When you hear news that the Federal Reserve is “raising interest rates” (which occurred just weeks ago), the Fed is, in reality, raising just one interest rate: the federal funds rate.
The federal funds rate is the interest rate at which banks and credit unions (depository institutions) lend the funds they keep at the Federal Reserve to other depository institutions overnight. In essence, it is an overnight lending rate from one bank to another.
As of this week, the federal funds rate was yielding 0.91 percent. Just six months ago, it was 0.30 percent. Meanwhile, the 10-year Treasury currently yields 2.42 percent. That arbitrage is a really sweet deal for the Big Banks. The Fed prints money and essentially gives it to the Big Banks, who then loan it back to the government at a much higher interest rate. What a racket!
Since late 2008, the nation’s biggest banks have been receiving enormous sums of money from the Federal Reserve at near-zero interest rates. They are then able to invest this essentially free money in government bonds, collecting massive returns in the process. This results in pure profit, which is one hell of a business model.
Yes, the Big Banks are in the supreme and enviable position of getting virtually free money from the Federal Reserve, which they then loan out at interest.
It's no coincidence that the stock market took off like a rocket when the Fed initiated its zero-interest-rate policy, along with three successive rounds of quantitative easing. The S&P 500 doubled in value from November 2008 to October 2014, coinciding with the Federal Reserve's asset purchasing program.
This has led to massive speculation and malinvestment, such as the recent Snapchat IPO, for example.
What’s particularly amazing is that the Big Banks are using this nearly-free Fed money to buy billions worth of Treasury bonds, redirecting this money right to the federal government for its deficit spending.
"Including federally guaranteed mortgage-backed securities, banks now own $2.4 trillion of government bonds, which would be the most since the central bank began compiling data in 1973," Bloomberg reported in October. Obviously, that total has only grown in the ensuing months.
Yet, those bonds are eventually paid back, at interest, with taxpayer money. The Big Banks enjoy massive returns while doing zilch. They have done nothing and created nothing. They are simply riding the gravy train at taxpayer expense.
Think about that; billions of dollars are being loaned to the biggest banks, essentially for free. Those Big Banks then use all that nearly-free money to purchase Treasuries that currently pay 2.42 percent - 3.00 percent (30-year), resulting in huge gains for the Big Banks.
What borrower doesn’t love near-zero percent loans?
The government also loves this arrangement because it provides a buyer for hundreds of billions in Treasuries. It's a pretty cozy relationship, don't you think? It's kind of like your dad loaning you money so that you can spend it in his store and boost his sales.
It’s also called insanity.
The Fed’s cheap money policy has enabled the inexpensive financing of speculative, levered positions by Wall St. In short, the Fed has been financing concurrent stock, bond and housing bubbles, the likes of which flattened the economy in 2008-2009. And we're still trying to recover from that. All bubbles eventually burst, usually with devastating consequences.
Near-zero interest rates for the better part of the last decade have crushed savers, compelling many to chase the higher yields found in the equities markets. Low rates have also spurred a new housing bubble, sending home prices soaring above the levels that led to the last crash. This is largely keeping Millennials and other first-time buyers out of the housing market.
Of course, the stock markets are called “risk markets” for a reason. The hunt for yield has created “irrational exuberance” among investors and ballooned markets that will inevitably encounter a pin.
Investor optimism is now at its highest level since 2000, according to the latest Wells Fargo/Gallup Index survey. The herd mentality has taken hold, which is always the time to run for the exits. Unfortunately, not everyone will fit through the door, and the losses will be enormous.
During the current bull market, which began in March 2009 and is the second longest in history, the Dow Jones has more than tripled. This won’t go on indefinitely. We’re long overdue for much more than a mere correction. When this bubble inevitably pops, the resulting blast will feel like a Category 5 hurricane.
As the old saying goes, pigs get fat and hogs get slaughtered. The Fed is leading the hogs right into the slaughterhouse and the Big Banks will profit from the massacre.
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