The Fed’s Frankenstein Monster Is Ready, We’re Just Waiting for the Lightning
This blog (and the more complete one in the Requisite Blog section) is about some important impacts on our economy that you may not have seen, but which may well have a very dramatic impact in the next few years. For especially my younger friends, this is a critical part of your future... it's well worth learning about and having opinions on. I hope that this helps start you in that process. -- Gary
The Federal Reserve, working directly with the Treasury Department, has created a new initiative for the purchase of corporate debt, municipal bonds, and ETFs. They have done this despite the law that created and governs the Fed — the Federal Reserve Act of 1913 — giving them no legal authority to do so.
Their solution? A shell corporation, managed by Black Rock Financial and funded by the Treasury cash (remember the $500 billion in the CARES Act that was allocated for Mnuchin’s discretionary use?) and a couple of trillion dollars of new money provided by the Reserve for leveraging the purchases.
By establishing this separated entity, the Fed can direct the buying of various debt instruments that otherwise it wouldn’t be allowed to through Black Rock, and establish a deep support system for the corporate credit markets. To expand the range of their influence, the Fed is going to purchase bonds down to BB- ratings, which are commonly referred to as Junk bonds, in cases where the underlying company was rated higher prior to the current struggles.
Traumatic Economic News
If you’ve been wondering why the stock market has been strong in the face of such traumatic economic news, consider this: the values that you see represented by the Dow, the S&P, and the NASDAQ reflect the perceived financial health of the publicly held companies. The Federal Reserve (along with the Treasury) has essentially promised that it will commit an unlimited amount of money to ensure that corporate America will have as much cash as it needs on very good terms for the foreseeable future.
This “new” money will come from expanding the amount of money in the system by trillions of dollars, along with those hundreds of billions of taxpayer money from the CARES Act. The power of this promise led the stock market to recover from its low of 18,000 on the day that the program was announced to its the current level of 24,000.
While this appears on the surface to be a good thing — supporting the ability of companies to access funds while the market is in turmoil — there are significant issues that have potentially dire longer-term consequences, as well as raising important questions about the role of the government in capital markets. My larger article of the same name provides the history and reasons for those concerns, but among the now possible outcomes include these:
A federal debt that costs well more to maintain in interest payments than the government can reasonably tax, leading to accelerating deficits that are ultimately unmanageable
An avalanche of new money into the system, dramatically increasing the present inflated amount and establishing the historical parameters for massive inflation and market instability
A Federal Reserve system that holds and controls substantial amounts of all of the corporate debt outstanding, giving it significant influence over many of the country’s public corporations
A Treasury that is committed to maintaining hundreds of billions indefinitely to protect the Reserve from market risk, providing direct access (and influence) of the federal government into both money supply and corporate America, two places where its participation has long been precluded
Financial Market’s Expectations
The decision to substantially alter the role of the government in our “free” market system has already been put in place and incorporated into the financial market’s expectations. Historic separations of Monetary and Fiscal policy, assumed for well over a century and having definable benefits, have been torn down overnight. Enormous critical and limited resources have been allocated to the preservation of near term corporate profitability, with an open-ended commitment in amount and duration.
The choices made appear extreme, a panicked focus on today without a stated program for dealing with tomorrow. In the absence of a national dialog, legislative evaluation, or oversight, the American economy has been launched into a new world that will have important impacts far after we have gained control over the virus and its economic impact.
The Fed and the Treasury have conspired to create a monster, a patchwork aggregate of their respective responsibilities and resources that was never intended to exist. It was created outside of nature and the law, but it is unquestionably about to rise from the laboratory table and do what monsters do.
It may well appear to be benign, perhaps even helpful… but we have the ability (and obligation) to see its true nature. In properly recognizing it for what it is, we can prepare for its emergence, and look to find the best way to contain its damage.
Ultimately, it will be necessary to decide whether to destroy it (if in fact it can be destroyed), or to attempt to reconfigure it into something more appropriate… but regardless of the response, it cannot be ignored, or given reign to roam free… and most importantly, it should never be allowed to come into existence again.
