Is Fed Action Fostering Another Bubble?


The Fed’s “quantitative easing” (QE2) a second round of experimental monetary policy in which the Fed buys long-term government bonds and other assets, is designed to bring down interest rates, spur lending and borrowing, reduce unemployment, and reignite the economy. Whether it will do that remains to be seen. “But it has already worked in one significant way: the speculative juices of the markets are flowing,” according to Jesse Eisinger’s New York Times Dealbook blog, “Where the Bubbles Are.”

As one Fed official said in a recent speech, QE2 will add to “household wealth by keeping asset prices higher than they otherwise would be.”

Eisinger says that this “levitation-by-decree” may or may not reduce unemployment, but “there’s no doubt that the central bank has already helped the Henry Kravises and Lloyd Blankfeins of the world.”

Exuberant speculation in facially bad deals ? money-losing, debt-loaded Harrah’s IPO, and “B notes” backed by commercial real estate loans that leave holders on the hook for the early losses if the loans go bad, for examples ? is rampant, says Eisinger.

Rating inflation is back. “Here, something isn’t just Triple A. It’s ‘Super Senior Triple A.’ So when the best investment bankers can do is to dress something up with a lowly ‘B,’ you know it’s trash,” says Eisinger.

Leverage has gone wild again. One discount brokerage firm will lend (for certain special customers) $566,000 for every $100,000 in equity for the purposes of trading in volatile markets.

Thank the Federal Reserve, Eisinger says, adding, “All of this is Finance 101. The cheaper money is to borrow, the more it makes sense to take a bigger risk with it'”
Except that you can lose it all, and be forced to pay it all back with interest. Brokerage firms that hold themselves out as financial advisors have a duty to advise their clients against undue risk taking.

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