My favorite quote from Charlie Munger is:
To a man with a hammer, everything looks like a nail.
Rest assured, Mr Bernanke is acting like a man focused only on nails.
The genesis of the current economic malaise is, of course, the US housing market. The virtuous cycle that lead to the inflation of a Ponzi, housing economy has burst, and the deflationary forces that are unwinding are clearly in effect.
Let's clarify the purpose of the Fed's monetary policy and quantitative easing.
- The banking system's capital base is threatened if loan losses spike too sharply and overwhelm equity capital and/or unsecured debt.
- The banking system needs steroids (steep yield curve) to help accelerate the replenishment of capital to offset the pipeline of loan losses that continues to fill.
- The thesis runs that if equity capital is overwhelmed, lending will not occur, which will lead to further economic contraction, more job losses, etc.
- Absent a healthy credit transmission mechanism, the economy is doomed. Or if you prefer.."Where would we be without the banks?"
Ergo: The decision to "prop-up" the financial system with loose monetary policy is just - because we need banks to lend.
So, the cure for the illness is to liquify markets, prop-up falling assets prices, and artificially reduce "market based" interest rates through government intervention.
Now, let's look at the unintended consequences of this policy.
1) The federal reserve is taxing/stealing from all responsible Savers in the USA. Interest rates paid on deposits or Money Market accounts are effectively nil. This nil rate forms the baseline or lowest rung on the yield curve's ladder. Absent this low baseline, the slope would not be steep enough to accelerate the replenishment of bank capital. So, instead of interest earned on savings staying in the hands of individuals, instead, the Federal Reserve Board is stealing this money and reallocating it to the banking system. Instead of these earnings from savings being made available for private consumption, they are being use to prop-up the interests of bank shareholders, over-levered consumers, and bank debt holders alike.
2) The federal reserve has immunized unsecured bondholders from loss in the banking system. Instead of letting loan losses fall where they might and forcing debt to equity conversions or recapitalizations...the fed is again, taxing the public to keep the existing capital structures intact subsidized by US citizens across the country.
3) The access to cheap money has introduced an arbitrage/carry trade for the likes of Goldman Sachs (GS) or Morgan Stanley (MS), who can now borrow money from the Fed for free and lend it out to hedge funds, etc. to finance Wall St.'s Casino activities. This has also lead to a run on the dollar, a spike in Gold and a spike in Oil prices.
4) The purchase of long-dated treasuries that drive the pricing for mortgages continues to artificially suppress the natural rate for long-term mortgages, and thereby underwrites an entirely false pricing in the housing market.
The Fed's entire enterprise is built on the notion that without the transmission mechanism known as the banking system, the economy is destined to falter. The prescription for the illness is to immunize the banking system from loss. So, the policy agenda lines-up like nailheads to the man with the hammer.
The Man with the Hammer seems to be trying to save us from ourselves.
But, what if we stopped trying to artificially boost the housing market?
But consider the following ideas as a substitute thesis.
1) The problem is not "we need more lending" but rather one of too much debt. Household balance sheets don't need to borrow more money. Rather, they need to get their debt to equity ratios back in line. In order for the funding of the transmission mechanism to work, the end user must have the demand for the output. But, in the case of the US consumer, they are full. Banks have more than adequate levels of capital today to finance growth in loans/assets, but the demand simply isn't there. So, why do we need a steep yield curve other than to bail out shareholders?
A look at the Federal Reserve's website shows clearly that credit is contracting.
Why are we lowering the price of debt when the demand is seemingly inelastic? Is it not about reducing the quantity of debt rather than changing its price? Shouldn't we be pushing the idea of less lending and not more? And more investment financed by savings vs. by debt?
2) Rather than using monetary policy to steal money from savers to replenish bank capital, why not leave interest rates at the short-end of the curve at a responsible level and let savers allocate their earnings privately vs. the taxation that is occuring today?
3) What if we let the housing market settle out where it may with Mortgage rates at 5.5%-6% instead of a govt financed teaser rate of 4.7% and let the capital structures of the banking system respond accordingly? The govt can surely step-in if the event a bank needs recapitalization and/or debt needs to be converted to equity to keep an enterpirse functioning and sevricing it customers, but why are incumbent investors and executives given such ridiculous protections at the expense of hard-working Americans who have never missed a mortgage payment or defaulted on a loan ever!
4) Instead of artificially influencing lending rates by inflating the asset side of the Fed's balance sheet at subsidized borrowing costs, what would be so incorrect about providing a liquidity backstop but doing so at a reasonable cost of capital?
5) Instead of deferring loan losses/bankruptcies/workouts, why not allow them to accelerate? Rather than stealing from responsible Americans with clean balance sheets who avoided the mess, shouldn't the capitalist sytem permit these assets to move from weak to strong hands? If you can't afford to own, rent! There are lots of responsible investors out there who are waiting to take on these assets as they get liquidated in an orderly way.
I think they call that free market Capitalism. After all, there is a reason we have a bankruptcy code.
Fed policy today is clearly unsustainable. At some point, asset prices must trade according to a "normalized" rate environment or "normalized discount rate". Gold speculators may learn that lesson the hard way!
In the interim, efforts to undermine the free market's ability to discover fair, market clearing prices only shift the eventual price adjustment to some point in the future.
Nassim Taleb has it right - the solution is not to continue to try to prop-up asset prices with misplaced monetary policy and govt/ subsidized interest rates/debt costs, but rather to let market forces discover which assets need to be worked out through debt to equity conversions or outright liquidations, and which ones do not, at an appropriate cost of money.
Fears of a general run on housing are likely largely misplaced. After all, people need a place to live. As we deal with the unintended consequences of a Macro-economic policy (low fed funds) to deal with a Micro-economic issue (local market housing deflation/surplus inventory, we destroy our currency and our credibility as a nation???
If 20% of houses in the US go into default, so be it! Somebody will be there to buy the assets!
If bank capital has to be replenished and existing investors get wiped out, so be it! Somebody will come-in to buy-up the goodwill.
If prices have to fall to a new natural equilibrium, so be it, we need this new equilibrium in order to start again.
We will get through it, just as we have before. But, in the interim, Mr. Bernanke and Company need to stop stealing from Americans by:
- Paying them 0% on their savings
- Devaluing the purchasing power of the dollar
- Artificially propping-up the price of real assets in the real economy that might otherwise find their way into the hands of new, reponsible investors v. kept in the hands of irresponsible, economic agents who are, effectively, on the dole from their neighbours.
Failure to flatten the yield curve sooner than not amounts to outright theft.
Mr. Bernanke and his hammer are stealing from me and my family each and every day, to help fund the survival of bank shareholders, employees, and bondholders and their reckless under-writing policies.
As a result, Mr. Bernanke needs to go!
Disclosure: Long Hard Earned Cash...would like to See Its Purchasing Power protected.