by Cato 8/14/14
Glenn Fairman asked: I was wondering if Cato would explain how the current regime’s economic policies helps the “rich.” I do not doubt that it does, but I need some ammunition for future debates. It would seem that this is a short term strategy, since in the long run, the machine falls to pieces. I await your answer.
In a reply to my post “The Symptoms Are Not The Disease” Glenn Fairman wrote the above. I answered that I would try to put something coherent (not always a given) together, focusing on the monetary effects of the Fed’s actions, rather than upon the massive swamp of WDC regulatory and campaign contribution croynism. So, narrowed down to something I have some training and background to handle, this is my offering to Glenn and to you all.
Background: The actions of the Federal Reserve commonly referred to as “extraordinary” are at the core of Glenn’s question. These are programs and executions that had never been attempted before by the Fed. These “extraordinary” actions were in response to what the Fed (rightly in my view) saw as an economic heart attack; a very severe seizure in 2008.
These actions do represent a huge step up the ‘activism’ ladder and it’s a ladder upon which the Fed has climbed ever higher for decades … certainly since the 1970s.
It is quite rational to argue, as I do, that what has caused a series of increasingly dangerous and deep recessions, starting with the 1973-74 recession, is political intrusions into the economy aided and abetted by the Federal Reserve System … not just the Chairman but the entire system of regional and central banks. The deepest flaw in the concept of the Fed is that it can be and is independent. It is nothing of the sort. Like the Supreme Court, the Federal Reserve follows the election returns.
“Extraordinary” actions: The final effects and outcomes of these “extraordinary” programs were unknowns, merely theoretical estimates, when they were undertaken. The long term effects remain to be seen. The Quantitative Easing (direct purchase of Treasury and mortgage bonds, ie, money printing) and ZIRP (zero interest rate policy) programs are the two most important “extraordinary” programs, the ones that have had the most impact both positively and negatively, and the ones upon which I will focus.
My conclusions, cutting to the chase, with details and arguments to follow: Both the QE and ZIRP programs undoubtedly benefit “the rich”. Both, though to varying and to considerably lesser degrees throughout the income and wealth strata of America, benefit the rest of us as well. That “the rich” are in a better position to take advantage of those benefits, to access them to a greater degree than others and in some instances exclusively, is absolutely true. That those Fed tools were specifically designed and intended to inordinately benefit ‘the rich’ to a greater degree is not.
The negative impacts are shared as well. That the Fed’s effort “falls to pieces” in Glenn’s words, in the sense that these efforts will eventually precipitate conditions that create more harm than good, is both true and insightful. All simplistic interventions into an economy as deep and complex as ours are doomed to fail; the law of unintended consequences can’t be avoided.
The Fed is already seeing the negative effects of the current QE program, for instance, in the shrinkage of the “repo” markets.
Technical details aside, “repos” (repurchase agreements) are major financial mechanisms for short term trade and liquidity funding for all major international corporations and banks. The “repo” markets are also a major source of income for money market funds. Without “repos” we all lose. Were this market to seize up completely it’s 1955 all over again.
The Treasury bill, note and bond markets are the bedrock layer for our entire financial system, acting as risk-free capital for banks, underpinning much of the zero coupon markets and as a pricing base for municipal and corporate debt. The Fed has bought so much Treasury paper in the QE programs that private investors were being squeezed out, creating volatility precisely in the broader debt markets the Fed is trying to stabilize!
By late 2013 even avowed Keynesian interventionists like Ben Bernanke and Janet Yellen were getting nervous with QE. The Fed is winding down QE as fast as possible this year without capsizing the intermediate and long term bond markets, has been arm-waving frantically that interest rates will have to rise off the zero floor, ending ZIRP in the near future for reasons mentioned below, and struggling publicly to respond to the systemic distortions these two programs have caused.
These “extraordinary” programs have been carried on far too long and are now more disease than cure, as noted in “The Symptoms ….”.
Those are my judgments.
Here’s my thinking and understanding, and I hope this gives Glenn the logic trail for which he’s looking.
Start with ZIRP. In Keynesian theory reducing interest rates spurs economic activity. ZIRP is targeted at short term rates. Reducing short term rates increases liquidity in the marketplace generally, making it easier, for instance, for firms to finance purchases and fund receivables. Credit is cheaper, loans easier to get. At least that’s the Keynesian ‘truth’.
Reducing short rates to near zero is extreme stimulus intended by the Fed to pump up liquidity in the economy, to boost transactional funding and support for Main St firms.
It hasn’t worked that way. The extremely low rates and abundant supply of credit wasn’t made available to Main St because the banks, the funnels of that credit and low rates to small businesses, were being pounded into the ground by politicians and regulators for their “sins”. Even small and midsized banks that were NOT impaired in 2008 were forced into the regulatory perdition of TARP and overrun by bureaucrats. While the Fed was trying to push money through the banks into Main St., banks were being fined tens of billions of dollars for all manner of “sins” by federal and state regulatory jihadis.
Aside: No, I don’t think banks were responsible for the 2008 mess. I think Democrats were. I think they not only tried to redistribute income (welfare), I think they not only tried to redistribute outcomes (affirmative action), I think starting in 1998 they tried to redistribute mortgage credit, too. Fannie and Freddie were turned into “affirmative credit” agencies. Banks either got on board with the “affirmative credit” political demands of progressives or were sued into oblivion for discriminatory credit practices. $Billions went to people who had no business with a mortgage.
