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Pay No Attention to the Man Behind the Curtain

The year is 2030. On a cold January morning the head of the United States Nuclear Regulatory Commission calls a national press conference and says the following:

"Good morning. As you know, after dumping 75 million tons of nuclear waste beneath the Nevada desert at the Yucca Mountain facility, Commission directors yesterday issued a press release clarifying the true nature of that facility. Regrettably, this release generated far more public scrutiny, attention and skepticism than the Commission desired, so I am here this morning to reiterate the facts, which are as follows: The materials stored at the facility do not, and never at any time, presented any risk whatsoever to public health. Furthermore, our technicians have developed a tool for permanently neutralizing all potential future negative public health effects from these materials. And I happen to have the very latest version of that tool right here in my shirt pocket."

He pulls out a pen and holds it up for the cameras.

"Thanks for your attention, and have a good day."

On January 6, 2011 the U.S. Federal Reserve issued a little-noticed press release as an addendum to its weekly balance sheet update. The release announced an accounting change which essentially allows the Fed to denote losses by the various regional reserve banks as a liability to the Treasury, rather than a deduction to its own capital. The reason for the change? If the Federal Reserve were forced to properly account for the losses which it has suffered on $1.2 trillion in mortgage securities purchased in 2009 as part of an effort to prop up the housing market, it would be insolvent. The math here is pretty simple: a 5% mark on a $1.2 trillion portfolio (home prices are down more than 5% since the Fed stopped buying) creates a loss of $60 billion. The Fed has only $53 billion in capital.

The Fed is insolvent, and needed accounting legerdemain to hide that fact, so it simply passed the losses along to the U.S. Treasury in the form of an IOU to taxpayers. But wait...isn't the Treasury already issuing gigantic amounts of IOUs which the Fed is buying? Isn't that what we call QE2? How does one cash-strapped and nearly insolvent entity (the U.S. government) get propped up by another, already insolvent, entity (the Fed)? It doesn't. What you've just witnessed (and the Fed has tried to obfuscate) is the "closing of the loop" on the largest financial shell game in history.

You would think an announcement of this sort would've generated headlines. So far, it has not. This is because the average American has no understanding of the minutiae of financial accounting, and neither does the average financial reporter. Ever since the Fed starting buying mortgages in early 2009, I've wondered how the Great Paper Hanger, the Ben Bernanke, would cover his tracks. Now we know. A few mirrors here, a puff of smoke there, and tens of billions in losses continuously fold in on themselves and disappear!

I have a suggestion for Mr. Ron Paul, the new Chair of the House Financial Services Subcommittee on Monetary Policy. The first item on your 2011 agenda should be a clear and simple explanation of this chicanery on the part of the Fed. Hiding an entire mountain of bad debt is no mean feat, and the American people have a right to know exactly how it was done.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.