Saturday, January 16, 2010

The Federal Reserve's Failure to Learn and Its Consequences

In a speech given January 3, 2010, Ben Bernanke placed the blame for the financial crisis on everything from lax regulation to poor peasants in China.

Yet, the 2009 Time Person of the Year refused to look in the mirror and accept the fact that much of the blame for the financial crisis lies with the Federal Reserve and its low interest rate policies.

This bodes ill not only for the future course of monetary policy in the United States, but also does not bode well for the future of the US economy. It's simple - one cannot fix what is broken until there is a full understanding, by those in power, of what went wrong and how.

What Ben Bernanke seems to conviently be ignoring is the impact that ultra-low interest rates had, and continue to have, on the investment world - particularly the effect low rates has on Wall Street's bond managers, including large pension funds, retirement plans and trusts.

Interest rates of zero or one per cent produced an enormous cascading effect on the demand for high-yielding instruments. The details of the effect that low interest rates had was laid out beautifully by Barry Ritholtz, the author of Bailout Nation, at his blog.

I won't go into all of the details, but here some of the important points:

1) Ultra-low yields led to a scramble by fund managers for higher yields;

2) At the same time, there was a massive push into subprime lending by unregulated nonbanks whose sole purpose was to sell these mortgages to Wall Street firms that securitized them;

3) Since these nonbanks did not hold these mortgages for long, they lowered their lending standards to where almost everyone qualified;

4) Massive ratings FRAUD by the ratings agencies led to this junk being rated as Triple AAA;

5) That high investment grade allowed bond managers to purchase this junk which they normally would not have;

6) High leverage allowed a huge securitization process, then more leverage was piled on by the non-regulated derivatives market. This allowed firms like AIG to write $3 trillion in derivative exposure!

7) Compensation in the financial sector was asymmetrical, where employees had all of the upside and shareholders/taxpayers had all of the downside. This led to increasingly risky activity, which continues to this day.

You may say - who cares, it's water under the bridge. But the problem is that the consequences of the financial crisis continue to this day to effect the United States and its citizens in their daily lives.

In order to bail out Wall Street, the government has gone trillions of dollars deeper into debt, with that debt growing exponentially every day.

So far, the Federal Reserve has had their printing presses running full speed day and night in order to have enough money to purchase all of the government debt - Treasuries - to keep the country running.

But that game can only go on for so long before an already weak and declining US dollar goes into a steep dive into oblivion and economic chaos for the American public.

So the federal government has to come up with another solution...finding another pot of money somewhere.

Leave it to our elected officials - they have.

The Treasury Department is looking at ways to FORCE a large portion of ALL retirement plans into "fixed payment annuities" other words, the money would be forced into long-term Treasury bonds.

Officially this is about "retirement security", which sounds nice, but in effect it will be a seizure of private assets in order to fund government deficits at negligible interest rates.

And remember my prior warning - the value of these bonds has only one way to go - down. So the government is thinking about forcing its citizens into a guaranteed losing investment in order to fund the bailout of Wall Street and other privileged elites. Amazing!

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