W tried three times to stop the deterioration of credit standards and end sub-prime lending and each time was crucified by Democrats.
The derivatives created out of those mortgages failed because the credits were “affirmative”. The loans were sub-prime because the borrowers were sub-prime. It blew up in the Democrat’s faces and the banks (and of course President Bush) were the fall guys. JP Morgan Chase is being fined $17 Billion today for the “sins” of two businesses they own, businesses the Federal government demanded JPM buy in 2008 despite JPM’s refusal to do so! But that’s another story.
Regardless of your opinion on “banksters”, the fact is Main St was cut off from the Fed’s intended gift by a political jihad that punished banks for taking any sort of risk at all, including loans to small businesses.
The low rates and abundant credit did attract Wall St. however, and it attracted large credit worthy businesses.
Low rates led to massive borrowing by large firms to fund share buybacks and increase dividends. What they did NOT do with the cheap money was invest in capital (land, buildings and equipment); investment of the sort that leads to new jobs. Why not? Because the deluge of regulation out of the Obama administration in the last six years has made it nearly impossible to forecast the prospects and profitability of a new project with any degree of certainty. CEO’s don’t steer their ship full steam ahead through rough seas into a fog.
No CEO in his right mind is going to invest heavily with the regulatory jihadis writing new abuses daily. So CEOs just “repaid the shareholders” by borrowing cheap money. Who owns most of the stocks and bonds being rewarded? “The rich”. So naturally all this balance sheet finance primarily paid off “the rich”.
Low rates also led on Wall St to the founding of dozens of hedge funds, private equity partnerships and dark pool investment funds. None of these enterprises create anything patentable; manufacture or ship or sell anything material. They create no jobs. They simply speculate on prices in every market known to exist with money borrowed at near zero rates of interest. “The rich” alone have access to them, so “the rich” alone profit from them.
Neither of these results were what the Fed desired and expected. And THAT is why I consider the ZIRP to have been a failure. It’s created little more than a global financial asset bubble.
Consider QE. The crisis was centered in the mortgage markets. There was no crisis in the government bond market nor in the commercial bond market. Only mortgages had been “affirmatively” bastardized and so only mortgages collapsed. That being where the damage was, that was where the Fed went.
Mortgage loan rates are based on the 10 year US Treasury bond. The 10 year, about 2.5% now, plus about 2% in normal times equals the 4.5% one sees on 30 year fixed rate mortgages. If you want low rates on mortgages, you have to engineer low rates on the 10 year. Which is exactly what the Fed did. They bought 10 year bonds by the trillions. Demand up, prices up, rates down, as bond prices and yields are inversely related.
Over the last six years the Fed has purchased $4 Trillion … Trillion … worth of long dated T Bonds and, in order to assure a flow of credit into the mortgage lending market, mortgage loans.
The desire was to prevent the mortgage loan market from drying up completely, which would have caused even more foreclosures and losses as home prices fell. And to the degree the Fed’s money allowed credit worthy buyers to buy, it worked. Unfortunately most mortgages are originated by the same banks and mortgage brokers (like Countrywide) that the regulators were busy savaging, criminalizing and fining for taking any kind of risk. Overly loose credit caused the crisis. Overly tight credit, reinforced by regulatory guns to the heads of every banker in the country, prolonged it. Warren Buffett could borrow for a house. Joe and Janie Bluecollar could not. Main St went dry. And once again Wall St stepped into the void.
Thousands of homes were purchased by massive investment pools to create REITs and private real estate portfolios, all to create huge rental companies. They had access to near zero interest bridge loans and very cheap commercial mortgage funds, thanks to ZIRP and QE respectively. Tens of thousands of homes were vacuumed up into these funds. Who had access to these funds … which were all private while the big gains were being made? “The rich”. So naturally it was the upper tier who benefited the most.
And THAT is why I contend QE was a failure. The intended benefits the Fed put out were simply never delivered to Main St, at least not directly to Joe and Janie, and the actual beneficiaries were only “the rich” who could gain access corporately or financially.
One last note: I said everyone gained, though to a lesser degree than “the rich”, from the Fed interventions. The argument, and it’s valid, is that this was a different kind of crash from others we’ve experienced since WW2. It truly was. It had the potential to be a global chain reaction nightmare.
We in the US could have “gone Greek”. We could have hit a much deeper bottom than we saw. We could easily be in the position that Italy and Japan and France are in today … boxed in and headed back into the abyss. We may still end up there but that I am not yet willing to concede that point.
It’s also painfully true that just about everything the Obama administration did by way of regulatory actions was counterproductive to the real Main St economy, and that they disrupted and fouled the Fed’s intensions. Whether that was Obama’s intention or purely out of ideological ignorance I leave to you. The list of bad ideas Obama loaded onto a struggling economy is endless.
It’s also true, at least my truth, that the Fed had its heart … though not its head … in the right place. By that I mean they failed because they never found a way to circumvent the disaster coming out of the White House. A truly independent Fed is a myth; no Fed will ever circumvent any White House. The Fed as an institutional design is in my mind a relic of 19th Century, predicated on the flawed musings of a 20th Century economist, and an anachronism in the 21st.
Sorry for the length, GF. But this easily could be a 300 page book, or a semester-long seminar, fully detailed and laid out. Hope this helps.
Cato blogs at Cato’s Domain.
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