Guest Post: QE3 And Bernanke's Folly - Part II

Tyler Durden's picture

Submitted by Lance Roberts from StreetTalk Advisors, Click Here For "QE3 And Bernanke's Folly - Part I

QE3 And Bernanke's Folly - Part II

Mark Twain once wrote that "History doesn't repeat itself, but it does rhyme."  While this is a statement that is often thrown around by the media, economists and analysts - few of them actually heed the warning.  It has been even worse for investors.  Over the past 800 years of history we have watched one bubble after the next develop, and bust, devastating lives, savings and, in some cases, entire countries.  Whether it has been a bubble created in emerging market debt, rail roads or tulip bulbs - the end result has always been the inevitable collapse as excesses are drained from the system.

On September 6th, 2008 I gave a presentation discussing the December 2007 recession call we had made (NBER officially stated the recession started in December 2007 a full year later) and the potential for a substantial crisis ahead (the market began its collapse one month later.)  During the presentation I showed the following slide discussing history and why this time was "not going to be different." 

Each previous bubble was predicated on expansion of credit, lax lending policies, inflation, speculation, unique investment opportunity (tulip bulbs), or leverage which ultimately led to speculative fervor.  The speculative fervor occurs as the bubble becomes fully developed and sucks the last of the "buyers" into the market creating a vacuum when sellers emerge.  

Since that presentation in 2008 many of the predictions that we had made at the time came horrifically true.  Today, we once again have to ask ourselves whether the markets are repeating history or if this time is "truly" different?  Unfortunately, the answer is most likely "no."

Over the past couple of months the markets have advanced sharply in anticipation of a third round of Large Scale Asset Purchases (LSAP) by the Fed which has become affectionately known as QE3.  The Fed delivered not only the expected QE3 program but expanded it by making it an open-ended program that will last until "employment reaches an acceptable level."  This is quite a departure from the previous two programs, which were finite in nature, and has a lofty goal of boosting the economy to boost employment.  The problem is that an artificial intervention program of this magnitude leads us once again into the realm of "unintended consequences." 

History is replete with examples of interventions that go wrong.  The chart below shows the actions by the Federal Reserve in the past and the subsequent "crisis" that those actions bring.  What the media misunderstands is that it is the policy of artificially manipulating interest rates that creates the bubble.  It is when interest rates rise that has historically been the "pin" that popped it which explains much about the Fed's stance on ensuring that rates do not rise - ever again.

Since the turn of the century the U.S. economy has been subjected to the bursting of the stock market "tech" bubble that was driven by investor fervor followed by the collapse of the real estate bubble created by excessive credit and leverage.  Since the end of the last financial crisis the Federal Reserve has remained consistently engaged to try and stabilize the financial system.  By injecting trillions of dollars of liquidity into the system the Fed has made a concerted effort to reduce the probability of another financial crisis caused by a freezing of the credit markets.  However, in the endeavor to prevent one event they may unwittingly be creating another.

The Federal Reserves goal has been clearly stated that by boosting asset prices consumer confidence will be lifted supporting economic growth.  The chart below shows the balance of excess reserves at Federal Reserve banks as compared to the market, consumer confidence and GDP.

What is evident is that while QE programs have flooded the excess reserve accounts of Federal Reserve banks there is little evidence that it translates to anything other than higher asset prices and a boost to the profitability of the banks through trading activities.  However, these increases in bank liquidity, which are ultimately transformed into proprietary trading activities, is something that we witnessed during the real estate bubble from 2004-2008.

As we stated in our weekly missive: "While no two markets are ever the same – in this case, however, the issuance and repackaging of mortgage debt previously supplied massive liquidity to banks.  This liquidity was then funneled into proprietary trading operations which drove markets higher.  Today, the Fed is buying the mortgage bonds from the major banks in turn providing excess liquidity which again is funneled to proprietary trading desks. The net result is same."   The importance of this is that the Fed was blind to the asset bubble being built in late 2007-2008 just as they will most likely be blinded by a focus on employment to the exclusion of risks building elsewhere in the system.

One of the signs of a potentially burgeoning asset bubble in stocks is valuations.  As opposed to the previous QE programs where earnings were rising sharply - during the recent market advance leading up to QE3 valuations have risen by more than 2 points as prices advanced in the face of declining earnings.  Recent manufacturing and corporate reports are citing the weakness of the continuing recession in the Eurozone now beginning to impact the U.S.

