Tags: Bair | Fed | Bond | Bubble

Former FDIC Chief Bair: Federal Reserve Fueling a Bond Bubble

Monday, 23 Apr 2012 10:06 AM

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The Federal Reserve is pumping up a bubble in the bond market by keeping benchmark interest rates near zero and doing almost everything it can to ensure overall long-term borrowing costs stay low, says Sheila Bair, former chairwoman of the FDIC.

Since the downturn the Fed, has slashed benchmark interest rates to near zero.

The Fed has also purchased over $2.3 trillion in assets from banks, a liquidity-inducing measure known as quantitative easing, and has shuffled its Treasury holdings in way to keep long-term interest rates such as mortgages low.

Editor's Note: You Deserve to Know What Obama and Bernanke Are Hiding From Americans

However government deficits remain, and when interest rates eventually rise and investors turn to other asset classes, the bond market could collapse.

"The Fed's actions have kept Treasury bond prices high (while keeping the government's interest costs low), but the fundamentals do not support the high valuations, given the fiscal mess we are in. Sooner or later, the bond bubble will burst," Bair writes in a Fortune column.

"History has shown that a structurally weak economy combined with a fiscally irresponsible government propped up by accommodative central-bank lending always ends badly. Absent a change in policies, a toxic brew of volatile interest rates and uncontrollable inflation could define our future."

Many experts agree that stimulus measures undertaken by the Federal Reserve and central banks elsewhere served as a needed lifeline to keep the global economy afloat, but painful reforms at the fiscal level will be needed for more lasting reform.

In other words, politicians must cut spending and narrow deficits — often politically unpopular tasks — to restore economic health.

"In many countries, just stabilizing debt, let alone bringing it down to a sustainable level, will be a major challenge," the Organization for Economic Cooperation and Development said in a recent report, according to Reuters.

U.S. households continue to chip away at their debts and are making progress, although marked improvement lies far beyond the horizon, says David Resler, chief economist at Nomura Securities International.

"The lessons of history suggest that the remaining process of healing will likely be measured in years rather than quarters or months," Resler says, according to Reuters.

Editor's Note: You Deserve to Know What Obama and Bernanke Are Hiding From Americans



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