The Fed is Creating New Bubbles; Who is Really Borrowing and Making Money

The Washington Post published a piece by Steven Pearlstein which discusses many importants aspects of what the Fed is doing - and creating. Some important topics below:

- There's a good chance that the growth we are seeing will be temporary, a result of one-time events like "Cash for Clunkers," the tax credit for first-time home buyers, and the restocking of inventories.
- Businesses are still cutting payrolls, lending by banks is still contracting, and consumers are determined to save more and spend less, a sustained recovery in 2010 is not likely.

The article says to "his credit", at the G-20 meeting in Pittsburgh later this week, president Obama "will push world leaders to take measurable steps over the next few years to move away from a global model that relies on Americans who buy too much, Asians who consume too little and Europeans who spend too much time at lunch". He is indeed saying this, but it will have no real effect, as we have already discussed in our post "G-20 Meeting Chaos and a Very Weakened U.S.".

"To prevent future bubbles, the leaders are also expected to embrace new international rules requiring banks to hold more capital and bankers to take less pay. " Fat chance that the U.S will do this in practice.

The article goes on to say that the excessive liquidity generated by the printing of money by the Fed has now spawned another financial bubble. The Fed committed $1.45 trillion to propping up the mortgage market, effectively, most of that has been used to buy up bonds issued by Fannie Mae and Freddie Mac from investors (who then bought U.S. Treasury bonds with the money).

The Fed also lowered the interest rate at which banks borrow from the Fed and each other to zero., while banks still charge everyone else a much higher rate.


So who is actually borrowing?

- It is not households and businesses, which are reluctant to borrow during a recession.
- It is 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.

The article then says that excess liquidity is even being used to finance a new "carry trade" in which global investors borrow at U.S. rates and buy government bonds in places like Australia, where prevailing rates are higher. Because the carry trade involves exchanging dollars for foreign currencies, it has been a major contributor to the recent decline in the dollar. " You read this here before.

"Naturally, this has been a blessing for Wall Street's biggest banks, whose trading desks have not only made big money executing and financing the investment strategies of others, but have also been trading actively for their own accounts. And with bubble profits come bubble bonuses."