18 Jan 2010

Fed as the World’s Biggest Carry Trader?

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I am not immersed in the data to say whether this is a good description, but it might be. After quoting James Hamilton, Arnold Kling writes:

The Fed is now the world’s biggest carry trader. In Hamilton’s view, the Fed’s huge injection of bank reserves, on which it pays interest, amounts to borrowing from those banks at the short-term rate. It then lends long term in the mortgage securities market.

This is what the Savings and Loans did back in the good old days. They borrowed money short term at 3 percent and made mortgage loans at 6 percent. It worked really well until the mid-1970’s, when interest rates moved up. Those 6 percent mortgages don’t look so sweet when short-term money costs 10 percent.

Long-term mortgage rates are now lower than they were in the heyday of the S&Ls. Taxpayers bore some of the cost of the S&L blowup. We stand to bear all of the interest-rate risk that the Fed is taking.

Have a nice day.

No one knows the future, but it’s interesting that some of us have concluded that the Fed’s actions are going to blow up and yet we are using different ways of reaching that answer. So either we’re all right, and are merely focusing on different angles of the horrendous situation, or we’re all nuts and are erroneously reaching the same wrong answer through mutliple invalid chains of reasoning.

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