Rewarding Bad Behavior

Stocks have been going crazy since the Federal Reserve stepped in to once again help the banks meet their obligations. While Fed Chairman Jerome Powell has said the current operation is "not Quantitative Easing", whatever it is it is having a significant impact on attitudes towards risk in our financial system. I wrote about the "Cracks in the Financial System" back in September shortly after the Fed was forced to help the banks.

I seem to be the only one concerned with the fact it has been 592 weeks since the Fed first stepped in to help the banks. The "unwind" lasted just 88 weeks before the financial system broke. Since mid-September the "not QE" operations have added another $255 Billion to the financial system, an increase of 6% to the Fed's already bloated balance sheet.

Ironically, just as EVERY TIME the Fed has done a Quantitative Easing type operation, long-term interest rates have gone UP which will actually be a drag on economic growth --- the opposite impact they are hoping to have. I wrote about this concern last week.

Will banks ever be able to stand on their own? What happens if all these "emergency" operations have done is encourage more risk taking by the banks, knowing the Fed will save them? What if there is something so big (like some mass downgrades of Investment Grade Bonds during a recession) that is so big the Fed won't be able to save them? What would happen given the current social mood in our country if the Fed had to once again bailout the same banks they bailed out in 2008?

We're happily participating in this Fed induced rally, but know the answers to the above questions give significant risks to those who believe the Fed will be able to continue doing this indefinitely. The banking system is broken, thanks to the Fed and eventually the free markets will take over. You better have an unemotional way of protecting your investments because that will be a frightening time.

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New Kent, VA
Jeff joined SEM in October 1998. Outside of SEM, Jeff is part of the worship team at LifePointe Christian Church where he plays the keyboard and bass guitar. He also coaches a club soccer team.