When most people discuss how the Federal Reserve benefits the big banks, they usually only focus on the ways that the Federal Reserve directly brings in income. But there is so much more to it than that. The truth is that the Federal Reserve is used in a whole variety of ways to indirectly assist the big banks in making huge gobs of money. One of the ways this is currently being accomplished is through the U.S. Treasury carry trade.
So how does this carry trade work?
Well, it basically has three steps and it works something like this….
#1) Mr. Big Bank goes over to the Federal Reserve and says, “Hey Mr. Federal Reserve – please loan me a big bag of cash for next to nothing.” Of course, the Federal Reserve is more than happy to loan it to him.
#2) Mr. Big Bank then invests the same big bag of cash into U.S. Tresuries which have a much higher interest rate than what Mr. Big Bank just borrowed at. To give you an idea, 10-year U.S. Treasuries are earning around 3 and a half percent right now.
#3) Mr. Big Bank sits back and enjoys the huge amount of risk-free cash which comes pouring in.
This little three step procedure helped enable four of the biggest U.S. banks (Goldman Sachs, JPMorgan Chase, Bank of America and Citigroup) to have a “perfect quarter” during the first quarter of 2010. What that means is that these four banks had zero days of trading losses in the first quarter.
Wouldn’t you like to have a perfect batting average?
Don’t you wish you could pitch a perfect game every time?
Well, it certainly helps when you are being subsidized by the Federal Reserve as Bloomberg recently explained….
The trading results, which helped the banks report higher quarterly profit than analysts estimated even as unemployment stagnated at a 27-year high, came with a big assist from the Federal Reserve. The U.S. central bank helped lenders by holding short-term borrowing costs near zero, giving them a chance to profit by carrying even 10-year government notes that yielded an average of 3.70 percent last quarter.
Doesn’t it just seem like whenever we turn around the Federal Reserve is doing something new to “help out” the big banks?
This is just getting ridiculous.
Remember all of that talk about how the U.S. government had to help out Wall Street so that they could help out Main Street?
Well, a ton of money did get injected into the banking system.
In fact, the Federal Reserve pumped hundreds upon hundreds of billions of dollars into the banking system since the beginning of the financial crisis. This has caused the U.S. monetary base to explode….
So did the big banks use all of that money to help out Main Street?
In fact, business lending by the big banks has been falling precipitously.
So what have the big banks been doing with all of that money?
Buying U.S. government debt of course….
So instead of making loans to American businesses who desperately needed it, most of this new money has gone to pump up yet another bubble. This time the bubble is in U.S. Treasuries. Asia Times recently described how this trillion-dollar carry trade in U.S. government securities is setting up a very dangerous situation….
Remarkably, the most aggressive buyers of US government debt during the past several months have been global banks domiciled in London and the Cayman Islands. They borrow at 20 basis points (a fifth of a percentage point) and buy Treasury securities paying 1% to 3%, depending on maturity.
This is the famous “carry trade”, by which banks or hedge funds borrow short-term at a very low rate and lend medium- or long-term at a higher rate. This works as long as short-term rates remain extremely low. The moment that borrowing costs begin to rise, the trillion-dollar carry trade in US government securities will collapse.
But as long as the gravy train of the U.S. Treasury carry trade continues, why should the big banks make risky loans to American businesses and consumers when increasing numbers of them are turning out to be deadbeats anyway?
That is a good question.
Meanwhile, we have this sick situation where the Federal Reserve subsidizes the big banks and enables them to buy up a big chunk of the debt the U.S. government is constantly churning out.
Our national banking resources are increasingly being turned away from building up our once great system of free enterprise, and instead are being devoted to servicing the never ending spiral of government debt and funny money that we have created.
But a bunch of folks down on Wall Street are getting exceedingly rich from this little game, so they certainly aren’t going to complain about it. And as long as the vast majority of Americans continue to stay in the dark about all of this, the bouncing ball will just continue to keep rolling.