What Are the Risks of Quantitative Easing, Really?

What Are the Risks of Quantitative Easing, Really?

In the financial market there is a demand for risk-bearing capacity by firms and others who want to borrow but who cannot guarantee that they will be able to repay. The higher is the price of risk--the greater the risk premium interest rate spread over short-term Treasuries they must pay--the less they will borrow.
In the financial market there is also a supply of risk-bearing capacity by savers and financial intermediaries who want to lend, and are willing to accept and bear some risk in return from getting more than the short-term Treasury rate. The higher is the price of risk----the greater the risk premium interest rate spread over short-term Treasuries they must pay--the more they will be willing to lend.

When the Federal Reserve undertakes quantitative easing, it enters the market and takes some risk off the table, buying up some of the risky assets issued by the U.S. government and its tame mortgage GSEs and selling safe assets in exchange. The demand curve for risk-bearing capacity seen by the private market thus shifts inward, to the left: a bunch of risky Treasuries and GSEs are no longer out there, as the government is no longer in the business of soaking-up as much of the private-sector's risk-bearing capacity:

And this leftward shift in the net demand to the rest of the market for risk-bearing capacity causes the price of risk to fall, and the quantity of risk-bearing capacity supplied to fall as well. Yes, financial intermediaries that had held Treasuries and thus carried duration risk take some of the cash they received by selling their risky long-term Treasuries to the Fed and go out and buy other risky stuff. But the net effect of quantitative easing is to leave investors and financial intermediaries holding less risky portfolios because they are supplying less risk-bearing capacity.
How do we know that they are holding not more but less risky portfolios? We know because we know that supply curves slope up, and if they were holding more risky portfolios in total--supplying more risk-bearing capacity to the market--the price of risk would have not fallen but risen, and interest rate risk spreads would be not lower but higher, wouldn't they?
So when the intelligent and thoughtful Mark Dow tweets:

I, too, think risks [of QE] overstated, but they're non-zero. Main ones r credit leverage buildup…

I am at a loss. As long as supply curves slope up, QE does not increase but reduces the leverage of private-sector financial asset holders.
And when the intelligent and thoughtful Mark Dow tweets:

I, too, think risks overstated, but they're non-zero. Main ones r… outsized int'l capital flows

I am again at a loss. Yes, the Federal Reserve has taken some domestic risky assets off the table. Yes, U.S. financial intermediaries and savers will respond by buying foreign assets to so deploy some of their now-undeployed risk bearing capacity. Yes, they will now bear some exchange-rate risk. But, once again, the fact that QE pushes interest rate spreads down is very powerful evidence that these capital flows are not "outsized"--that the extra exchange-rate risk U.S. financial intermediaries have now taken onto their books is less than the duration risk that QE took off of their books.
At least, that is the case as long as the supply curve for risk-bearing capacity slopes up, like a good supply curve should.
Perhaps those who claim that there are big risks to quantitative easing regroup. Perhaps they claim that financial intermediaries are perverted, and that the lower is the price of risk the greater is the amount of risk-bearing capacity they supply to the market because they lose their jobs if they don't make at least three cents on every dollar of assets in a normal year in which risk chickens come home to roost.
In that counterfactual world, the supply-and-demand graph would look like this:

And in that counterfactual world, the Federal Reserve's adoption of quantitative easing policies triggered an enormous expansion of the quantity of risk-bearing capacity demanded by firms and households and a huge private-sector lending boom as firms issued enormous tranches of risky bonds and as firms and households took out risky loans. In that counterfactual world, employment in bond underwriting tripled as $85 billion a month in QE was more-than-offset by an extra $120 billion a month in private-sector bond issues. In that counterfactual world, we saw a rapid recovery of housing construction and a thorough equipment investment boom as far across the U.S. as they eye could see.
That didn't happen.
So what are the risks of QE?
It really seems to be this:

• Commercial banks traditionally accept deposits, put the deposits in long-term Treasuries, rely on the law of large numbers and on deposit insurance to allow them to always hold their long-term Treasuries to maturity, and so have a riskless and profitable business model.
• When commercial banks cannot do this, they find some way to gamble with government-insured deposits.
• ????
• LOSS!!

But this is not a source of systemic risk: because the deposits they may be gambling with are government insured by the FDIC, no run on the banking system or the shadow banking system occurs when risks come due. It would be embarrassing, yes. And the proper response to thinking that commercial banks are running undue risks with government-insured money is to send in the bank examiners--not to undertake policies that raise unemployment.

