Blame the Bankers... Not so fast

Many feel that Wall Street bankers are to blame for the current economic woes faced around the globe.  Wall Street bankers in pursuit of never ending greed enabled the excessive growth of credit and promoted the shadow banking industry to over lever America.  They peddled reckless mortgage loans via complex derivative securities to naive buyers across the World who relied on the Rating Agency's flawed credit ratings.  Recognizing this, bankers and hedge funds took short positions in these securities that were designed to result in windfall profits from their inevitable failure.  The IBGYBG (I'll Be Gone You'll Be Gone) mentality led to the destruction of many institutions including Lehman Brothers.

But, is it really the bankers fault? It is interesting to note that Alan Greenspan lowered the fed funds rate from 6.5% to 1% over the last decade in order to correct a stock market bubble that in turn created a credit bubble as investors blindly sought higher yields.  The loose monetary policy increased debt levels as a % of GDP to record levels and created the biggest bubble of all in the housing market causing an unprecedented redistribution of wealth enlarging the middle class without hurting the rich or the poor. That is until it made everyone worse off...

Ben Bernanke is now left with an economy that has an unemployment rate of 9.1% and an increasingly high CPI index (recent rates of change of 3.8% y/o/y and a core rate of 2%).  There is no other place to turn to inflate another bubble to lift us out of the current economic depression.  So what has the fed done, turned back to the housing market for support with Operation Twist - an effort to decrease long term rates at the expense of short term rates thereby lowering mortgage costs for new buyers and providing further opportunity for existing home owners to refinance at a lower rate.

The problem is that increasing short term rates will hurt the banking industry which profits by borrowing cheap short term debt to fund long term lending.  Banks will continue to demand more equity from home owners to pad capital ratios, offsetting the economic impact of lower interest rates.


Source:  Robert Shiller's plot of U.S. home prices, population, building costs, and bond yields, from Irrational Exuberance, 2d ed.

It is clear that the fed created an environment to support the creation of an asset bubble in the American housing market.  It's also interesting to note that almost half of the $14.7 trillion US federal government debt is held by the Federal Reserve and the government itself according to an IMF report. The Big Picture reports a further 22 percent of debt is held by foreigners (mainly central banks) which when combined with the federal government share of US debt results in almost 70 percent of US government debt being held by non-market/non-profit oriented investors.

This unfortunately may mean that we will see elected officials continue to cloud the real issues with meaningless political finger pointing as they continue to kick the can down the road.

Trade deficits and imbalances faced amongst sovereigns will result in more gold purchases by central banks as they seek to protect against a run on their currencies.  This problem will intensify if the availability of dollars declines.  No wonder gold is at an all time high.

If you want to hear more about trade deficits read what Warren Buffet has to say:

Warren Buffet on Trade