Fed Halts Sales Of Toxic AIG Sludge Upon Realization Any Balance Sheet Unwind Crashes The Market

Zero Hedge ^ | 06/30/2011 | Tyler Durden

[The Magical Mischief Tour]

Three weeks ago, when discussing the failed (yes, failed) Maiden Lane 2 auction by the New York Fed, we said: 'Something quite disturbing happened during today's latest attempt by the Fed to sell $3.8 billion in face amount of Maiden Lane 2 assets: it had a busted dutch auction. In fact, the auction was so massively busted, the New York Fed managed to sell only half of the bonds for sale, or $1.898 billion in 36 Cusips of the total 73 Cusips offered for sale." Subsequently we noted the sudden radiosilence from the Fed on this issue on Twitter. To be sure, every MBS trader and the kitchen sink promptly complained that the Fed was saturating the market with toxic AIG garbage, which prompted us to declare that: "unless someone opens up a release valve, we are about to see a massive regurgitation and even more massive repricing of credit risk, first in IG, then in HY and ABX/CMBX, and lastly, and most massively, in equities, which continue to exist in their own world and which are now totally disconnected with HY, which they used to track so very closely."

We just got the release valve: from Bloomberg: "The Federal Reserve Bank of New York is halting its sales of mortgage bonds acquired in the rescue of American International Group Inc. "Given prevailing market conditions” for residential mortgage-backed securities, “we do not anticipate any sales of bonds in the near term or until such time as the New York Fed deems it will achieve value for the public," Jack Gutt, a New York Fed spokesman said in an e-mail." Uh, what prevailing market conditions: a Nasdaq which has ripped over 100 points in one week (granted on no volume and on unprecedented market manipulation but so what). Regardless, this is a huge slap in the face for the Fed, which has just proven that even in a surging market it can not unwind an amount from its book that is less than 1% of its total asset holdings without actually crashing the market.

We certainly can not wait for BTIG's spin on this news tomorrow.

In the meantime, we remind readers of what we predicted, accurately, on June 9:

If dealers and funds are unable to handle a mere $31 billion MBS portfolio disposition, and its weekly sale (think of its as a reverse repo) is starting to cause massive ripples in the bond market, just what will happen when dealers are forced to hold back the tens of billions in weekly bond auctions they freely flip back to the Fed now. In other words, is the credit market on the verge of a oversaturation implosion (hence the title)?

Good luck with that end of QE2 boys. You will need it.

[Melchior]

I understood very little of what this gentleman had to say. But what I did understand scares the bejabbers out of me.

[blam]

Will someone transklate this for us (ahem) normal people.

[P.O.E.]

even more massive repricing of credit risk

Not good. Seems to me that long term negative projections by the "offficials" is understated.

[Uncle Ike]

” Will someone transklate this for us (ahem) normal people. “

I think that what the author might be trying to say (or carefully *not say*) is something like -

Regardless of the publicly stated rationale, the real-world effect of the QE programs has been to provide artificial demand to prop up bond prices, and with the end of QE2, that artificial prop disappears, and bond values will catastrophically return to their ‘natural’ level....

Or, in layman’s terms that I can readily understand — “We’re soooooo SKROOOOD!!!”

[Elendur]

ditto
and while i don’t understand a lot,
i can add things from other threads,
like all the restaurants closing,
because of Obamacare,
and the much higher minimum wage, etc.

i don’t think the recession ever really ended.
it was a “false recovery” from the stimulus.

[MotherRedDog]

Hmmmmmmmmm, should I take the red pill or the blue pill?

[Tucker39]

The only thing I recognized were the words Maiden Lane. In a former life I was an IBM repairman, at that time known as a “Customer Engineer.” That was 1961-62 in the days of the old 80 column punched cards. Anyhow, my territory for keeping customers’ machines running was the Insurance District which included Maiden Lane. I kept my tool case at AMEX Credit Cards building, and the office I answered to was at 220 Church St. That Church St. building was demolished, along with a number of others, to make way for the Twin World Trade Towers.

[Attention Surplus Disorder]

“Maiden Lane 1” and “Maiden Lane 2” are cesspools, err, repositories of toxic loan tranches and horrifically losing options positions (think of a huge bundle of insurance claims an insurance company might have to pay out after hurricane Andrew passes through and thousands of houses are crunched) which were purchased by the Fed, generally during the 2007-2008-2009 period. They were purchased from the major banks by the Fed at *face value*, even though they were (and apparently are) worth many many tens of billions LESS than their face values. It was this mechanism that permitted the major banks to continue to operate as going concerns. Had the Fed not purchased these diseased assets, the banks would have all detonated.

The idea was to remove these smashed assets from the market, let some amount of time go by and allow the market to heal; both in terms of the implied underlying real estate values and the trust implied in arms-length transactions within the bond and debt markets.

Well, some time has gone by, but the market is having a hard time absorbing these assets, because 1: RE prices have not rebounded as expected, and 2: the trust that was supposed to return to the market HAS returned, to some extent, making the Maiden Lane assets phenomenally undesirable things for anyone to own.

