The Fed's Ponzi Scheme Has Run Out

The stock market is up approximately 57% since its March lows. One would forgiven for assuming that investors were pouring money into equity mutual funds. Actually it is bond funds which have garnered investors' attention. Morningstar reports that bond funds have received net deposits totalling $209.1 billion while stock funds attracted $15.2 billion in deposits. Why have many investors shunned equities, especially with its sharp rise, and have flocked to bonds?

The answer is two-fold:

1. Baby Boomers are aging. They will focus less on stocks and more on bonds. An aging population means more focus on bonds.
2. Not everyone buys into the recovery story. In fact, it is mostly equity oriented money and fund managers who talk the V-shaped recovery story.

It is true that the bond guys have fund managers talking their books and the markets higher. PIMCO's Bill Gross is one. However, not everyone on the bond size of the business is talk a book. Art Laffer, Alan Greenspan and even Ben Bernanke, to name a few, are warning of sluggish growth once government stimulus ceases. The plain truth is that there can be no sustained strong growth or core inflation pressures (at least not at first) without job growth and either wage growth (which has been sluggish during the past two decades) or easy access to increased amounts of leverage. The Fed decided to focus on cheap leverage to stimulate the economy, cycle after cycle.

The problem with using ever cheaper leverage to reinvigorate the economy is that it is a finite proposition. After all, interest rates cannot be lowered ad infinitum. At some point rates will approach zero and the ability to stimulate the economy ceases. Another factor in the economic growth experienced during the past two decades is securitization. Securitization enables lenders other than traditional banks and finance companies to write loans to risky borrowers, securitize the loans, sell them off and loan the proceeds to new borrowers. Again, leverage is not forever. eventually these borrowers have to make payments on these loans. Paying debts would strain family budgets. The Fed's answer was to lower rates again. Wall Street would find new ways to lend to who really should be unlendable. Home prices would rise due to low interest rates and easy loan terms attracting more buyers. Now the existing borrower could refinance their mortgages and spend either the new budget surplus or spend the increased home equity resulting from Fed policy.

We have hit bottom. No longer can the Fed lower rates from here. No longer can loans requirements be lowered to the point where the unemployed were receiving credit. Wages have little chance of growing as companies keep a tight hold on expenses. The consumer is out of the game. The treasury market is right. The economy will be sluggish once again. Today's poor ADP Employment report and Chicago Purchasing Managers' report is only the beginning. I am looking for more poor data during the next several quarters.

Comments

[sethmcs:]

Gloom and doom can't last forever. It's morning in America. Where is Ronald Reagan?

Oct 01 09:33 AM

[TLassen:]

" The Fed's Ponzi Scheme Has Run Out "

slight disconnect between the headline and content of your article.

Contributors (or SA editors) should be careful using emotionally laden words like Ponzi to illustrate Fed action that they either disagree with or do not comprehend. Ponzi schemes are criminal schemes, with an intent to defraud investors. Are you suggesting the Fed's have a 'criminal intent' in their actions?

Oct 01 09:38 AM

[valuestocks...:]

I know people that are paying the mortgage payment with a credit card. This cannot go on forever. Then they will be one of the newly found foreclosed upon. The damage is just beginning in this economy.

Oct 01 10:06 AM

[MssrLeKinque:]

vocabulary is germaine to the issue.
we will either learn the meaning of the word ' unsustainable '
or be obliged to learn the meaning of the word ' capitulation . '

Oct 01 10:17 AM

[CGP:]

Not that I'm an expert but I would think those piling into bond funds are not buying what they think - "safety". Because of financial engineering and credit crisis bailout I'm thinking there has been a big injection of volatility into that market. Volatility may not be as fast moving and extreme as in equities but I'm pretty confident the risk/reward is skewing more to equities as "safety" in debt instruments might be a little more illusory now.

That Ron Paul and others like to demonize the Fed amazes me that people don't know or research history. Before the founding of the Fed, the stability of banks and the money supply was an "iffy" proposition at best. It was up to the Morgans and syndicates of deep pocketed bankers (domestic and foreign) to rescue the system on an ad hoc basis. At the least, we now have a somewhat accountable institution that has been our backbone during a period of enormous growth of US financial (and political) influence.

People focus on where we are now but don't seem to understand where we were or where we could be if not for certain safety nets. Blame the greedy, those who take inordinate amounts of risk because everybody else is doing it and those who act w\o really understanding what they're doing.

@TLassen:
100% agreement, equating the Fed w\Ponzi is irresponsible; it's just to get attention (win for Mr. Thomas).

Oct 01 10:50 AM

[31October:]

Laying around unemployed, like 7 million Americans.


On Oct 01 09:33 AM sethmcs wrote:
> Gloom and doom can't last forever. It's morning in America. Where
> is Ronald Reagan?

Oct 01 10:50 AM

[buyitcheap:]

You're dead on - but with this latest drop, TLT will spike and TBT will drop substantially, perhaps to its all time lows. after that, you and I are in agreement. For more juiced returns try the options on these.


