Due to an ongoing health crisis in the family, blogging will be 'on and off' as time and circumstances permit for the foreseeable future. I also beg your indulgence if I am slow in responding to emails. New posts will appear below this notice.

Tuesday, September 22, 2009

A New Bubble of the Fed's Creation

...Less encouraging is what's happening on Wall Street. It turns out that all those bold and necessary steps by the Federal Reserve to prevent the financial system from collapsing wound up creating so much liquidity that it has now spawned another financial bubble.

Let's start with the $1.45 trillion that the Fed has committed to propping up the mortgage market -- money that, for the most part, was simply printed. Effectively, most of that has been used to buy up bonds issued by Fannie Mae and Freddie Mac from investors, who turned around and used the proceeds to buy "safer" U.S. Treasury bonds. At the same time, the Fed used an additional $300 billion to buy Treasurys directly. With all that money pouring into the market, you begin to understand why it is that Treasury prices have risen and interest rates fallen, even at a time when the government is borrowing record amounts of new money.

As it was printing all that money, the Fed was also lowering the interest rate at which banks borrow from the Fed and each other, to pretty close to zero. What didn't change was the interest rate banks charged everyone else. As a result, "spreads" between what banks pay for money and what they charge are near record highs.

So who is borrowing? By and large, it's not households and businesses, which are reluctant to borrow during a recession. Rather, it's hedge funds and other investors, who have been using the money to buy stocks, corporate bonds and commodities, driving prices to levels unsupported by the business and economic fundamentals...
Read the rest here.


Visibilium said...

Yes, Steven, yes, yes, yes. But just to interject a little balance, let me point out that M3 growth has slowed and that banks' net interest margins are typically wide during recoveries. Also, the whole point of being a lender of last resort, in effect, is to prop up asset prices to avoid a market lock-up. You should spend your time watching Bernanke instead of a slug like Blinder.

Reactionary said...

Also, the whole point of being a lender of last resort, in effect, is to prop up asset prices to avoid a market lock-up.

There is no such thing as a "market lock-up." Markets clear, everywhere and always. They just don't always clear at the prices that were previously bid. This is part of the market process: foolish spenders have to take their lumps; prudent savers get the assets at a realistic price.

Visibilium said...

Not really. That's why the stock exchanges have circuit breakers, for example. They don't lend money, but they halt trading. Similar tool.

Reactionary said...

Halt trading? There's your market lockup.

Visibilium said...

Yes, organized markets are paradoxical. They don't just occur, but take capital and strategy to create and maintain them.