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While President Obama may be speaking this evening in regards to Syria crossing his “red line” and just itching to attack, the real red line is probably 3% on the 10 year Treasury bond (actually, more than likely we have already crossed the line a while back).  This level will equal a roughly 100% increase in interest rates since May and has already made the real economy feel the effects.  If you look at the housing market, it has gone from a so called “orchestrated and advertised boom” to bust literally overnight.  Mortgage lenders have been cutting back staff and even closing their doors over the summer…which is supposed to be the strongest season for home sales.

Closings are down, refinancing has crashed and the mortgage industry is shrinking fast.  One thing that not many are talking about is the fact that the Fed is buying up some $500 billion per year in mortgages making them a larger and larger player in this market.  They already own 31+% of the 10 year Treasury market and have purchased well more than 100% of Treasury issuance so far this year up from 70% last year.  What kind of market is this where the Fed is THE biggest player?

In August the Treasury apparently ran a $146 billion deficit and now $753 billion so far for the fiscal year (even with the sequester) and yet the “Federal debt” remained unchanged for the month?  Treasury Sec. Jack Lew has projected that their “extraordinary measures” can only continue for about another month which means Congress will need to raise the fictional debt ceiling before then.  How cool would it be if you could call Visa and tell them that you’d like to raise your credit line so that you could pay your MasterCard?  Of course the next question is “how high?” Will the debt ceiling need to be raised to accommodate what has already been spent and for borrowing needs for another year.  Can you imagine the “bulge” on the day that Treasury gets the official Congressional okie dokie to borrow more?  $300 billion…$500 billion…in a day?  One day?

I know that I’ve mentioned this on more than one occasion but as far as derivatives are concerned, there IS definitely a red line in the sand somewhere…where yields are just too high.  My guess is that we probably already have reached it and the $400+++ trillion interest rate derivatives market has already blown sky high.  You see, we just don’t know and we can’t know… for if we really did then everything would stop dead in its tracks.  If you recall, some years back (I think by a Bush executive order), financial institutions were allowed to not report losses for …ready for this?  “National security” reasons!  Well, of course, if it were known that the financial system was upside down then everyone, everywhere, would run on their accounts.  Foreigners would be massive sellers (they already are) of Treasuries and interest rates would move upward uncontrollably (again, they already are)…but, not a peep anywhere.  The bond market has outright crashed in the middle and long maturities yet apparently no one anywhere has taken any big losses?  And since no one has taken any “large losses” then no one is insolvent, right?

So what happened to all of the losses?  Is everyone, everywhere absolutely and perfectly “hedged?”  But then who hedged the “hedge?”  Do you see what I’m getting at here?  So let’s say that everyone is perfectly hedged (not possible), what about the underlying positions?  Oh…they were hedged?  The “hedges” were hedged and no one anywhere lost anything?  I’m sorry, it doesn’t work like this.  “Risk” can be laid off to another entity but it will never just “disappear” because somebody somewhere has taken the responsibility for it.  Heck, the Federal Reserve itself has over $300 billion in mark to market losses just on the Treasury side of their portfolio which is 5 or 6 times their capital.  Does anyone even care that they are insolvent?

Yes I know, they can just “print” more dollars so they cannot ever be insolvent…which leads to the question of “what are these dollars worth if new ones can be created at will to cover losses?”  Yeah I know, ’round and ’round we go…and keep ending up at the same place…don’t worry about it, everything is fine and nothing bad could ever happen, right?  Well, no, there is a “red line” somewhere in the sand.  At some point the losses that exist won’t be able to be covered up.  At some point interest rates will bite the real economy hard enough so that even a blind person can see it.  At some point there won’t be anyone, anywhere willing to buy Treasuries.  Oh wait, the Fed is already the only buyer left.  Never mind!