Marketplace Scratch Pad

The next bubble’s already here?

Scott Jagow Sep 23, 2009

The Federal Reserve just made its announcement on interest rates. The Fed said it would leave rates near zero and will in fact keep them low for an extended period even though economic activity has “picked up.” Could be a very dangerous strategy.

In a column titled A New Bubble of the Fed’s Creation, Washington Post business columnist Steven Pearlstein writes that super low interest rates have spurred borrowing. But clearly not by households and businesses:

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…

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.

Back at the Fed, the attitude has been to welcome anything that strengthens the balance sheets of banks, particularly while they continue to write off billions of dollars in soured loans each quarter.

If stocks and commodity prices are the new bubble, the Fed has no excuse for missing it, given the bubble that just blew up in its (our) face. Pearlstein continues:

Given the new architecture of global finance, the Fed can no longer think of its job solely in terms of the trade-off between inflation and unemployment. Nor should it become complacent about restrained consumer prices while ignoring rapidly rising prices for financial assets. As Alan Greenspan discovered, it is also a mistake for central bankers to assume that they can quickly sop up excess liquidity whenever they decide the moment is right.

Chairman Ben Bernanke has continually expressed confidence in the Fed’s ability to react if inflation, of any kind, rears its head. A case of overconfidence?

Pearlstein held a chat about his article, and someone pointed out that he had been scooped:

Fort Worth, Tex.: Uh, I hate to bring this up Steven, but you’ve been scooped by the Onion – by over a year. I’m referring of course to their 7/14/08 article titled “Recession-Plagued Nation Demands New Bubble To Invest In”. There have already been a lot of people pointing out that all we’re doing now is creating another bubble and continuing the preferential treatment for the finance industry. What will it take to level the playing field?

Steven Pearlstein: You know, I was at a party last night where a prominent administration economist was in attendance and I mentioned the column I had just written and his first reaction was to recall that same headline from the Onion. I wish I had known about it since it would have made for a great lead.

It really would have. From the Onion piece a year ago:

A panel of top business leaders testified before Congress about the worsening recession Monday, demanding the government provide Americans with a new irresponsible and largely illusory economic bubble in which to invest…

Congress is currently considering an emergency economic-stimulus measure, tentatively called the Bubble Act, which would order the Federal Reserve to begin encouraging massive private investment in some fantastical financial scheme in order to get the nation’s false economy back on track.

Current bubbles being considered include the handheld electronics bubble, the undersea-mining-rights bubble, and the decorative office-plant bubble…

The most support thus far has gone toward the so-called paper bubble. In this appealing scenario, various privately issued pieces of paper, backed by government tax incentives but entirely worthless, would temporarily be given grossly inflated artificial values and sold to unsuspecting stockholders by greedy and unscrupulous entrepreneurs…

“Every American family deserves a false sense of security,” said Chris Reppto, a risk analyst for Citigroup in New York. “Once we have a bubble to provide a fragile foundation, we can begin building pyramid scheme on top of pyramid scheme, and before we know it, the financial situation will return to normal.”

How often spoof imitates life?

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