Pearlstein: A New Bubble Of The Fed’s Creation

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Steve Pearlstein is one of the best in the business.  Today’s column is a gem:

Yes, the financial crisis has passed and the economy is growing again, but there’s a good chance that growth will be temporary — the result of one-time events like “Cash for Clunkers,” the tax credit for first-time home buyers….  But with businesses still reducing payrolls, bank lending still contracting, and anxious consumers determined to save more and spend less, a sustained recovery in 2010 isn’t looking very likely.


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.

“A New Bubble Of the Fed’s Creation”, Steven Pearlstein, The Washington Post, September 23

I forecasted just as much almost a year ago in “The Next Bubble”, Top Gun Financial, October 29, 2008.

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