On Oct 01 10:27 AM Mad Hedge Fund Trader wrote:

> qit Reviewing the current political and monetary landscape, I would
> beremiss, irresponsible, even negligent, if I didn’t revisit one
> of myfavorite ETF’s, the Proshares Ultra Short Treasury Trust (seekingalpha.com/symbo...).
> This isthe 200% leveraged bet that long Treasury bonds, the world’s
> mostovervalued asset, are going to go down. While the Fed is going
> to keepshort rates low for the indefinite future, it has absolutely
> no directcontrol over long rates. The only political certainty we
> can count onis the continued exponential growth in the supply of
> government bondsof all maturities. Like all Ponzi schemes, their
> eventual collapse isjust a matter of time. It’s simply a question
> of how many greater foolsare out there (sorry China). Look at how
> they are trading now. Wecurrently have the greatest liquidity driven
> market of all time, andthe ten year is only eking out a 3.40% yield,
> pricing in near zeroinflationary expectations. The average yield
> on this paper for the lastten years is 6.20%, a double from the current
> level. Get the yield backup to 5%, a distinct possibility in 2010,
> and that takes the TBT fromthe current $45 to $70. Sure, we may get
> a sideways grind in yields fora few months, which will be expensive
> due to the mathematicidiosyncrasies of the 2X ETFS. But a security
> that is unchanged if I amwrong, and doubles if I am right is the
> kind of risk/reward ratio thatI will take all day. And I believe
> that in my lifetime Treasuries maylose their vaunted triple “A” rating
> and be priced closer to subprime(warning: I am old). That could enable
> the TBT to deliver the holygrail of trades, your proverbial ten bagger.

Oct 01 10:51 AM

[WOT:]

He is dead. For that matter, so is the national economy.


On Oct 01 09:33 AM sethmcs wrote:

> Gloom and doom can't last forever. It's morning in America. Where
> is Ronald Reagan?

Oct 01 03:31 PM

[Charles Eas...:]

Mr. or Ms. Lassen,

Giving Mr. Thomas the benefit of my doubt, perhaps his heading is a reference to Mr. Minsky's economic stage of "Ponzi Finance", which has some similarities to the content of this article.

The connection between the Federal Reserve and its role in the "financialization" or over-leveraging of our economy is admittedly tenuous until and unless one accepts the idea that the Federal Reserve is a necessary and willing participant in the Department of the Treasury's nationalization of the bad debts/toxic assets of select financial firms/institutions, which occur at the expense of the citizens of our country.

By this way of thinking, all of us become unwilling investors.

I hope this helps.


Best regards,

Charles


P.S. Although I disagree with Mr. Minsky on many points, I found his thoughts worth reading.
-C

On Oct 01 09:38 AM TLassen wrote:

> " The Fed's Ponzi Scheme Has Run Out "
>
> slight disconnect between the headline and content of your article.
>
>
> Contributors (or SA editors) should be careful using emotionally
> laden words like Ponzi to illustrate Fed action that they either
> disagree with or do not comprehend. Ponzi schemes are criminal schemes,
> with an intent to defraud investors. Are you suggesting the Fed's
> have a 'criminal intent' in their actions?

Oct 02 01:49 PM

[TLassen:]

it's definitely Mr. :)
I'll give the author the benefit of my doubt in this case. Positive SA actually decides on the headlines to attract more readers to the articles. Case in point, worked to get me lured in !

I just wanted to point out how easily "populist expressions" can take on a different meaning.


On Oct 02 01:49 PM User 494820 wrote:

>
> Mr. or Ms. Lassen,
>
> Giving Mr. Thomas the benefit of my doubt, perhaps his heading is
> a reference to Mr. Minsky's economic stage of "Ponzi Finance", which
> has some similarities to the content of this article.
>
> The connection between the Federal Reserve and its role in the "financialization"
> or over-leveraging of our economy is admittedly tenuous until and
> unless one accepts the idea that the Federal Reserve is a necessary
> and willing participant in the Department of the Treasury's nationalization
> of the bad debts/toxic assets of select financial firms/institutions,
> which occur at the expense of the citizens of our country.
>
> By this way of thinking, all of us become unwilling investors. <br/>
>
> I hope this helps.
>
>
> Best regards,
>
> Charles
>
>
> P.S. Although I disagree with Mr. Minsky on many points, I found
> his thoughts worth reading.
> -C
>
> On Oct 01 09:38 AM TLassen wrote:

Oct 02 04:11 PM

[Bernard Thomas:]

Not really. A Ponzi scheme leads the last person holding bag. A zero-sum game. The feds scheme is a zero sum game. It kept lowering rates thinking it could fix the problem later. This is not unlike Bernie Madoff who thought that he could keep the scam going and make investors whole when necessary. The problem with the Fed, Madoff and Ponzi, you can never recover without paying the piper. The Fed had to admit the economy had to correct back to fundamentals (and it could not be prevented and Madoff eventually had to admit to himself and clients that he could not perpetuate his scheme.

The Fed wanted us to believe that by deftly lowering and raising inetrest rates it couldmanage the economy and reduce volatility. The problem was that the Fed could never raise rates back to where they were before. You can't lower forever. Zero is the bottom.


On Oct 01 09:38 AM TLassen wrote:

> " The Fed's Ponzi Scheme Has Run Out "
>
> slight disconnect between the headline and content of your article.
>
>
> Contributors (or SA editors) should be careful using emotionally
> laden words like Ponzi to illustrate Fed action that they either
> disagree with or do not comprehend. Ponzi schemes are criminal schemes,
> with an intent to defraud investors. Are you suggesting the Fed's
> have a 'criminal intent' in their actions?

Oct 03 04:56 PM

[TLassen:]

Well Mr.Thomas, if you don't understand the difference between an action with a criminal intent and one which you don't comprehend or agree with...good luck to you.

"The feds scheme is a zero sum game" this statement is not only offensive but of course completely misguided. Zero sum principle is best left where it belongs....in gambling theory.

"The Fed wanted us to believe that by deftly lowering and raising inetrest rates it couldmanage the economy and reduce volatility"

at least you are half way there. That is exactly the role of the Fed's. They manage an inflation target monetary policy . They control the easing and tightening of the money flow to commercial banks. Nothing 'deftly' in that, this monetary policy is adopted by all industrialized countries in the world. You may not agree with this Keynesian policy but this is economic reality.

Anyhow, I have no beef with your overall article, you make good points, but I think you go way too far with the inference of criminal intent

Oct 04 06:10 PM