You stated "The Fed has no incentive to manipulate higher interest rates as it would become obligated to purchase those treasuries for more than its worth."
Of course there is no incentive, in fact, this is exactly the opposite of their intentions (they are artificially keeping long term rates LOW).
They will indeed become exposed to collapse when (as you stated)"the Fed sells Puts, it then becomes obligated to purchase the underlying security (treasuries) if the price is below the strike price at expiration".
As pure brute bond market forces drive up the US treasury yield spreads (and thus lower the price), this ponzi scheme will make the AIG debacle look like a walk in the park.
These forces are already in play at multi-variate levels, here is a brand new example:
http://thescotsman.scotsman.com/business/SP39s-US-debt-downgrade-hits.6754108.jpS&P's US debt downgrade hits
LONDON FTSE 100 CLOSE 5,870.08 -125.93
JUST two stocks were left on the FTSE 100 risers' board yesterday after credit ratings agency Standard & Poor's slapped a surprise "negative outlook" warning on the United States.
Outsourcing specialist Serco and advertising firm WPP were two companies in the black as a sea of red washed 2.1 per cent or 125.93 points off the Footsie, which closed at 5,870.08.
David Jones, chief market strategist at IG Index, said: "Expectations of a quiet week ahead were dashed in the afternoon as S&P said there was a 'material risk' that the US would not deal with its deficit and put a negative outlook on its credit rating.
"Whilst this probably isn't news to anybody, it was maybe something that the markets hoped nobody would actually say out loud................."
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the above mentioned Serco is a wicked firm, btw
http://www.youtube.com/watch?v=vyFkXmx8gxcSerco is a British-based business services company listed on the London Stock Exchange & FTSE Index. Styled "the biggest company you've never heard of," it performs a range of services in various countries.
It operates light rail systems in England, Australia, Holland, and elsewhere. It operates traffic camera systems in the UK. It runs prisons & immigration detention centers. It runs hospitals. It has defense contracts world-wide. It runs air traffic control in Dubai. It runs hospitals. It runs drivers' licensing centers in Canada. It runs leisure centers, scientific labs, border security, & welfare-to-work programs. It also runs schools, contracts with governments & other providers to inspect schools, and supplies student data systems.
Serco began as an operational division of the Radio Corporation of America (RCA) -- which was itself a creation of General Electric. RCA Service Division was bought by its management sometime after 1969 & renamed Serco.
Serco North America (Serco, Inc) is based in Reston, VA & has 11,500 US employees. It provides professional, technology, and management services to the federal government, especially the Dept of Defense, in keeping with its heritage -- RCA & GE were also big defense contractors.