January 15, 2010
In 2009, one investor earned more than the combined profits of Exxon Mobil, Microsoft, and Wal-Mart by employing a common Wall Street trading strategy-the carry trade. The carry trade is a strategy where an investor borrows money at a low rate and invests the proceeds at a higher rate. To make substantial profits from the carry trade, you have to use gobs of leverage. The investor I am talking about used leverage of more than 40 to 1-enough to make even Goldman Sachs blush. What investor in his right mind would use leverage of 40 to 1 so soon after the worst credit crisis in U.S. history? The Central Bank of the United States, of course. The Federal Reserve made over $52 billion in profits in 2009 by borrowing short and investing the proceeds in mortgage-backed securities (yes, the same instruments that almost destroyed the U.S. financial system) and Treasury securities.
The Fed borrows virtually without limit at close to nothing through the creation of currency and bank reserves, and invests the proceeds in high-yielding mortgage-backed securities and treasuries. The Fed earned a return on equity of 100% in 2009. There is not a more profitable trade in the world. There is also not a more risky strategy, but the risk is borne by you and me, not Mr. Bernanke. The Fed’s unprecedented move to lever up its balance sheet risks insolvency and runaway inflation. The Fed is an unaccountable and dangerous organization. I support Ron Paul’s calls to end the Fed, and I would advise every American to pick up a copy of Congressman Paul’s book, End the Fed.