These rising valuations show a clear detachment between price and underlying fundamental and economic realities.  The risk to investors is that a liquidity induced stock market rally creates a further disparity between fantasy and reality.  It is the disillusionment, as the dream turns into the next nightmare, which devastates market participants.

There has been much commentary about how the market can support higher valuations due to lower interest rates.  This is a fallacy of the Greenspan era that has continued to be perpetuated (see full analysis here.)  With interest rates artificially suppressed by the actions of the government the theory loses much of its integrity.  

The risk that the Fed is running is the creation of another "unrecognized" asset bubble in stocks one again.  The chart above shows the Shiller cyclically adjusted P/E based on trailing reported earnings.  Historically when P/E's have reached a level of 23x earnings, or greater, it has normally been indicative of the end of a bull market cycle.  The major exceptions were the 1929 and 2000 stock bubbles.  With valuations currently at 22.5x earnings the stock market, even in a low interest rate environment, are no longer "cheap" by many measures.  This puts investors at risk of a sharp decline in equity prices as valuations adjust to the underlying fundamentals.

I am not saying that an asset bubble exists at this particular moment.  What I am saying is that Bernanke's folly of thinking that asset purchases that flood Wall Street with liquidity will improve housing, employment or the economy.  There is currently no evidence of that.  However, there is clear evidence that the continued suppression of interest rates is forcing unwitting investors into chasing yield which can most dangerous to their financial future.

Most likely the markets will push higher in coming months as liquidity floods the system pushing commodity prices and interest rates higher while devaluing the U.S. dollar.  This will be great for the major banks trading profits but will impose a harsh tax on the consumer which ultimately impacts aggregate end demand for businesses.  It is this degradation of the consumer that will likely push the economy towards the next recessionary drag and is something that yield spreads are already warning of.

While Bernanke has high hopes that QE3 will support the economy long enough for a grid-locked Congress to enact fiscal policy to support the ailing economy - the reality is that we already may be closer to the next asset bubble than we realize.

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Precious's picture

Bubbling bath crystal Ben.

Your face is on his menu.

vast-dom's picture

i tell you charts mean nothing these days. we have unconventional to the Nth central planning and nothing rhymes and nothing reasons here and history will only be made after the uncorrelated unforeseen facts converge.

Rainman's picture

What a shame they try so hard to bring the dead back to life. Eventually the Europlosion will fukk up all their schemes.

magpie's picture

Yeah, just realized today that there are far more people on the Euro kill switch than expected.

Still no reason to short though, sigh.

blunderdog's picture

All ya gotta do to be the big winner is be the last place to fall apart...

kito's picture

the reality is that we already may be closer to the next asset bubble than we realize.....

please dont say "we" mr. lance roberts, because while you may not realize it, i, like most of the zh brethren, have been realizing it for a long time.....................................

Hedgetard55's picture


The author appears to be either incredibly naive or stupid - Biden stupid.

bank guy in Brussels's picture

For some years already, the excellent Doug Noland has been describing this final bubble of mass destruction we are experiencing as, more accurately, the 'Government Finance Bubble', the greatest bubble in history and on a global scale as well.

Far beyond housing or stocks or any category like that, it is sovereign debt itself that is the bubble holding everything within its fragile expanding ball.

For example just yesterday Noland was talking about the US $2 trillion it is taking every year in new credit just to keep the US-centred Ponzi afloat a little longer ... before it all finally explodes at some point of colossally catastrophic drama.

Recent columns of Noland's superb 'Credit Bubble Bulletin' at PrudentBear:

stocktivity's picture

I still have that window of opportunity to buy silver coins dated before 1964. That window is already starting to close as these coins are already appreciating in value.

TrustWho's picture

Basically, one un-elected, un-accountable and 4 year appointed bureaucrat gets to spend $4 trillion, because he thinks spending this money might help employment.  I, and many more, think Daddy Bernanke is a liar!

