Sunday, March 10, 2013

The Federal Reserve’s Conundrum

The commodities markets have just about played out and the bond market can’t go much lower. Real estate is no buy, unless you want to finance it with nothing down. It looks like stocks market is the last gambling parlor with any real action.

The Federal Reserve is buying bonds to prop up the real estate market. This has in effect kept interest rates very low and it’s doing a very good job of goosing the housing market even with the baby boomers selling and downsizing. The trouble is, people are starting to sell bonds and buy stocks. Interest rates can only remain this low if the Fed buys all bonds presented at par. This is not a bad deal for bond sellers. A buy and sell price that are different implies risk in the market. With a locked interest rate, the buyer is guaranteed the same price when he sells. You have to marvel at the liquidity of bonds, there is no risk.

There is one problem. The bond market is 10 times bigger than the stock market. What happens when a large majority of people make the decision to sell bonds and buy stocks? It’s a little like the passenger ferry many years back in India where two star-crossed lovers decided to commit suicide--their parents wouldn’t let them marry. All the passengers rushed to one side of the boat to watch them jump. The ferry rolled over and drowned hundreds of people. Kind of gives new meaning to the phrase “Misery loves company.”

Ben Bernanke faces a similar situation. Does he buy all bonds presented and trash the currency or let the rising interest rates trash the bond and the real estate market? The stock brokerage houses loan money at prime plus 1 ½ percent. And they don’t care who they borrow it from. Ben’s dollars are as good as anyone else’s. And if stocks are going up, the interest paid by the “investor” is a cost of doing business. All it would take, to start the ball rolling, is for Google to jump up a couple of hundred dollars a share. The Internet is this new frontier with values expanding geometrically. It’s an opiated dream of possible future returns; hold on for a wild ride —the South Sea bubble comes to mind.

We know one thing for sure, the baby boomers, with cash in the bank, ready for retirement, are sick and tired of ¼ of 1 percent interest on their savings. This investment “ferry” is going to rock and roll --—over.

What can Bernanke do? Will he allow rates to rise or endeavor to keep them fixed? The Bernanke conundrum. Remember one thing; an economist can’t predict the future they can only explain, the why of what happened--after the fact.

Welcome to Wall Street, "Faites vos jeux." Let's give the dice a roll. I get the feeling that we've been here before---maybe in a previous life.


Rob in N.S. said...


Your post is even more relevant considering what is now happening in Cyprus. I think we are going to see full on bank run with Bernanke doubling down to protect his masters.

Jim in San Marcos said...

Hi Rob

Haven't heard from you in a while, welcome.

My next post touches on the problem in Cyprus. Governments have the ability to regulate their currencies in ways that most bank savers deem irresponsible.

I agree with your thinking and add the thought, rats don't leave the ship unless its sinking.

Take care