Why you need to Understand POMO

on 12 21, 2010

POMO from the NY Fed website:

Permanent OMOs: Treasury

“The purchase or sale of Treasury securities on an outright basis adds  or drains reserves available in the banking system. Such transactions  are arranged on a routine basis to offset other changes in the Federal  Reserve’s balance sheet in conjunction with efforts to maintain  conditions in the market for reserves consistent with the federal funds  target rate set by the Federal Open Market Committee (FOMC).”

So what is POMO is laymens terms:

It is when the FED adds liquidity to open market.  The Federal Reserve buys bonds from primary dealers.  Their accounts are credited.  The primary dealers with created money in their account have to put that money to use to capture a higher rate than the crushed bond rates.  So they put this money into equities.  Some have claimed the primary dealers use only high beta stocks to drive up the market.  Basically as they push the big names, then the rest of the market has to follow.

So what does this do for the average investor? Well, it only gives a false picture of fair value for the “market.”  If you have primary dealers continually buying because they are constantly getting credits in their account, then why would anyone in their right mind step in front of them and sell.

So this is artificially raising the market value to unprecedented prices given an economy that is crumbling beneath it. Historically POMOs were rarely monetized.    Even Bernanke himself said he would not monetize the POMOs under oath to Congress.  Now because we are a nation of insurmountable debt, the Fed is monetizing the POMOs in much shorter durations.  They started off slow, but now they are monetizing bonds that were issued only a few weeks ago.  This is a serious problem that we need to understand.

If they are starting to monetize this debt immediately, then they are creating money out of thin air.  We know the US Dollar is no longer backed by gold so they can create Dollars out of thin air either way.  The problem is that they are trying to flood the market and giving loans to anyone who needs it to keep this economy afloat.  Who is on the hook for that debt?  You and I, the taxpayers.

So who is benefiting from this debt being monetized?

The primary dealers, hedge funds and even European Central Banks –link to story.

Primary Dealers like Goldman are flipping bonds.  – link to story

We are faced with the proverbial double edge sword.  On one side with have Bernanke running up our debt, monetizing it, driving up inflation.  On the other we face reality.  We do not want to face either, but once they stop the POMOs reality will fight back.  Our stock market will be the first to take the plunge.

The economy is much worse then the media is reporting.  Unemployment is not getting better and POMOs do not create jobs.  The POMOs are driving rates up, so besides the temporary “get off the fence” home buyers, this will only hurt long term mortgage rates, which will basically put the housing market into a deep sleep.  Rising rates will hurt the holiday shoppers as they pay back their credit card debt.  It may help the savers, but our economy can’t afford the savers.  We need them to spend.  Our GDP is made up of about 70% retail spending.  Maybe people are finally starting to see the light!  Just like our country, they know they can not continue to live beyond their means.

Reality will mean tightening our belts.  No one wants to hear the truth, because we have to go through some bad times before we can get to the good times.  No country or currency, in the history of civilization has ever lasted through an expansion of debt like we are doing.  The only way to survive it is to stop it.  We can not spend our way out of debt.

We had a great nation and for the past 30 years the expansion has only gone exponential. We will have to pay the piper sooner or later, let’s just hope it can be a controlled decent vs a complete freefall.

What will set the decent in motion? Any of the following: European country or bank failure, Major US bank failure, any major Treasury buyer stepping away..China, Japan.

The Federal Reserve can not be the largest buyer of  US Treasury debt.  Link We can not continue to buy our own debt.

If China says “uncle” and throws on the brakes then the Fed will have to pick up the slack.  When do the American people force Congress to stop this madness?

All it will take is one shoe to drop and we start.  I hope you are protected.  Just keep the POMOs coming.  Our children and grandchildren will be born into debt.  I for one would like to stop the cycle.  It will take one generation to say enough is enough and stand up to the generations of the past who have live beyond their means.

Until we see a shoe drop and the POMOs continue, then you have to stay with the trend.

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