 1 above indicated that this is not the case:
In the case of J.P. Morgan
in particular [forgetting about the lesser obscenities at Citi
and B of A]; their interest rate swap book is so big that there
are not enough U.S. Government bonds being issued or in existence
for them to adequately hedge their positions.
This means that the obscene,
explosive growth in interest rate derivatives was all about overwhelming
the long end of the interest rate complex to ensure that every
and any U.S. Government bond ever issued had a buyer on attractive
terms for the issuer. Concurrent with the neutering of usury,
the price of gold was also "capped" largely through
Fed appointed banks "shorting gold futures" as well
as brokering gold leases [sales in drag] sourcing vaulted Sovereign
Central Bank gold bullion. The gold price had to be rigged concurrently
because historically, according to observations outlined in Gibson's
Paradox - lowering interest rates leads to a higher gold
price. Gold price strength is historically synonymous with U.S.
Dollar weakness which leads to higher financing costs or the
possibility of capital flight.
Metaphorically, this meant
the extinction [or assassination, perhaps?] of the fabled "bond
vigilantes" who, in conjunction with a rising gold price,
historically acted as the bond market's conscience whenever rampant
monetary debasement reared its ugly head.
Alan Greenspan was more than
aware of the obscene growth in derivatives activities at J.P.
Morgan and was complicit in a litany of contributing events providing
cover for this charade to develop and continue:
- During his tenure as chairman
of the Federal Reserve, in November 1999, Congress repealed the
Glass-Steagall Act - the culmination of a $300 million lobbying
effort by the banking and financial-services industries, and
spearheaded in Congress by Senator Phil Gramm. Glass-Steagall
had long separated commercial banks (which lend money) and investment
banks (which organize the sale of bonds and equities); it had
been enacted in the aftermath of the Great Depression and was
meant to curb the excesses of that era, including grave conflicts
of interest. In one feel swoop the repeal of Glass-Steagall meant
that future financial abuse would be "systemic" in
nature instead of isolated.
- Also on Greenspan's watch,
in April 2004, the Securities and Exchange Commission succumbed
to intense lobbying chiefly by Goldman Sachs' Hank Paulson allow
big investment banks to increase their debt-to-capital ratio
(from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed
securities. This further inflated the housing bubble and made
our already-casino-capital-markets even more RECKLESS.
Additionally, to think that
Mr. Greenspan was not aware or may very well have had a hand
in this development is unthinkable. First reported by Dawn Kopecki
back in 2006 when she reported in BusinessWeek Online in a piece
Czar Can Waive SEC Rules,
"President George W. Bush
has bestowed on his [then] intelligence czar, John Negroponte,
broad authority, in the name of national security, to excuse
publicly traded companies from their usual accounting and securities-disclosure
obligations. Notice of the development came in a brief entry
in the Federal Register, dated May 5, 2006, that was opaque to
the untrained eye."
What this means folks, if institutions
like J.P. Morgan are deemed to be integral to U.S. National Security
- they could be "legally" excused from reporting their
true financial condition.
The entry in the Federal
Register is described as follows:
The memo Bush signed on May
5, which was published seven days later in the Federal Register,
had the unrevealing title "Assignment of Function Relating
to Granting of Authority for Issuance of Certain Directives:
Memorandum for the Director of National Intelligence." In
the document, Bush addressed Negroponte, saying: "I hereby
assign to you the function of the President under section 13(b)(3)(A)
of the Securities Exchange Act of 1934, as amended."
A trip to the statute books showed that the amended version of
the 1934 act states that "with respect to matters concerning
the national security of the United States," the President
or the head of an Executive Branch agency may exempt companies
from certain critical legal obligations. These obligations include
keeping accurate "books, records, and accounts" and
maintaining "a system of internal accounting controls sufficient"
to ensure the propriety of financial transactions and the preparation
of financial statements in compliance with "generally accepted
That this transfer occurred
at all is highly suggestive that The Powers That Be were acutely
aware that systemic financial problems were already manifesting
themselves [likely at Fannie, Freddie and J.P. Morgan] or soon
would be - and - they were going to attempt to fraudulently COVER
IT UP in the name of National Security.
Folks need to understand that
all of these shenanigans are occurring to perpetuate faith in
the empirically failing irredeemable fiat U.S. Dollar based monetary
Are you a believer?
The balance of this article
posted under the same title at Kirbyanalytics.com for subscribers
includes an analysis of the U.S. Dollar, global fixed income
markets, a section on murder-and-mayhem as well as a discussion
on the likely signposts we are apt to see on our dissent into
monetary disorder. Subscribe here.
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