Trade of The Day: Buy Freddie Paper With Fed Leverage: “We don't know who bought the Freddie notes today. But buyers of Freddie notes who have access to borrowing from the Federal Reserve would have found the decision to bid relatively easy. That's because the ability to exchange the Freddie debt for Fed cash means banks can buy Freddie debt with a huge amount of leverage, dramatically increasing the return on their capital.
Here's how it works. A bank that bought the six month notes from Freddie this morning could also bid to borrow from the Fed's Term Facility, which held an $75 billion auction today. As collateral for the borrowing, the bank could offer the newly purchased Freddie notes, for which the Fed would give them credit for 97% of their market value. Recently, the TAF pricing topped out at 2.35 percent for 28-day borrowing. So a bank buying $100 million of Freddie paper yielding 2.858% could flip it to the Fed, borrowing $97 million at around 2.4% (assuming the pricing will be slightly higher this time around).
At the end of the day, a credit desk could buy $100 million of Freddie debt for just $3 million down. On that $3 million, the desk would receive a 17.7% annualized return, or 8.8% over six months, for paper that is thisclose to being explicitly backed by the Treasury Department. Not a bad deal at all.”
Fun fun fun.
This is EXACTLY what had to happen. That is how liquid markets work. Market participants will find and arbitrage all ‘free money’ away.
In this case it didn’t long and the end result is this: PROFITS are PRIVATIZED and LOSSES are SOCIALIZED.
You see, if this trade goes bad enough, the Fed would just call in the collateral. In this case, for this trade to implode, Fannie and Freddie would have to implode. That also means the collateral would implode. The Fed would then get stuck both bailing out Fannie and Freddie AND holding a pile Fannie and Freddie paper that got ‘put’ to them as collateral.
The Fed would then just turn around and demand the Treasury expand THEIR balance sheet. The Treasury would in turn issue more debt. At the end of this donkey chain is the poor (literally) U.S. taxpayer who gets bent over and rammed…
This will all happen. It almost has to. I bet it happens so quickly and so suddenly the taxpayer will be left confused wondering, “Did I just get raped?”
For WallStreet right now, this is the BEST TRADE EVER. All upside and no downside.
Wednesday, August 27, 2008
Posted by Ben Bittrolff at 8:10 AM