I just found this great Hussman article where he says essentially the same thing I said here (albeit five years earlier)--that the Fed has basically cut the true reins of control of the banking system (as of the early 90s) and now does little of anything (at least, in terms of restraint--it still seems to be able to make bubbles worse).

I recommend reading Hussman's article in full, but I just wanted to echo and underscore part of it here:

When the Fed "cuts interest rates", what it is really doing is replacing one government liability held by the public -- Treasury securities -- with another government liability: currency and bank reserves (monetary base). That's all the Fed does. It determines the mix -- but not the total amount -- of government liabilities held by the public.

It follows naturally that controlling only an infitesimal percentage of the currency base implies the Fed cannot do much about altering M1-level liquidity.

But what of liquidity at higher levels?

I would say that this has become a meaningless question, because our economy has become one in which all forms of debt are treated essentially the same -- as cash money. So it doesn't matter what particular form the debt-notes (money) the Fed has created (or allowed to be created) take. It's all a shell game.

One manifestation of this is consumer credit. This goes even to the extreme extent of being able to write onesself checks out of credit (which believe me, I've tested). In general, we know that consumers are now living directly off credit, as the negative savings rate implies.

But money "locked" into supposedly-illiquid classes of debt notes are like US Treasuries are really just as liquid as this, and therefore as liquid as cash. If you can use Treasury bills/bonds as collateral, for example, then they've become very liquid. This is how standard brokerage accounts work--including those for commodities and futures. Any securities you put in a standard brokerage account with margin, including T-bills, are essentially as good as cash collateral!

This means you can expand your positions based on them, or even in some cases extract cash.

Now, if this is the situation for standardized accounts, imagine what the situation is when you consider special-case financial leverage--anytime a major financial agent counts a large quantity of US Treasury securities as part of their "assets", and uses this as a justification for taking on more debt, they're using Treasury securities as de facto money!

So while you cannot typically run down to the corner store and buy milk with a Treasury bond, you can use them to increase your apparent net worth, which may give you access to cash and additional revolving credit (which is as good as cash). Thus, there is sure to be considerable "trickle-out" to M1 (which may explain much apparent M1 growth and measured real inflation in recent years).

But perhaps more significantly, one can see how this situation might engender "froth" and bubbles in the financial economy, as any debnature can be collateralized and leveraged against a larger quantity of debt in some other form. And early on, lots of people will end up with "real" M1 money, as they happily cash out of their bubble-inflated positions early. But most ultimately won't. That money isn't there; it isn't real, and the Fed can no longer stop its growth without radical banking system reform.