Tags: Roubini | QE | Fed | exit

Roubini: Fed's QE Is 'Boosting Leverage and Risk Taking'

Thursday, 02 May 2013 08:05 AM

By Michael Kling

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Instead of improving the economy, the Federal Reserve's ongoing quantitative easing (QE) is 'boosting leverage and risk taking,' which will lead to asset bubbles in the next two years, warns Nouriel Roubini, economics professor at New York University.

The Fed's massive bond purchasing has prompted the issuance of risky junk bonds with loose covenants, a booming stock market despite slow growth, and a surge of money to high-yielding emerging markets, Roubini writes in an article for Project Syndicate.

"The problem is that the Fed’s liquidity injections are not creating credit for the real economy, but rather boosting leverage and risk taking in financial markets," he notes.

Editor's Note:
Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

The Fed has said will keep rates low until unemployment reaches 6.5 percent. When it finally does start raising rates, it will surely raise them slowly, and probably not before 2015. If it moves too fast, it will crash asset markets and prompt a hard landing, predicts Roubini, who predicted the housing bubble and subsequent financial crash.

"But if financial markets are already frothy now," he says, "consider how frothy they will be in 2015, when the Fed starts tightening, and in 2017 (if not later), when the Fed finishes tightening."

Still, high unemployment, slow growth and low inflation suggest the Fed should continue injecting liquidity and exit QE only slowly. However, a slow exit may create credit and asset bubbles as large, or even larger, than the last ones.

Some at the Fed argue they can raise rates slowly and provide economic stability by using regulations to control leverage and risk taking, while others say limiting leverage in one part of the financial system will only push it elsewhere, he notes. Only interest rates can flow into all the financial system's cracks.

"But if the Fed has only one effective instrument — interest rates — its two goals of economic and financial stability cannot be pursued simultaneously," Roubini writes.

The Fed can keep rates low for longer and create huge bubbles or raise rates faster and squash an already-sluggish recovery.

"If the exit cannot be navigated successfully," Roubini concludes, "a dovish Fed is more likely to blow bubbles."

Federal Reserve officials have said there are no asset bubbles in sight.

Boston Fed President Eric Rosengren said he sees "no bubbles of any kind, even in real estate," Forbes reported.

Chicago Federal Reserve President Charles Evans said, "We've looked at a lot of things and there's nothing in the horizon that causes me great angst," according to Forbes.

After the Federal Open Market Committee's two-day meeting ended Wednesday, the Fed announced that it would continue purchasing of $85 billion in Treasurys and mortgage-backed securities per month "until the outlook for the labor market has improved substantially in a context of price stability."

"The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes," the Fed said in its policy statement.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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