The latest government induced bubble: not Alt E but Treasuries?

[c1ue]

I was reading back articles from Northern Trust, and this caught my eye

http://web-xp2a-pws.ntrs.com/content...usoctnov08.pdf

The Federal Reserve can help remedy the capital inadequacy problem by promoting a steeper Treasury yield curve through further reductions in the federal funds rate. Banks can lend to the Treasury without incurring a risk-based charge to their capital because Treasury securities have no credit risk associated with them. The only limit on the amount of Treasury securities a bank can own is its overall regulatory leverage ratio – some maximum ratio of earning assets to net worth. By purchasing large amounts of Treasury securities yielding more than their overnight funding costs, banks can increase their profits and, thereby, increase their capital to the point that they can begin lending more to the private sector.

Why is this interesting? Because just in July in an interview with Martin Mayer here at iTulip - Mr. Mayer pointed out how the banks being given Treasuries as part of the Fed loan pyramid were in turn using the Treasuries to drive up commodity prices.

http://www.itulip.com/forums/showthread.php?t=4681

Mayer: Commodity prices. The Fed induced commodity price increases inadvertently by giving banks treasuries in exchange for securitzed debt. The banks then found a way to use the Treasuries as cash in the commodities market. All of this follows from a key failure in the Fed’s thinking: that asset bubbles don’t matter. This philosophy goes all the way back to 1916 and the era of Benjamin Strong.

This got me thinking: is it perhaps possible that what we're seeing now is actually the next bubble? One based on Treasury bonds?

The mechanism is: Banks on the 'Fed borrow list' lend to the Treasury by buying Treasuries. Borrow from the Fed. Repeat.

In the process all lending for any other purposes by these banks ceases. As these banks comprise a huge part of the overall credit capacity of the system...would explain why we're seeing such ugliness now.

Of course this process must eventually end: when the banks simultaneously hit their maximum regulatory leverage ratio AND Treasury yields hit zero.

Then what happens? A collapsing bubble: interest rates shoot up to 15%, so does inflation, doom and gloom etc.

Comments?

[Southernguy]

Re: The latest government induced bubble: not Alt E but Treasuries?

On a long and very interesting speech yesterday, B. Bernanke said:

"Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand. Indeed, last week the Fed announced plans to purchase up to $100 billion in GSE debt and up to $500 billion in GSE mortgage-backed securities over the next few quarters. It is encouraging that the announcement of that action was met by a fall in mortgage interest rates".
Maybe they have just begun?
by the way there is one procedure to play this game, and it is TBT.
But one risk, apart from the obvious one of playing against the FED is the counterparty risk of the operations that the managers do. Any comments are welcome.