Now even the fig leaf is gone.
On March 23rd the Fed announced its largest-ever intervention in the financial markets. Bazooka is too timid a word to describe it. More like a neutron bomb. Our central bank, supposed defender of the currency and the stability of markets, can now purchase an unlimited amount of US Treasury and agency mortgage-backed securities (now running at the unheard-of rate of $625 billion per week). That’s on top of $1 trillion per week in repurchase operations. As amazing as it sounds, that’s not where the real action lies. As part of Congress’s CARES act (ha, nice try!) the Treasury will create (or resuscitate) a series of special-purpose vehicles (SPVs) to buy all manner of financial assets, backed by $425b in collateral conveniently supplied by the US taxpayer via the Exchange Stabilization Fund. The Fed will lend to SPVs against this collateral which, when leveraged, could fund $4-5 trillion in asset purchases. That includes municipal bonds, non-agency mortgages, corporate bonds, commercial paper, and every variety of asset-backed security. The only things the government can’t (transparently, yet) buy are publicly-traded stocks and high-yield bonds.
You may ask, is this legal? Not exactly. The Fed’s charter prohibits it from buying securities that lack an explicit government guarantee. Hence the convenience of murky SPVs, to which the Fed is printing lending the majority of the funds. Jim Bianco spells out a slew of new acronyms: CPFF (Commercial Paper Funding Facility); PMCCF (Primary Market Corporate Credit Facility); TALF (Term Asset-Backed Securities Loan Facility); SMCCF (Secondary Market Corporate Credit Facility) and a bone to small business in the form of the MSBLP (Main Street Business Lending Program). These SPVs involve the Fed in nearly every major US financial market. That’s not all: by providing low/no cost financing to large corporations, asset managers, distressed debt vultures ventures, and private equiteers, our Federal Reserve has fast-tracked the hoovering up consolidation of American business into the hands of the few, the wealthy and the powerful.
In case you were wondering who gets to make these all-important “investment” decisions: it’s Treasury Secretary Mnuchin, the one who bought troubled mortgage originator IndyMac in a 2008 fire sale, then supervised the illegitimate foreclosure of thousands of California homeowners. Mnuchin won’t have to do all the heavy lifting however, his old friends at Goldman Sachs are happy to help out, just as they did in 2008. And the Fed tapped asset-management giant BlackRock to direct three of its bond-buying programs, which can purchase some of its own funds on behalf of the central bank. No conflict of interest there!
Democrats in Congress made a big show of their supposed oversight of these programs; in reality, there is none. The final draft removed most of the SPV reporting requirements. Even the Sunshine Law that governs the release of Fed minutes has been waived for the duration of these programs. Secretary Mnuchin is permitted to dispense with the already-feeble limits on CEO compensation (they can get only two times what they earned in 2019!) as well as the suggested restrictions on stock buybacks and dividend payouts by bailed-out companies. Last but not least: these firms are not required to share any upside from the rescue (in the form of an equity stake) with the US government. Heads: company CEOs and investment banks win. Tails: the taxpayer loses.
These bailouts are not (or should not be) necessary; Chapter 11 was designed as a mechanism to keep companies operating while they restructure their debts. However, as Wolf Richter points out, that would mean wiping out the shareholders and replacing the company managers. To me, that sounds like a very good outcome for CEOs who set their companies up for failure by leveraging their balance sheets in order to buy back stock (and juice their own compensation) rather than saving some cash for a rainy day. The airlines are merely the most egregious example, as Ben Hunt explains. Talk about unlocking shareholder value via the US taxpayer! Nice work if you can get it.
Some are wondering whether the market can absorb so much liquidity from a firehose. The more pertinent question is whether, having been such poor stewards of capital over the past decade, the companies who will benefit from this largesse are its proper recipients. The sums allocated to state and local government, small businesses and households pale in comparison to what large corporations and their investors will get, and are inadequate to support the collapsing US economy. Additionally, there is little incentive for bailed-out firms to protect their employees. They are greenlighted to fire 10% of their staffs over next six months (and will undoubtedly be hurrying to get more of that out of the way before the loan documents are signed). There are no employment requirements thereafter. United—the airline that dragged Dr. Dao off the plane—has already announced that it will begin layoffs as soon as the 6-month hiatus is over. GM has made a similar announcement.
You cannot revive a consumer-led economy by depriving people who need money to survive while rewarding those who don’t need it at all. Even a cynic knows the math doesn’t work.
The longer-term consequences are arguably worse. This is a giant step towards the nationalization of US financial markets. Our policymakers have been moving in this direction for decades, as their interventions have grown in size and frequency. What are the consequences?
- There is effectively no obstacle to monetization of US government debt—meaning large increases in government spending financed directly by the Federal Reserve. Modern Monetary Theorists might be happy about this, if the funds were put to good use. They won’t be.
- Treasury oversight of these programs opens the door for the executive branch to direct lending to favored parties, and to manipulate financial markets to achieve political objectives. As Jim Bianco observes, “we have a president who has made it very clear how displeased he is that central bankers haven’t used their considerable power to force the Dow Jones Industrial Average at least 10,000 points higher, something he has complained about long before the pandemic hit.”
- Capitalism (other than the crony variety) depends upon competitive markets to correctly price and distribute resources and risk. In theory, financially-sound businesses get loans and capital, whereas profligate or obsolete companies do not. Those days are officially over, as price discovery is dead. Slower growth and higher inflation will almost inevitably result.
- In the short run, an unprecedented government backstop of financial markets is a salve for anxious investors. But we think it’s a poisoned chalice. America has never run deficits of this magnitude (on the order of 30% of GDP) in the context of globalized capital markets and significant foreign ownership of US debt. Investors will re-evaluate their US holdings in the context of this new paradigm, once they are able to wrap their minds around it. And when they do, we expect to see a significantly weaker US dollar in our future.