So the scheme has “worked” to a single digit percentage, but the Maiden Lane tranches are simply massively bigger than the market can absorb. So, the Fed cannot offer them for sale in the size they would like to get rid of without driving down the pricing, which makes them even less attractive from the Fed side because of the losses implied. And they are not especially desirable even from the buyers’ sides, because there is no mystery as to what they are.

Basically, the idea was to bundle up a whole pile of dog turds with the expectation that after some number of years, they wouldn’t smell so bad and perhaps the dog-turd market would regenerate itself.

It worked, about as well as most other things the government undertakes.

[dirtboy]

Well, what I (as a working stiff) believe - that all of the talk about the assets that the feds bought up and were gonna make a net profit with regarding the bailouts - well, that was based on the feds own valuation of those assets. And once the feds attempted to put those assets back on the market, well, market valuations promptly came back into play (surprise). And what a shock, the gov valuations were proven to be complete bullcrap. Hence the shutdown of that process.

[Ghost of Philip Marlowe]

I’m not good on the technicals, and what is happening in the equities market is massively and intentionally complex, but I follow zerohedge daily and read tyler durden’s articles, but I have only about half a clue what this tech-speak means, but I’ll offer it here in a nutshell :

The Fed has been monetizing the debt in order to artificially prop up the markets.

While they have been doing this, the bond markets have been tanking.

The Fed and the bond purchasers have a silly little game where the bond purchasers buy bonds and then very quickly (less than 22 hours yesterday) sell them back.

This is all financial sleight-of-hand.

The Fed wants to prop up AIG and get rid of the toxic assets.

But no one is buying their bonds.

QE2 has run out.

Essentially the Fed is stuck with a lot of bad assets that they cannot unload and are no longer able to monetize the debt with their financial sleight-of-hand, and they can’t unload the toxic assets, because if they do, that garbage will crash the markets.

The amount that is at issue is less than 1% of the Fed’s total holdings. What that means is that the Fed is so incestuously involved with artificially propping up the markets that if they fail to untangle themselves from the AIG garbage, it could crash the markets. What is happening with that other 99%?

You know what happens when a single bank is over-leveraged and has a bunch of garbage on its books...it folds. The Fed is in this position.

All this said, however, never underestimate the power of the central bank’s suddenly to shift assets and funds to bury them somewhere.

Finally, don’t doubt for a moment that the Fed will not not allow that AIG garbage to unwind, thus crashing the market and starting the rallying cry for QE3.

Personally, I believe everyone in finance and banking right now is doing everything they can to ensure a QE3. They’d need a big crash to force that.

QE3 would not work, based upon the principle of diminishing returns. QE2 did practically nothing. QE3 would have to be way over the trillion market to even pretend to make a dent, and this new money at ZIRP would have repercussions all the way down the line.

[blam]

Thanks.

[blam]

Thanks.

[SnuffaBolshevik]

Thanks.

Ta-Ta. Off to buy more DAK hams, diesel, rice and 5.56.

[SueRae]

ping for later

[SueRae]

Eeeeeeew. Well, forewarned is forearmed. Appreciate the response.

[RetiredTexasVet]

The ugly stepchild returns home!

[Texas Songwriter]

Back in the fall of 2008 when Paulson was pumping sunshine up our collective rectum we were told to pony up 781 billion dollars to get our banking in order. In those several purchases of the FED was AIG. The FED was initally paid $85 billion dollars. Later they purchased almost 80% of AIG, not knowing what the real value was because the 'derivitive' problem was about to begin its nuclear chain reaction. They bought the 80% worth about $150 billion at that time, all the while telling the taxpayers that moneyu would be recouped. Now today they tried to sell over $3 billion of AIG bonds and the sale did not happen....they only sold 1.89 billion or about 1%,....they could not 'unwind' their position,(sell their position) to recoup the taxpayers money. Now the FED has about $150 billion minus $1.89 billion worth of AIG bonds which they cannot sell.....because those derivitives were worth NOTHING and today they are worth NOTHING.

This will do wonders for sticking to their crappy game plan of stopping QE2,,,,,,,can QE 3 be far behind. Now they have spent 180 billion of AIG Bonds which will never be marketable. It is a nice statement of how well the ben bernank understands the problem and how efficacious his offered solutions are. We are in for the dollar printing to infinity. Sorry folks, but in the infamous words of Gecko in Wall Street Two, 'You guys are all,......pretty much......f.....d." (sorry for the implied expetive, but is seemed most appropo to this particular discussion.

[Notary Sojac]

and bond values will catastrophically return to their ‘natural’ level....

The longer we try to prop them up, the worse the eventual damage. Ya can't cure melanoma with Band Aids.

-- Notary Sojac, sayin' this since 2008

[Roccus]

Good explainations of how the FED used AIG as a washing machine to launder taxpayer money into banks (foreign and domestic) with no viable expectation of recouping said taxpayer money.