Some of Wall Street’s most profitable trades are coming with the Federal Reserve, making some wonder whether the government is being played for a sucker in the bailout.
The Fed has bought massive amounts of securities from major banks to help buoy the financial system during the credit crisis. In some markets, including that for mortgage-backed securities, the Fed is the biggest buyer around.
But to keep its policies public, the Fed often announces its buying plans in advance.
That enables banks to take advantage of the central bank, charging inflated prices, according to a former Fed official cited by the Financial Times.
“You can make big money trading with the government,” an executive at one leading investment management firm told the FT.
“The government is a huge buyer and seller, and Wall Street has all the pricing power.”
New York Fed President William Dudley defends the Fed’s actions.
“We believe that opting for transparency is a greater good,” he told the paper. “If we didn’t have transparency, we’d be criticized on other grounds.”
Meanwhile, the chorus of outside Fed critics is growing louder.
Economist Allan Meltzer says that the Federal Reserve’s exit strategy from its easing is likely to fail and that the central bank should start tightening now.
Otherwise, high inflation is likely to ensue, Meltzer, one of the foremost Fed scholars, writes in Fortune magazine.
When Fed Chairman Ben Bernanke announced the Fed’s exit strategy from its vast intervention earlier this month, he said it would happen "in a smooth and timely manner," Meltzer points out.
“It's reassuring that Fed officials are aware of the inflation risk, but their program is unlikely to succeed. Much research shows that it takes about two years for anti-inflation policy to work.”
“That means the Fed needs to start now and stick with it.”
If the Fed is determined, it can squelch inflation, Meltzer says.
“However, history warns that we should be skeptical of the Fed's willingness to sustain the program when pressured to abandon it by so many powerful forces: Congress, the Obama administration, the business community, and labor unions.”
Beating inflation “requires accepting a temporary medium-term increase in unemployment and interest rates and maintaining a degree of independence that this Fed has not shown,” Meltzer writes.
Reuters columnist James Saft also worries that the Fed will succumb to political pressure.
“The role the Fed has played in the crisis has made it subject to more political interference, not least because it has strayed into areas of fiscal allocation that are traditionally, and best, left to elected officials,” he writes.
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