Back in 2008-2009, I chronicled how the Primary Dealers caused the stock market crash. They were the most important and least recognized cause of what the media has labeled the Great Financial Crisis.
The dealers were overleveraged and positioned wrong then. They are overleveraged and positioned wrong today.
It’s not that they choose to be wrong. While greed, stupidity, and even criminality are definitely involved, they’re actually forced to be wrong by virtue of their role as market makers and Primary Dealers. When their biggest clients, in particular the US Government, are all on one side of the trade, the dealers must, by definition, take the other side.
Unfortunately, they get increasingly reckless when they do. Even more unfortunately, they almost never face consequences when they do. It’s called moral hazard. And the Fed is happy to enable and promote it.
Of course, there’s an important difference between 2008 and now. In 2008, when that crisis was at its peak, we did not already have the massive flow of money that the Fed steadily pumps into dealer accounts. The Bernanke put, which became the permanent Fed put, did not exist yet. The Fed didn’t start QE until November 2008, well after the crash was in full swing. It did not start direct Primary Dealer QE until March 2009.
Today, QE is a given.
Today we have constant, permanent QE. The Fed now has no choice. Its constant bailouts have engendered ever larger bubbles, and ever greater reckless behavior.
Because of that the system has collapsed. It looks the same as the old system on the surface. But it’s not. The dealers are no longer independent business entities. They are now fronts for the Fed. They are merely conduits for getting the new money into the markets and the banking system.
Despite that, now, the dealers are again on the verge of precipitating another crash.
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