Defaulting banks - where will it stop?

[Jan Klimkowski]

Provocative articles from Zero Hedge, and Market Ticker, based on US Federal Reserve documents which strongly suggest that the Fed has taken out derivatives on interest rate movements and bonds.

Zero Hedge's view is that:

Stunningly, today we learn that to keep long rates low, the Fed may have resorted to nothing short of the same suicidal trade that destroyed AIG FP and brought the entire system to its knees. Namely, Ben Bernanke is now quite possibly the second coming of Joe Cassano, since in order to keep rates low, Bernanke is forced to a last resort action of selling billions upon billions of Treasury puts to "pin" rates low contrary to natural supply-demand mechanics. If so, the Fed is now basically AIG Financial Products, although instead of being synthetically long mortgages (and thus betting on a rate decline) and selling hundreds of billions in CDS to amplify its bet, Bernanke has done the same thing, only this time with Treasurys. Of course, Ben has the printing press on his side apologists will claim. Alas, that will have no impact whatsoever, if indeed the Fed has been reduced to finding ever fewer counterparties to a synthetic bet to keep long-term rates low, as very soon, with inflation ticking up, all hell may break loose in an identical replay of what happened to AIG once the Fed's put is called against it. Only this time there will be nobody to bail out the ultimate backstopper, resulting in the long overdue end of the current failed monetary system experiment.

Market Ticker's judgement:

There's a problem with this, of course: The Fed had, and has today, no authority whatsoever to buy or sell derivatives on interest rates or bonds. Why? Because every instrument The Fed actually takes ownership positions in (as opposed to lending against) must be something that has the full faith and credit of the Federal Government. Derivatives inherently cannot, because the writer (or buyer) is taking a position that, when the party on the other side is not the government, is their risk.

Therefore, such an action appears to be black-letter illegal under The Federal Reserve Act without express Congressional authorization.

(snip)

People often have wondered why I continue to holler about apparent lawlessness and continue to ask why anyone in this country bothers with obeying the law when our government agencies refuse to do so, and also refuse to stomp on those agencies that violate the law. Well, here's another example.

Incidentally, selling options or swaps (e.g. credit default swaps) on your own debt is easily argued to be an intentionally-fraudulent act. Either you won't have to pay (you win and the buyer loses) or you can't pay because you go under even though you would otherwise be obligated to pay. That is, the buyer is in fact buying nothing, but thinks he is buying a valuable protection policy. Does that constitute black-letter fraud? I'd argue it does.