The Lords of Easy Money

The link:   Jerome Powell’s Fed policies have boosted the system that made him rich

Excerpt:

Jay Powell was something of an agitator when he arrived at the Fed. At the time, in 2012, Fed Chairman Ben Bernanke was pushing FOMC members to commit to another round of quantitative easing, the experimental program first used in 2008 and then used again in 2010.

Quantitative easing has a complicated name, but a simple goal. It was a way to pump hundreds of billions of dollars into the bank vaults of the 24 primary dealers during a time when the Fed was keeping short-term interest rates pegged at zero. This strategy—pumping money into the banking system while removing the incentive to earn interest by saving it—created an all-powerful force in financial markets called a “search for yield.” Anyone with lots of money, like pension funds or insurance companies, were frantically searching for investments that would provide even a small yield. This is why quantitative easing drives up the price of assets, like the stock market. Billions of new dollars are all chasing the same assets, which boosts the price of those assets.

One type of asset that gained popularity was the kind of corporate debt that Companies like Carlyle Group used for buyout deals, like leveraged loans and corporate junk bonds. Companies like Carlyle could package and sell this debt to investors who were searching for yield.

Jay Powell thought that this was dangerous, according to the statements he made inside of FOMC meetings, the transcripts of which are released after a five-year delay. The Fed was pushing too much money into the leveraged loan market and was driving up prices to unsustainable levels.

“While financial conditions are a net positive, there’s also reason to be concerned about the growing market distortions created by our continuing asset purchases,” Powell had said at the January FOMC meeting (the “asset purchases” he referred to were the result of quantitative easing. The way the Fed moved money to Wall Street was by purchasing assets, like Treasury bonds, with newly created dollars). Powell warned that the Fed was wrong to presume that it could clean up the mess after a bubble burst.

“In any case, we ought to have a low level of confidence that we can regulate or manage our way around the kind of large, dynamic market event that becomes increasingly likely, thanks to our policy,” he said.

Another critic of easy money was Richard Fisher, who was the then-president of the Dallas regional bank. During one meeting, Fisher pointed out that quantitative easing primarily helped primary equity firms and banks.

Quantitative easing “has, I believe, had a wealth effect, but principally for the rich and the quick—the Buffetts, the KKRs, the Carlyles, the Goldman Sachses, the Powells, maybe the Fishers—those who can borrow money for nothing and drive bonds and stocks and property higher in price, and profit goes to their pocket,” Fisher said during one meeting. He argued that this would not create jobs, or boost wages, to nearly the degree the Fed hoped it would.

Bernanke prevailed with the argument that the Fed needed to do something. Congress seemed incapable of managing America’s economic affairs during the 2010s, and the Fed had the ability to act. During 2013, the Fed operated its biggest round of quantitative easing yet, creating roughly $1.6 trillion.

As Powell gained stature within the Federal Reserve, he changed his outlook on quantitative easing. A review of Powell’s comments during meetings show that his warnings softened and then seemed to disappear.

As late as June 2014, Powell seemed wary of the Fed’s easy money stance. “After almost six years of highly accommodative policy, the risks are out there and continue to build,” Powell said during one meeting. What worried him more was the prospect of “a sharp correction amplified by the liquidity mismatch in the markets that would damage or halt the progress of what is still a weak economy.” He was saying that a lot of traders and hedge funds had built up risky positions using a lot of debt. If markets fell—because inflated asset prices started to reflect their real value—then traders might dump their assets and cause prices to crater.

But just seven months later, Jay Powell gave a speech at Catholic University in Washington, D.C., aimed at disarming the central bank’s critics, such as libertarian figures like former congressman Ron Paul, who was calling for more oversight of the Fed. Powell said that the increasingly vocal criticisms of the Fed were misguided.

“In fact, the Fed’s actions were effective, necessary, appropriate, and very much in keeping with the traditional role of the Fed and other central banks,” he said. He went out of his way, during that speech, to defend the very policies that he had been warning about internally since he had become a Fed governor. He said that “unconventional policies,” such as quantitative easing, were largely responsible for America’s economic growth, and that the critics of those programs had been proven wrong. “After I joined the Federal Reserve Board in May 2012, I too expressed doubts about the efficacy and risks of further asset purchases,” Powell said. “But let’s let the data speak: The evidence so far is clear that the benefits of these policies have been substantial, and that the risks have not materialized.”

His reversal was noted by his colleagues at the FOMC who had previously argued alongside him about the risks of quantitative easing.

“There was a shift, and I think it’s noteworthy,” Fisher, the former Dallas Fed president, says in an interview. Fisher was not aware of any study or new data set released between June and February that would justify a reversal of Powell’s judgment about quantitative easing or zero-percent interest rates.

“There was no condition in 2015 that would have indicated, or necessitated, easing off that argument,” Fisher says. More likely, he believed, was the effect of being a Fed governor. “The evolution may well have come from being there longer, being surrounded by brilliant staff that has a very academic side to them and bias,” Fisher says. “You’re living in a cloistered atmosphere. It’s a different environment when you’re in that hallway. You conform more. I don’t think there’s anything nefarious about it. I just think it’s the social dynamic.”

In closed-door meetings, Powell continued to cast doubt on the efficacy of quantitative easing. “I think we’ve never looked at asset purchases as other than a second-best tool,” he said during the FOMC meeting in September 2015. “I think that’s been the way it’s been talked about since the very beginning—uncertain as to its effect, uncertain as to bad effects, and certainly uncertain as to political economy characteristics,” he said. But a review of his comments, which are available only through the end of 2015, indicate that Powell was softening his arguments and his warnings. The language became less vivid and less focused on “large and dynamic” market crashes.

As Powell’s rhetoric appeared to cool, the markets for leveraged loans and risky debt were heating up. No company better illustrated what was happening than the company that made Jay Powell rich: Rexnord.

The full article: Jerome Powell’s Fed policies have boosted the system that made him rich