But there is one distinct benefit of such a policy – it alters the composition of bank balance sheets. At the end of the day it’s really just an asset swap and a transfer of risk via bond duration or bond type. The kicker here, is that if you’re a bad bank with a few trillion dollars in bad mortgage paper you’re delighted if a AAA rated entity comes in and swaps those assets out with their highly rated paper. This is exactly what the Fed did in 2009 and make no mistake – it was hugely successful in clearing the credit markets and altering the composition of bank balance sheets. This was Mr. Bernanke’s goal after all. He was simply trying to clear the credit markets and improve the banking system and he believed that would ultimately fix the problems in the US economy. Unfortunately, he misdiagnosed a household balance sheet recession as a banking crisis. QE1 provided liquidity in the credit markets and it gave the banks some much needed breathing room. Unfortunately, the impact on the real economy was far more muted.
I think Ben Bernanke knows all of this. He has added $1T in reserves to the banks already and it hasn’t resulted in a surge in borrowing or self sustaining economy recovery. It doesn’t take a genius to understand that adding another trillion won’t change anything either. If there is low demand for apples putting more apples on the shelves does not improve the apples salesman’s ability to sell more apples.
But Mr. Bernanke is seeing the same thing that I am seeing. He sees a weak economy and a housing market that appears to be rolling over again. Knowing that the banks are extremely fragile here and understanding that there is absolutely no political will for another bailout Mr. Bernanke is creating his own bailout by bypassing Congress.
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