Ponzi USA–Courtesy of the Fed and Treasury

The S&P500 slipped 0.7% last week, notching two consecutive weekly declines.  Volume, as with the prior down week, was higher than it was in the last up week that ended on August 7.  The VIX (or fear) index edged down slightly, but this could also be reflecting the end of the summer doldrums when big investment decisions are put off until September arrives. 

Last week’s economic data were awful.  The week began with a disappointing Empire State Manufacturing survey.  The housing market’s builders’ index fell.  Housing starts dropped, well below expectations.  And housing permits were also lower than expected.  Initial jobless claims jumped again, this time to the grim 500,000 level which hadn’t been reached in almost a year.  The leading economic indicators matched expectations.  And the Philadelphia Fed Survey came in a negative 7.7, when the experts were looking for a rise to positive 7.0. This was the worst reading in 12 months.  Ouch!

Technically, the S&P is in a newly formed downtrend–on the daily charts.  While this does not mean that a meaningful bounce to say 1,100 can’t occur, the downturn that began two weeks ago changed many of the daily indicators to now suggest that there’s more risk to further downward moves.  On a weekly basis, the downward sloping channel that began in late April has been redefined to use the early August top (at around 1,130) to mark the top of the channel.  Also, the 1,130 high more clearly completed the right shoulder of a large head and shoulders pattern that began to take shape after the April 23 head was formed.  If the early July lows near 1,000 fail to hold over the next four weeks or so, then there’s a lot of air before some minor support kicks in around the 950-970 range.  And if this fails to hold, then we could be looking at sub-900 levels for the next major source of support.

Most folks on the street do not understand how the Fed is propping up the Treasury and the banking system.  By creating $1.5 trillion out of thin air, the Fed can only put the new money to work by purchasing securities.  And it purchased two types of securities:  Treasuries and mortgage securities.  And the Fed bought the mortgage securities mostly from banks and primary dealers who turned around and bought Treasuries with the proceeds. 

So who benefits?  Well, the banks have replaced risky mortgage securities with safer Treasury securities to boost their risk adjusted returns.  In addition, banks have access to additional funds–from other banks and from the Fed itself–at near zero rates (the Fed, by creating so much more demand for Treasuries, drives down the interest rates) to buy more Treasury notes and bonds, from the Treasury, that pay 3% to 4%, locking in fat risk-free rates of return.

Who loses?  Well, mostly you the taxpayer.  You get to pay all that interest (to the banks holding the Treasuries) on all that extra borrowing that the Treasury is doing.  And you suffer from the debasement of your dollar; since the Fed just created $1.5 trillion of new money backed by now risky mortgage backed securities (and is showing no signs of removing this new money), the huge increase in supply of dollars, now backed by shakier assets, translates into a drop in the value of each dollar–the dollar that you get paid in, the dollar that your assets will provide you when you sell them.  Finally, if the Treasury goes too far, borrows too much money, causing the bond market to revolt, then watch out–soaring rates and a dollar crisis would force to the government to slash borrowing and spending.  This would plunge the US economy into an almost certain depression, shoving unemployment rates into the stratosphere, putting millions of taxpayers out of work and into desperation.

The final result?  Bankers win.  Taxpayers lose. 

Welcome to the Great American Ponzi scheme, courtesy of the Federal Reserve and the US Treasury.  The country is being looted.  And the public doesn’t even know it.

Bernie Madoff would be proud.

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