Since the power equation is a function of money and other more minor variables, is Daddy Bernanke more powerful than POTUS?
















adr's picture

You can't fix the economy by giving money to banks and letting speculators run wild with the proceeds. When trading every contract is seen as a profit opportunity instead of a vehicle to purchase raw materials at a set price, to turn them into something else to make profit, the actual consumers of raw materials are unable to set accurate pricing. They have no idea what their input cost will be from month to month, and can't write price quotes that are good for longer than 15 days. It has completely disrupted the real market system from production to store shelf.

Of course certain commodity traders manipulating the market have made out like bandits. The last thing they care about is the pipe manufacturer who has to compete with a few thousand speculators who will never take delivery for the material he needs.

An easy fix is to force delivery and limit the number of times a contract can be rolled over into the next months. I would say a 60 day limit on all contracts would be fine. Sometimes a large order is cancelled and a company needs to rollover a contract. This would give them an opportunity to sell the contract instead of forcing them to take delivery of material they don't need. This would also work to limit the profit that could be made off rolling contracts. Prior to the CFMA contracts almost always fell before the delivery date. After the bastard act was passed contracts always seemed to jump in price as speculators looked to roll the contracts over.


Hedgetard55's picture

"You can't fix the economy by giving money to banks and letting speculators run wild with the proceeds."

Master criminal Bernanke knows that.

Miramanee's picture

When the Federal Reserve purchases bonds and/or distressed assets, it does so to lower interest rates - to stimulate more lending and borrowing. As you know, our economy is fueled by debt. Over 70% of U.S. GDP derives from debt-based consumer spending. And so when the U.S. economy is in recession, The U.S. government and the Federal Reserve initiate policies that they hope will compel middle class Americans to borrow more money. And as more money is “printed”, speculative investing pushes the cost of such commodities as food and energy upward. This then is the squeeze on the middle class to which pundits and political mouthpieces refer: Stagnant wages + rising prices + increasing debt to service = a falling standard of living for the American middle class. But while both sides of the political aisle trade ideological barbs about who’s to blame for our disappearing middle class, no one appears willing to admit that the only honest solution to this ongoing crisis – a crisis in which private banks reap outrageous profits because our economy only grows when more credit and debt are contracted, and a crisis in which middle class purchasing power continues to slip away – is to have the government, not private institutions called banks, create the money. The bottom line is this: if we continue to live in a world in which banks create money through the extension of credit, the gap between rich and “not-rich” will continue to widen and the real wealth of middle class will continue to shrink.

poor fella's picture

"An easy fix is to force delivery and limit the number of times a contract can be rolled over into the next months."

That's the word right there! I want to see JPM, MS, and GS stuck with tens of thousands of tons of ___, and a million barrels of ___, and 4 trillion quatloos, saying, "Ohhhhh drats!!!"

Have fun selling your booty on a REAL market, Jamie "Dickhole" Dimon.... Instead of towels we'll receive a mayo jar of aviation fuel with every new account.

Sandmann's picture

The financial system used to be controled by Interest Rates and Quantitative Controls on Banks. Now it is based on NO Controls and 0% interest. If that is not an admission that the Economic System has run into the sand and the institutions have failed, what is ?

Snakeeyes's picture

Centrally planned housing market? Nothing has been the same since Clinton started the National Homeownership Strategy wiith HUD partnering with Fannie Mae, Freddie Mac and the banks to greatly expand mortgage credit (and ease lending standards). Throw in the Fed rate cutting, and we have a housing bubble ,.. and financial disaster.

So what does Bernanke do? Tries to revive the housing bubble started by Clinton. This is pure INSANITY!

adr's picture

Another thing that could be done to fix the economy is a variation of what Charles Hugh Smith posted earlier. He proposed the Fed buying mortgages directly from home owners instead of the banks. There is a bit of a moral hazard with the Fed directly owning the titles to millions of homes, but in essence they already do anyway. It is just the semantics of the contract allowing the bank to lay claim.

If the Fed bought the mortgage and gave the bank the full remaining principal of the loan, the bank would net zero but would have the mortgage and the potential loss taken off their books. It would help the bank strengthen their position without giving them a massive bailout. The idea would be to make it like the bank never made the loan in the first place. Since only the remaining principal loaned would be returned to the bank, balancing the book, the bank can't use the cash to make excessive bets in the market.