Manipulate

Gold and Silver Are Manipulated

The Guardian and Telegraph report that gold and silver prices are “fixed” in the same way as interest rates and derivatives – in daily conference calls by the powers-that-be.
Long-time trader Andrew Maguire told told King World News this week that 2 JP Morgan whistleblowers have handed over evidence of gold and silver manipulation by their bank:

Very recently [Commodities Futures Trading] Commissioner Chilton assured me, and I’m going to quote him exactly, “I can’t appropriately express my frustration and disappointment with how we’ve handled the silver investigation
And, as you know, I’m prohibited from actually saying much.  That said, I will not let September go by without speaking out if the agency doesn’t do so.”
***
I was also contacted by two JP Morgan employees who told me they had a large amount of documented evidence of market trading abuses in gold and silver by their bank (JP Morgan). [And they handed it over to the CFTC.]

We’ll have to wait to see if Maguire’s explosive allegations pan out.
As shown below, big banks have manipulated virtually every market  – both in the financial sector and the real economy – and broken virtually every law on the books.

Energy Markets Are Manipulated

The Federal Energy Regulatory Commission says that JP Morgan has massively manipulated energy markets in California and the Midwest, obtaining tens of millions of dollars in overpayments from grid operators between September 2010 and June 2011.

Commodities Are Manipulated

The big banks and government agencies have been conspiring to manipulate commodities prices for decades.
The big banks are taking over important aspects of the physical economy, including uranium mining, petroleum products, aluminum, ownership and operation of airports, toll roads, ports, and electricity.
And they are using these physical assets to massively manipulate commodities prices … scalping consumers of many billions of dollars each year.

Interest Rates Are Manipulated

Interest rates are rigged:

• The big banks have conspired for years to rig interest rates … upon which $800 trillion in assets are pegged

• This was the largest insider trading scandal ever … and the largest financial scam in world history

• Local governments got ripped off bigtime by the Libor manipulation

• Libor is still being manipulated

Derivatives Are Manipulated

The big banks have long manipulated derivatives … a $1,200 Trillion Dollar market.
Indeed, many trillions of dollars of derivatives are being manipulated in the exact same same way that interest rates are fixed: through gamed self-reporting.

Currency Markets Are Rigged

Currency markets are massively rigged.

Oil Prices Are Manipulated

Oil prices are manipulated as well.

Everything Can Be Manipulated through High-Frequency Trading

Traders with high-tech computers can manipulate stocks, bonds, options, currencies and commodities. And see this.

Manipulating Numerous Markets In Myriad Ways

The big banks and other giants manipulate numerous markets in myriad ways, for example:

• Engaging in mafia-style big-rigging fraud against local governments. See this, this and this

• Shaving money off of virtually every pension transaction they handled over the course of decades, stealing collectively billions of dollars from pensions worldwide. Details here, here, here, here, here, here, here, here, here, here, here and here

• Charging “storage fees” to store gold bullion … without even buying or storing any gold . And raiding allocated gold accounts

• Committing massive and pervasive fraud both when they initiated mortgage loans and when they foreclosed on them (and see this)

• Pledging the same mortgage multiple times to different buyers. See this, this, this, this and this. This would be like selling your car, and collecting money from 10 different buyers for the same car

• Cheating homeowners by gaming laws meant to protect people from unfair foreclosure

• Pushing investments which they knew were terrible, and then betting against the same investments to make money for themselves. See this, this, this, this and this

• Engaging in unlawful “frontrunning” to manipulate markets. See this, this, this, this, this and this

• Engaging in unlawful “Wash Trades” to manipulate asset prices. See this, this and this

• Otherwise manipulating markets. And see this

• Participating in various Ponzi schemes. See this, this and this

• Charging veterans unlawful mortgage fees

• Cooking their books (and see this)

• Bribing and bullying ratings agencies to inflate ratings on their risky investments

Sharing

Most of the past century, Americans have been the world’s greatest consumers. And usually consumption has meant ownership: just before the Great Recession, the average American household owned 2.28 cars, and had more television sets than people. But these days a host of new companies are trying to disrupt the paradigm—offering the benefits of consuming without the costs of ownership. Ride-sharing companies such as Lyft, Sidecar, and, in some cities, UberX, own no cars themselves. Instead, they sign up ordinary car owners: when you need a ride, you can use their apps to find a driver near you and ask to be picked up. Many other companies are trying to cash in on what’s often called “the sharing economy.” Airbnb now features more than three hundred thousand listings from people making their apartments and homes available for short-term rentals. RelayRides and Getaround let you rent cars from their owners (rather than from Hertz or Avis). Boatbound offers boat rentals, Desktime office space, ParkatmyHouse parking spaces. SnapGoods makes it possible for people to borrow consumer goods from other people in their neighborhood or social network. It may not be too long before you’re able to pay to sit in a stranger’s living room and “share” his home theatre.
Just a couple of weeks ago, Uber (which also runs services allowing you to book livery cars and cabs) disclosed that it had raised more than a quarter of a billion dollars in venture-capital funding, most of it from Google. The flood of new money into all these new businesses feels like a mini-bubble in the making. But beneath all the hype is a sensible idea: there are a lot of slack resources in the economy. Assets sit idle—the average car is driven just an hour a day—and workers have time and skills that go unused. If you can connect the people who have the assets to people who are willing to pay to rent them, you reduce waste and end up with a more efficient system.
In the past, this was hard to pull off, because the transaction costs involved in borrowing and lending were high: there was no easy way to find someone who had what you were looking for and no easy way to know if someone was trustworthy. So if you borrowed a lawnmower it was typically from your neighbor. But digital technology has made it much easier for buyers and sellers to find each other quickly, and to evaluate the people they’re trading with. The effect has been to make sharing a much more plausible business model. “We now have hundreds of millions of consumers who are carrying in their pockets powerful computers that are always connected to high-speed networks,” Arun Sundararajan, a professor at N.Y.U.’s Stern School of Business and an expert on the sharing economy, told me. “That makes it possible for people to rethink the way they consume.”

