(The scene opens in the executive washroom of Goldman Sachs. Washroom attendant Selig Cartwright has just finished his morning chores as Mr. B. comes by for his usual 10 a.m. refresher.)
You’re looking chipper today, Mr. B. I thought all the layoffs on Wall Street would be getting you down.
Layoffs? Oh those. They’re only in The Street’s retail businesses with small investors or small businesses. Our derivative trade is booming.
Derivatives are that big a trade?
Selig, Selig, Selig. There are $846 trillion worth of these financial products out there now. Trillions, man. This isn’t chump change like the deals we did to help countries like Greece and Ireland in the past. Countries that now don’t even appreciate all we did for them.
Funnier about that, Mr. B. You’d think they’d be grateful.
A world of ingrates, Selig. Sometimes I wonder why we bothered.
Indeed, sir. But about derivatives. I thought that Dodd-Frank legislation was supposed to put a crimp in that trade. I mean, derivatives did almost bring down the world financial system a few years back.
Old news, Selig. Dodd-Frank could have been a problem for the derivatives market. But The Fed’s quantitative easing has solved that problem — along with a few others.
What is quantitative easing, Mr. B? It sounds mysterious.
Not at all, Selig. The Fed is buying $45 billion a month in Treasury securities and $40 billion a month of mortgage backed securities that are owned by Wall Street firms. By the end of 2013 it will own $4 trillion of these assets.
That’s the first thing I don’t understand. How can The Fed buy anything, Mr. B? It’s not a business. It doesn’t earn any money. How can it buy things?
The Fed doesn’t need to earn money. It makes money. Kind of like printing it, except using more up-to-date tools. And this new money has value because it’s ultimately backed by taxpayers.
Well that’s certainly reassuring. But sir, doesn’t creating new money out of whole clothe create inflation?
Ah, Selig. That’s the genius of this present quantitative easy. This money doesn’t get into places that cause inflation — at least not in places where the government measures inflation.
Look at it this way, Selig. If this new money somehow ended up going to little people like you, little people earning your little incomes, the way central banks used to do when they printed a lot more money, what would you do with that extra money?
Spend it, sir.
Exactly, Selig. Lots of little people spending lots more money on lots more things and you get inflation. But because more than half of it is being used to buy debt issued by the Treasury, and the other half is being used to buy Wall Street’s mortgage debt, it doesn’t get to greedy little people like you who could cause inflation — at least the way government measures inflation.
I guess we can all be grateful for that, sir. Kind of. By why is The Fed buying so much Treasury debt?
Because by buying so much of it, Selig, it can set the rates. Which The Fed sets very, very low. Near zero, in fact.
But don’t most debt buyers want to get more returns from higher rates?
Selig, dear fellow. That’s one of the things that makes this Fed program so innovative. It’s the reason everyone who follows what The Fed is doing is saying it’s going where no central bank has ever dared to go before. By making new Treasury debt so cheap, The Fed helps insure that the government can keep running up huge deficits it can afford to service. If rates on new Treasury debt went up more, even a little more, all taxes collected would have to go to debt servicing and they’d be nothing left for entitlements or the military.
You mean, Mr. B., one government agency is creating money out of nothing to buy another government agency’s debt at near zero rates so this other agency can meet the bills of the otherwise essentially insolvent government of which they are both a part?
You see a problem here, Selig? A cause for worry?
Worry? Heck no. In fact now that you’ve explained that part of The Fed’s quantitative easy strategy I’m actually feeling a bit giddy. And I can hardly wait to hear why The Fed is buying all those Wall Street-owned mortgage backed security bonds.
It’s doing that, Selig, so the banks’ reserves situation improves, and they can start lending more to small businesses. Which would do a lot to boost the economy if it happened.
If it happened? It hasn’t happened?
Well, no, Selig. Banks don’t want to lend to small businesses anymore because that’s too risky and they might lose money. They couldn’t do it even they wanted to because government bank regulators have mandated they can’t lend too much to risky enterprises since that would endanger their reserves positions, and the economy is still so weak that smaller enterprises tend to be risky ones.
So if banks are trading their junky mortgage backed securities for triple-A government ones from The Fed, Mr. B, and this improves their reserves position, and these improved reserves aren’t being used as collateral to boost small business lending, what are banks doing with this added investable capital?
Investing it in buying stocks. of course, keeping that market flying high. Sinking it in commodity trading, keeping that market fired up. And maybe most of all, using it to take the edge off Dodd-Frank and that law’s efforts to slow down the growth of the derivative market.
I don’t understand, sir.
The Dodd-Frank law, Selig, mandates that parties that take on the passed along debt from other parties have to have the capital reserves they’d need to pay up if this debt goes bad. The extra quality of reserves generated by The Fed’s mortgage backed bonds buying program allows Wall Street firms to have the needed reserves for more derivative deals.
I think I finally understand quantitative easing, Mr. B. May I run it by you one more time to see if I have it all down right?
Of course, Selig. I live to serve. Provided it doesn’t keep me from my private Stall # 8 for too much longer.
O.K, sir. Here goes. This government agency, which is really just a few unelected people, can create $4 trillion of new money without approval from anyone else in government or anywhere else.
And it can use it to buy the debt of another government agency at the lowest possible interest rates.
And if this other government agency didn’t have these unbelievably low rates, the federal government would soon not be able to afford to do anything but pay principal and interest on its old existing debt.
And the other part of quantitative easing, the buying mortgaged backed bonds from Wall Street firms, that is supposed to be a stimulus package that helps small businesses, is pretty much a total failure for this purpose.
But what this mortgage debt buying does instead is allow Wall Street firms to keep stock and commodity markets trading flying high, and derivative packaging and peddling of the sort that almost destroyed the world financial system in the past to expand even further.
And if this expansion leads to an even bigger bust in world markets, The Fed would still be on the hook to do a bail.
How could it not, Selig?
And none of this $4 trillion easing causes inflation of the kind the government measures because it doesn’t measure puffed up stock and commodity markets’ prices, or profits generated from derivatives as parts of its inflation measuring.
Right, Selig. But I should mention that some of the extra profits that people on The Street make from this mortgage-backed bond buying goes into our own purchases of houses in swank sections of Manhattan and London where prices are going through the roof. People like me are experiencing that inflation, while little folks like yourself only see some when buying food because of our commodity gaming.
Lucky us. But quite a burden for you Wall Streeters, Mr. B.
A burden the best and brightest must endure for the common good, Selig. And don’t you forget it.
Not likely, sir. Given the number of unemployed guys who have the washroom cleaning skills one needs to do my job.
Very prudent attitude, Selig. I no longer wish to endure not using Stall #8 now, however. Is it ready to receive.
Cleaned, stocked, and ready, sir.
Good man. I’m going in.
The two comic novels from the writer of this post are titled: The Bellman’s Revenge and Fifteen Feet Beneath Manhattan.