Since the Fed will have bought the loan at face value, they could rewrite the interest terms helping the homeowner. The Fed could set a 1.9% interest rate and do away with the insane Private Mortgage Insurance that forces people to waste hundreds of dollars per year. Someone holding a $150k mortgage at 4.5% would see an extra $100 per month from the lower interest rate and anywhere from $50-$100 per month with the elimination of PMI.

An extra $150-200 would go a long way to help an average income American and it wouldn't result in a higher tax burden. The better loan terms would also help a mortgage holder pay off more principal, opening up more home equity. The aggregate savings would result in much greater consumer activity creating a real rebound in jobs.

Cyclerider's picture

The Fed wasn't created to help taxpayers or homeowners.  It was created to protect banks from losses at the expense of taxpayers.  They've been doing their job as planned.

Non Passaran's picture

I support that plan underthe condition that I am allowed to load up on mortgage debt prior to its commencing.

Billy Shears's picture

(1st time) Happenstance, (2nd time) coincidence, (3rd time) enemy action!

Zero Govt's picture

"While Bernanke has high hopes that QE3 will support the economy long enough for a grid-locked Congress to enact fiscal policy to support the ailing economy.."

Central bwankers, like Govt, are subversives of society, unproductive anarchists, a vampire wrecking crew

only commerce is productive and creates wealth, only commerce drives mans progress forward and brings beneficial change

QE3 will not benefit the economy, none of his bailouts of unproductive gambling junkie bankers and thieiving political goons has helped anyone but the most corrupt 1% to cling onto their crumbling rotten empire another day

what is bullshitting Ben waiting on Congress for, their tax revenue is in decline, their debt is having to be propped-up by the Fed to the tune of 60% of issuance. The unreality of this reality is already fucking delusional

What will Congress say to Bernankenstein, "print more for us Bubble Ben, we're all out of other peoples money, it's down to you fruitcake"

Billy Shears's picture

Lock and load, motherfuckers!

Cyclerider's picture

The divergence between interests rates and the stock market is glaring.  With interest rates the lowest they've been in 30 years, and not able to go lower, the market is not at an all time high.  Why not?

auric1234's picture

Interest rates are already negative once inflation-adjusted. They can always go lower, towards minus infinitum!


Sandmann's picture

If this policy ever could work - and that is in itself doubtful - it would need a Closed Economy to limit leakages. The essential problem has arisen because the USA let Japan then China run huge trade surpluses with the USA on the back of undervalued manipulated currencies recycling the surpluses into the US financial system at the same time as hollowing out the manufacturing core. It was a form of Reverse Protectionism "protecting" Chinese and Japanese plants to favour Wall Street liquidity.

It is how Mitt Romney could make his fotune with every other Buyout Group using cheap liquidity to hollow out US businesses simply because the US Tax Code allowed Interest to be deductible and double-taxed Dividends making Equity expensive. It simply jacked up returns to Equity by re-balancing the Sheet in favour of Debt and which sector has the highest Leverage....FIRE sector.

Only by curtailing Chinese imports will inflation rise because they will not let their currency float upwards. It requires Tariffs to raise prices in product markets and diminish returns in financial markets to re-balance the economy. That means the Global System must either move towards Tariffs on Mercantilists (as Bretton Woods allowed) or ruthless implementation of the law of One Price bringing Western living standards down to cHinese and Indian levels thereby destroying the US economic, political, and social system and reversing 200 years of history.

The only feasible solution is to stop corporations manufacturing in China....Japan has learned a recent lesson.....there are not enough jobs for Americans if they want to share with Chinese

Urban Redneck's picture

equity guys always think that they are the center of the universe, and everything revolves around them

another group of self proclaimed apostles was allowed to claim that the earth was the center of the universe, and the much larger sun and everything else revolved around the earth, for far longer than this miniscule timeline of financial manias

 one day, enlightenment will come knocking...

Grand Supercycle's picture


Due to recent central bank intervention and short covering spikes, all these daily charts are extremely overextended & a significant correction is expected very soon:

TWSceptic's picture

The greater depression is going to be something else. In a way I find it interesting to be able to live through one. On the other hand I know a lot of people will suffer immensely, and things may get very bad very quick, even for us prepared people. Perhaps the only positive thing will be that people may finally recognize the source of the problem, punish those responsible, and allow the system to reset in a positive way.

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