The Greatest Cost (dangerous gov. bubble)

Safehaven ^ | 05/02/09 | Doug Noland

[TigerLikesRooster]

/snip

Many would today argue that it was simply a case of the Fed's failure to take the punchbowl away in time. Such analysis misses a key facet of Bubble dynamics. Once the Mortgage Finance Bubble gained a foothold there was absolutely no way policymakers were going to be willing to risk bursting such a consequential Bubble.

I see ample support for my view that Bubble dynamics have taken root throughout government finance. This unprecedented inflation includes Federal Reserve Credit, Treasury borrowings, Agency debt, GSE MBS guarantees, FHA and FDIC insurance, massive pension and healthcare obligations, the myriad new market support programs, etc. This Government Finance Bubble is domestic as well as global. Amazingly, the scope of the unfolding Bubble dwarfs even the Mortgage Finance Bubble. And, importantly, it is reasonable to presume that the Federal Reserve will find itself in the familiar position of being trapped by the risk of bursting a historic Bubble.

So I see the probabilities as very low that the Fed will reverse course and impose tightened liquidity conditions upon the marketplace. Actually, reflationary pressures may force the Fed to increase its Treasury holdings in an effort to maintain artificially low interest rates. At the same time, I don't see higher inflation as the greatest cost associated with this predicament. Much greater risk lies with the acute systemic fragility that I believe is inherent to major Bubbles. Similar to mortgage finance 2002-2007, the marketplace is significantly mispricing the cost - and failing to recognize the risks - of a massive inflation of government finance. And while every Bubble has its own dynamics and nuances, the unfolding Government Finance Bubble has even more precarious Ponzi Finance dynamics than the Mortgage Bubble.

/snip

[TigerLikesRooster]

Ping!

[ovrtaxt]

Excellent insight. The presence of the global Central Banking Cartel is the largest bubble in human history.

[savedbygrace]

I know very little about all this economic stuff, so I’m probably all wet on this.

The Fed stopped reporting M3 in March 2006. Included in M3 are Repurchase Agreements. Some, perhaps many, Credit Default Swaps and other Derivatives are Repurchase Agreements.

So, the huge uptick in CDS’ and other Derivatives (of home mortgages) would have been easier to see if the Fed had continued to report M3, no?

Even so, the components would still have been available to Greenspan, Bernanke, and Paulson way before Paulson and Bernanke suddenly announced in the Fall of 2008 how much trouble we were in. Did any of those three men raise any red flags about this stuff before the Fall of 2008?

But I’m merely displaying my lack of knowledge of these things.

[pointsal]

bttt

[curiosity]

Some, perhaps many, Credit Default Swaps and other Derivatives are Repurchase Agreements.

Nope. They are totally different things. Repos are simply short-term loans collateralized by Treasuries or other securities.

[savedbygrace]

Thank you. I had read a lot of articles before posting that reply, and it sure seemed like CDS and other derivatives were in the repo category. Looks like I read it wrong.

[curiosity]

Thank you. I had read a lot of articles before posting that reply, and it sure seemed like CDS and other derivatives were in the repo category. Looks like I read it wrong.

FYI, CDS are essentially insurance against default on a bond. Another common derivative is the option, which is the right but not the obligation to buy (a call option) or sell (the put option) a security in the future for a pre-specified price.

In general, derivatives are just securities whose value is based on the value of another security. They play a very distinct role in the financial markets.

The purpose of derivatives is to hedge against risk.

Repos are mainly used by securities dealers to raise short-term financing to fund day-to-day operations. In fact, repos are the primary source of short-term credit for most dealers. From the lenders' point of view, repos are a good investment for money market funds and other institutional investors who have a short-term need to park cash with minimal risk.

In addition, sometimes repos are used by bears who are speculating that the price of Treasury bonds (or other low-risk bond) will go down. A repo from the lender's point of view can be the bond market analogue to a short sale in the stock market.