Tuesday, March 25, 2008

Credit Crunch Characters (10) - Alan and Ben and the Foreign Men

The reason that bankers were able to lend so much money to the hedge funds and sundry investment vehicles was that the Federal Reserve has been pumping money into the economy for most of the decade. The big commercial banks had large amounts of money sloshing round in their coffers that they were only to glad to lend to highly leveraged hedge funds.

Thus it was Alan Greenspan and Ben Bernanke who allowed the high level of leveraging to occur. Every time they increased interest rates, the leveraging increased. There are two reasons. Firstly, as interest rates fall, yields fall, so profits are harder to make. Secondly, debt is cheaper. The fall in yield can be compensated for with an increase in leverage.

At the same time, China has kept its currency low to encourage exports to the rest of the world. One consequence was that the Chinese monetary authority was left with large volumes of dollars to invest. They chose to invest in US treasuries. The government of oil exporting countries also had huge surpluses to invest. All this cash eventually ended up in the vaults of the bankers, who quickly moved it on to the hedge funds and investment vehicles.

Alan and Ben empowered the credit bubble.

This full series is here

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