Sharing has also had a boost from the weak economy. People are leery of making big up-front purchases, and many have had to scramble for ways to monetize their time and their assets. More important, there are signs that the ties between consumption and ownership are loosening, particularly among younger people. Studies suggest that Millennials are less interested in owning cars than previous generations have been, and the success of sites such as Netflix and Spotify show that, at least with some goods, renting can trump ownership. For one thing, people get access to a much wider range of products than they could ever own. “There’s a mind-set that consumers are doing this just to save money,” Sundararajan said. “But I think that what’s really compelling about the sharing economy is the variety and expansion of choices that it offers. Instead of being tied to owning one car, I can drive twenty different ones. So I expect this will expand consumption, rather than shrink it.”

Before that happens, though, there are serious hurdles that the sharing economy has to get over. The most obvious of these is regulation. Cities typically have elaborate rules for cabs and limos that control drivers, vehicles, fares, and so on. These rules in part reflect the desire of vested interests (like cab companies) to protect their businesses and in part consumer concerns about safety and liability. Sharing companies circumvent some of those rules, in effect arguing that, if you choose to pay someone to give you a ride to the airport—or rent you an apartment—the state shouldn’t stop you. That’s an appealing position, but the companies are actually piggybacking on the trust that consumers feel in what is typically a highly regulated economy. If these companies become more established, they’ll have to reach some kind of accommodation with regulators, perhaps along the lines of rules that California’s Public Utilities Commission recently proposed, which would let Sidecar, Lyft, and Uber operate if they implement certain safety and driver regulations.
It isn’t just companies and regulators who will have to be flexible, though. Workers will, too, since the sharing economy requires people to function as micro-entrepreneurs. Uber is just a broker, and the drivers aren’t anyone’s employees, any more than the landlords in Airbnb’s system are. They are all independent contractors, working for themselves and giving the companies a cut of the action. This has certain attractions: no boss, the ability to set your own hours, control over working conditions. It also means no benefits, no steady paycheck, and the need to always be hustling; in that sense, it fits all too well with the free-agent nation we’re increasingly becoming. Sharing, it turns out, is often a hell of a lot of work. ♦

Rs probs

Rupee still looks vulnerable, India has three options, none very palatable. One is to let the currency fall further. In most countries a cheaper currency would boost exports and help close the current-account deficit. But India’s manufacturing industry is too small and too bound in red tape to ramp up quickly. So a turn-around in the balance of payments may take time during which investors could panic. Meanwhile the weaker currency may destabilise the domestic economy by adding to inflation and increasing the government’s subsidies on fuel and thus its borrowing.
The second option is to do the opposite and increase interest rates to attract more foreign money in, following the path of Indonesia and Brazil. But this would further hammer Indian industry, which is already in poor shape, and probably increase bad debts at banks too. If the economy slowed further as a result, equity investors might begin to worry about corporate earnings declining and pull out their roughly $200 billion of investments in listed shares. Inducing a credit crunch in India might make things even worse.
The last option is to lower government borrowing. It is running at 7% of GDP (including India’s states) and has stoked excess demand in the last few years, widening the current-account deficit. The populist political mood doesn’t make big spending cuts easy, though, and while it is often accused of epic profligacy, India’s central government has pretty low expenditure relative to GDP—about 15%. There is simply no way it can cut its way to a balanced budget. What India really needs is more tax revenues. But with a narrow tax base—only 3% of Indians pay income tax—this might mean concentrating tax rises on the formal economy, which is already reeling.
For now my sense is that the authorities’ plan is to let the rupee trade freely but hold out the threat of an interest rate rise or direct intervention in the currency market to try to scare off speculators. At the same time they will squeeze borrowing as much as is possible during an election and use administrative measures, such as higher duties, to try to cap imports. It is a bet that the economy will pick up soon and that growth will make India’s problems fade away. The trouble is that the economy is still decelerating.