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Sunday, September 22, 2013
One prerogative of blogging is an occasional rant.
Here's one lesson from recent Fed history: transparency is great WHEN YOU HAVE A PLAN, not so much WHEN YOU DON'T. In trying to reduce uncertainty and volatility, our Fed Chairman, the esteemed student of the Great Depression, has ramped it up. Ah yes...unintended consequences! Now markets are totally confused, and every piece of economic minutiae going forward will be analyzed to death as capital markets try to divine Bernanke's take on it.
What we see unfolding is starting to look more and more like the Greenspan exit. Recall Greenspan went out riding on accolades from fellow governors and others praising him as the greatest (apologies to Ali who is the greatest) and a maestro only to find out in short order that he had set the stage for the worst economic downfall since the the 1930s by pandering to Wall Street.
But let's review the downfall to gain some perspective. In 2003 Greenspan and, yes, Bernanke pushed short-term interest rates to the historically low level of 1% and kept them there for a year. This in the face of a robust housing market. By pouring gasoline on a fire, this was the single action that caused the housing boom and consequent bust. It wasn't greed by various groups, etc., although they played an important role in carrying it out. To be absolutely clear, let's restate it as follows: if short term rates had hovered around 3% as was normal prior to the Greenspan/Bernanke manipulation, there would have been no housing crisis as we saw it.
There is a lot of pussyfooting around on this subject, so it deserves some emphasis. Many point to Wall Street's greed as the culprit for the 2008 debacle. Well here's some news, folks. Wall Street has been greedy since the first gatherings under the buttonwood tree. Wall Street's ongoing thrust has always been to make a killing anyway they can. They will use inside information, front trade, and rip away the retirement years of the nation's workers by charging unconscionable fees. They'll structure products filled with toxic product that even Einstein couldn't understand and sell the product to your local school district. Whatever it takes! The point is that Wall Street and the investment banking community, including the ratings services, didn't just get greedy in 2008.
On Bernanke's watch, he has tried unsuccessfully over the short term to reignite inflation and, in the process, pushed investors (including retirees and Pension Plans and the whole investment community) into a much riskier posture than they should be in or desire to be in. This was undertaken by the Federal Open market Committee with eyes wide open. Another way to view this is to understand that assets aren't being allocated by free market forces but by the a Fed micro-managing interest rates.
Again, to be clear, it is important to understand that, in controlling interest rates, the Fed is controlling prices and, in this instance, the most important price in the economy - THE PRICE OF MONEY! Think about it - you can have a mortgage payment of $2,600/month or $2,200. You can borrow $15,000 at your bank to put on an addition or buy a car, and your monthly payment depends on the Fed setting interest rates.
I would be remiss if I outlined the problem and didn't indicate a solution. Here it is. Instead of a Federal Reserve that micro-manages the price of money, how about the Fed going back to Volcker's approach that broke the back of inflation by controlling the growth rate of money in the economy. Let the millions of economic entities that daily make asset allocation decisions set the price of money. This is called a free market economy. Granted this requires a dramatic drop in arrogance. It means admitting that the market knows better than the Central Bankers what interest rates should be. For what it's worth, you can be sure it's not coming from Yellen. She's steeped, as are present governors, in the Soviet-style price control mindset.
As you think about this, here are a couple of other points to throw into the mix. Whenever there is a debate in DC, it seems that the higher ground is taken by debaters asserting what the founding fathers intended. Along the same lines, what if we revisit the intentions of the creators of the Federal Reserve 100 years ago. It is beyond dispute that then (as today) people didn't trust big banks. Thus, they came up with a somewhat convoluted system IN ORDER TO PREVENT CONCENTRATED POWER OVER THE NATION'S MONETARY POLICY. They specifically intended for the regional banks to pull the levers. Instead, today, power resides in DC to the extent that the Fed Chairmanship is said to be the second most powerful position in the world!
A second point concerns whether the FOMC has any clue on what they are doing. Point one is their forecasts which, literally, are a joke. Forecasting GDP out 2 to 3 years is ludicrous. You can examine the record yourself. Suffice it to say that it's not just the emperor; but, in fact, the whole monetary policy committee is naked. Thirdly, and this to me is most telling, ask Bernanke if 10 years ago he could imagine (in his wildest "expert on the Great Depression" dreams) how an economy could have reported inflation under 2% with the Federal Funds target rate at essentially zero percent and the Federal Reserve monetizing the debt to an extent greater that the annual Federal deficit.
Any economist confronted with these policy facts would have made a good model for Edward Munch.
But where are we headed from here? It is accepted with absolutely no question that interest rates jumped 1% because of the talk of reducing the tapering by $10 billion (a scary thought in its own self). But maybe the cause and effect is over emphasized. After all, this rise in rates has been predicted for a long time. If it continues, it will be an upheaval because there will be a massive re-shifting of portfolio assets and could take the economy South.
Part of the problem is that past policy has pushed investors into assets they don't understand. I'm "boots on the ground," so let me give a simple example. I see people who I ask about their holdings in bonds. They tell me that they read up on bonds and they read that, by holding individual bonds, they can't lose money! They don't understand even that the 10-year bonds they bought 3 years ago, priced at $105.5, will drop to $100 at maturity and could go below $100 over the next 12 months with a big enough push upwards in interest rates. Many have zero understanding of corporate bond spreads and the impact on prices if spreads widen.
Sometimes I think the FOMC understands these underlying market dynamics about as well as they understood credit default swaps in 2007.
Going forward, if this all leads to a nasty collapse, Bernanke and his committee will thankfully have those they can point the finger at and blame. Front runners here are Congress, emerging markets, and the Far East. Part of the job requirement of central banking today is being able to cast blame elsewhere.