-- Posted Friday, 29 April 2011 | | Source: GoldSeek.com
By: Dr. Jeffrey Lewis
The Federal Reserve is up to its fraudulent games. In this latest round of open market operations, the Federal Reserve is not only engaging in manipulation of the credit default swap market, but also paying off its allies in the ultimate scam of creating low-risk, high returns for hedge fund managers.
Recently, it was found that the Federal Reserve has been issuing put options on US Treasuries, essentially underwriting Treasury debt, and telling the market that there is no risk in buying US Treasuries.
Fraud is Cheap
To persuade the market that US Treasury securities are worth owning, the Federal Reserve need not spend the trillions it spent to push the price of US Treasuries up and yields down. In fact, the best fraud is in making mincemeat of what should be efficient markets: the risk pricing markets.
The Federal Reserve is now actively selling puts against US Treasury debt obligations. The result for the Fed is that it makes money when the US does pay on its debt and when US Treasury rates do not increase. We could stop right there, realizing that this is actually a bet on the quality of US Treasuries and does not have any significant conflict of interest—except that it necessarily conflicts with the financial markets.
Manipulating Markets
Moving the options market is easy; it requires only a few million dollars, and it can be done discretely in what is ordinarily a very light-volume market.
Let’s take a look at a popular Treasury ETF: the iShares Lehman 7-10 Yr Treas. Bond ETF (IEF). This bond fund has some $2.5 billion in US Treasury assets, and it is one of the largest Treasury ETFs. However, while the ETF has many active traders working to ensure it accurately tracks the changes in the price of US Treasuries, its options are relatively inactive.
Looking at the next month option contracts, June calls look relatively boring; there is open interest of roughly 3000 call contracts. All is well, right? Wrong. In looking further into puts, you’ll soon realize the obvious fraud: there are more than 27,000 puts in open interest, nine times more than the amount of calls.
Someone—the Fed—is selling an obscene amount of insurance against US Treasuries. They’ve sold several times more puts, a protective bet, for anyone who might possibly want them and done so to such a degree that protection for US Treasuries is disgustingly cheap. Look at it yourself; the fraud is as obvious as obvious can be.
Go out to the January 2012 options, and you’ll find even more puts sold at the price just below the current offering—that’s the Fed saying that US Treasuries are safe as can be!
Why the Fed Sells Puts
Puts on exchange-traded funds are the best way to show the market that Treasuries are risk-free. By selling puts, the price for protection plummets, and banks can essentially borrow from the Fed at 0%, and lend to the US Treasury at 4%, all risk-free.
So why does the Fed target ETF options? This is easy to answer: the world of finance uses ETF options to price risk on the derivatives market. The Black Scholes options formula, which is used across the world to price risk, assumes that the options market provides for no arbitrage, which is just another backwards way of saying that the options markets are a free, efficient market. The options markets obviously aren’t, the Fed is playing with them.
What happens now? Well, the insurance companies around the world who write insurance, or credit-default swaps against US government paper, use the data of the options market to price trillions upon trillions of dollars of insurance derivatives.
In effect, the Federal Reserve can sell less than 100,000 puts against all Treasury ETFs for no cost, assuming they are never paid out, and force the derivatives market to issue trillions of dollars in insurance at below the real, risk-adjusted rate.
Where Hedge Funds Come in
Remember the Fed’s open borrowing window through which it lent billions of dollars to hedge funds? It’s all starting to make sense why they did it.
Hedge funds are called hedge funds for a reason; they hedge their bets and use arbitrage techniques to make a killing on Wall Street. What’s the best arbitrage out there? Buying US Treasuries with money you pay zero-interest on for a positive return with other people’s money, then insulating yourself from every iota of risk by purchasing underpriced, manipulated put options and credit default swaps.
In short, the Fed is making every American poor, every banker rich, and every investor a pawn in the largest scam to ever hit the financial world. Tell your neighbors, colleagues, friends, and acquaintances that there is no bigger scam than that which is permeating through the financial world and the sealed books of the Federal Reserve System.
Dr. Jeffrey Lewis
www.silver-coin-investor.com
