The Treasury Play

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I’ve heard one version or another of this story about a million times now. Here is William Cohan’s take on why Wall Street is so damn profitable right now:

Mostly [] Wall Street is making money by taking advantage of its rock-bottom cost of capital, provided courtesy of the Federal Reserve — now that the big Wall Street firms are all bank holding companies — and then turning around and lending it at much higher rates.

The easiest and most profitable risk-adjusted trade available for the banks is to borrow billions from the Fed — at a cost of around half a percentage point — and then to lend the money back to the U.S. Treasury at yields of around 3 percent, or higher, a moment later. The imbedded profit — of some 2.5 percentage points — is an outright and ongoing gift from American taxpayers to Wall Street.

I guess I’m demonstrating hopeless naivete by asking this, but huh? The market for U.S. treasury bonds is huge and extremely competitive, and the risk of holding treasurys is approximately zero. So if banks have access to giant pools of cash that cost them 0.5%, they should start bidding down the treasury rate until this particular arbitrage play is only barely positive. Treasury yields would very quickly end up around 0.6%, not 3%.

And yet, like I said, I’ve heard this same basic story over and over and over. Can someone with some serious financial sophistication explain it to us hicks? Are big banks, big as they are, not big enough players to really affect Treasury prices, so they’re just free riding on a price set by the rest of the market? What’s really going on here?

UPDATE: So far, the consensus in comments is that this whole story is wrong. Banks can borrow from the Fed at low rates, but those are overnight loans. They can buy treasurys at high yields, but those are ten-year notes. Chart here. As The Lounsbury puts it: “One does not finance a 10yr note off of a 24 hour repo. Of course buying and reselling (trading desk) using the overnight funding is possible, although the spread is not what he implies.”

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SIX TRUTHS

Reclaiming power from those who abuse it often starts with telling the truth. And in "This Is How Authoritarians Get Defeated," MoJo's Monika Bauerlein unpacks six truths to remember during the homestretch of an election where democracy, truth, and decency are on the line.

Truth #1: The chaos is the point.

Truth #2: Team Reality is bigger than it seems.

Truth #3: Facebook owns this.

Truth #4: When we go to work, we're in the fight.

Truth #5: It's about minority rule.

Truth #6: The only thing that can save us is…us.

Please take a moment to see how all these truths add up, because what happens in the weeks and months ahead will reverberate for at least a generation and we better be prepared.

And if you think journalism like Mother Jones'—that calls it like it is, that will never acquiesce to power, that looks where others don't—can help guide us through this historic, high-stakes moment, and you're able to right now, please help us reach our $350,000 goal by October 31 with a donation today. It's all hands on deck for democracy.

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