"Investors should view June 30th, 2011… like D-Day"

The above quote is from Bond King Bill Gross – who manages the world's largest bond fund for PIMCO. On June 30, the government's second round of quantitative easing (QE2) ends – after a combined $900 billion between new money and maturing bonds.

As a massive purchaser of U.S. Treasury bonds and municipal bonds, PIMCO is worried. Currently, Gross says, "Bond yields and stock prices are resting on an artificial foundation of QE2 credit that may or may not lead to a successful private market handoff and stability in currency and financial markets."As Gross notes, the Fed has purchased nearly 70% of the U.S. government bonds issued since the beginning of QE2. China, Japan, and other sovereigns purchase the rest.

So the Treasury issues bonds, and the Fed buys them. It's a scam. And the important (and obvious) question Gross poses is, "Who will buy Treasurys when the Fed doesn't?"At current yields (10-year Treasurys at 3.24%), we'd say the government will have a hard time finding buyers… But everything is a buy at the right price. The next question is, what's that price?

In Gross' opinion, "Treasury yields are perhaps 150 basis points or 1.5% too low when viewed on a historical context and when compared with expected nominal GDP growth of 5%."Gross concluded his letter saying, "PIMCO's not sticking around" to see how this situation plays out. When one of the world's biggest investors issues such a dire warning, pay attention… 

What else is the Fed spending its QE2 money on? Fannie Mae and Freddie Mac, of course. As part of their takeover, Fannie and Freddie are required to pay a 10% dividend on the Treasury's preferred shares. It costs the firms around $15 billion a year.

According to the Wall Street Journal, "The firms have paid $7.5 billion in total dividend payments, while receiving injections of $5.7 billion to help keep them in business."It's ludicrous, but Fannie and Freddie say it's working. Fannie reported fourth-quarter income of $73 million last week – its first profitable quarter in 3.5 years. Oh… but that doesn't count the $2.2 billion Fannie had to pay the government (the government gave Fannie $2.6 billion that quarter)."Even in their best years, they rarely had the type of income to pay these dividends," said Mahesh Swaminathan, senior mortgage strategist at Credit Suisse.  

So the Treasury sells its bonds to the Fed, which it pays for in printed money. And the Treasury "loans" billions to Fannie and Freddie (the U.S. housing market), which they then pay back to the Treasury. This is a Ponzi scheme… plain and simple. Except in this case, the patsy and the beneficiary are the same entity. One day, this will all end. And it will be ugly.