The previous few posts have been a bit heavy, so let’s change topics. Today I read an open letter from Charles Schwab asking the Fed to raise rates ASAP. His opinion is that retirees have been fleeced by the low rates, and are hurting to the detriment of the economy overall. Statistics are offered aplenty, as Chuck applauds the return of normal monetary policy.
Sigh. I’ve written about this a bit before. A summary:
- The unconventional monetary policy wasn’t intended to redistribute from savers to borrowers, nor was it designed to hurt retirees. The policy helped avoid catastrophic economic collapse, which would have hurt everyone.
- Savers (including yours truly) are disappointed with low interest rates. Borrowers (including all those people now buying houses, so that house prices are back to pre-crisis levels) are very happy. Though Chuck wants to focus on retirees’ marginal propensity to consume (i.e. they spend more than they earn), I would argue we’re about as well off with borrowers (who, by definition, spend more than they earn) having lower interest rates.
- Following the housing point: though it’s more common in the UK, there are probably a lot of US retirees relying on ‘trading down’ their housing to help fund retirement. Thank the Fed’s low rates for high mortgage – and thus housing – affordability among younger homebuyers. In this sense, the Fed saved retirees – not hurt them.
- Beware partial equilibrium analysis. Higher interest rates better for the economy? Really? Yes, higher rates mean more interest received, but also means more interest paid. In an environment where we want to encourage business investment and employment, higher interest rates are a bad thing.
In sum: this is the second letter written by Chuck that I have a serious issue with (the other one is this, which shows an absolute lack of information and analysis about high-frequency trading). Why does the man insist on putting his name to such insanity?? I guess he’s getting some free press, even if it’s discouraging.
Happy weekend, everyone.
From what I can tell, the Fed basically announced exactly what the market expected: no more $xx billion of price-insensitive demand for Treasuries and MBS per month; a better economy noticed; and rates will stay low for a considerable time.
So this is how the US Treasury Bond futures market waved farewell to QE:
Hurrah! Less demand going forward! Wait…what? Source: thinkorswim by TDAmeritrade
One would (naively) think the end of considerable, price-insensitive, demand would cause prices to fall. And…no. Must be that the event-risk of what the Fed could have said came to naught, so life is OK again.
On the plus side, bonds seem to be back to the ‘anti-equity’ trade: equity futures are off since the announcement. Better keep those long positions in bonds, then…
I’m a big fan of Vonetta Logan and her Nailed It! segment on tastytrade. In a somewhat similar vein to the Daily Show or Last Week Tonight, Vonetta doses her segments with enough humour to be able to hold attention for a fairly boring topic.
Last week’s Nailed It was about the Fed, including ways to improve oversight of their regulatory responsibilities and open market operations. Yes, generally a boring topic. The segment points out some generally known (though not universally agreed-upon) areas of Fed policy:
- No Congressional oversight of open market ops: the Fed can buy and sell Treasuries and such as it pleases. The bank’s leverage ratio (about 77 to 1, according to Vonetta, quoting Fed docs) is WAY above that required of too big to fail banks.
- Regulatory capture: Fed regulators are generally considered too lacking in knowledge and courage to stand up to those banks they are meant to govern.
- Punishment of savers/retirees/’pure market’ folks: the continuing unconventional policies of QE and forward guidance are keeping interest rates too low (hurting savers and pensioners) and volatility artificially deflated (hurting ‘pure market’ folks).
Vonetta has a few, rather uncontroversial, remedies for the situation. I encourage anyone to watch the segment to get the full scoop.
In the meantime, I’ve heard a lot of folks grumbling about the Fed, for similar reasons to the above. This got me thinking…has the Fed been acting outside its mandate? Has the group made markets worse for us? I can immediately think of a few reasons why the Fed is doing a good job, all things considered:
- Small interest > capital loss: yes, the unconventional policies mean 30-year Treasuries yield less than 3%. But, having worked in the financial services industry during 2008, I’m very familiar with stories such as the failing banks of several nations (Ireland, Iceland, Spain, Portugal, Greece, Cyprus,………) and the bailed out banks of several other nations (England, France, Germany, US, …….). The downward economic spiral of that time meant real rates needed to be very negative, to adjust for sticky wages and the like. The Fed has done what it can to make real rates as negative as possible, which (in theory, though I like Paul Krugman’s use of IS-LM liquidity trap framework) is as much as it can do.
- Regulatory capture is not a Fed issue. It’s a general issue: suppose you made $x million per year creating RMBS and related derivatives, or came up with the credit modelling to value said derivatives. It’s now 2008, and everything has blown up; what will you do now? In one corner is the regulators, who need to understand what the hell just happened; provided they don’t want to arrest you, they want you to help them figure out the mess. You can earn a government salary for that – maybe $100k or 200k. OR you could go work for the same bank, or a hedge fund, and pick up the gems from the crap; you’d probably still earn $x millions. Which do you choose? There should be no question that bank regulators, who could never be paid as much as the people they are regulating, would much rather ‘play nice’ and increase their (very small) chance of getting hired by the banks they regulate. It’s simple economics, and it goes on in probably every regulated industry there is (e.g. see all the examples of Congressmen/regulatory heads becoming industry lobbyists). This isn’t the Fed’s fault; it’s general greed.
- Low interest rates? Choose equities! so the Fed is to blame both for returns being too low (interest rates too low for savers/pensioners) and for returns being too high (equity market gains of 100%+ since 2009). Macro hedge funds can’t make money due to weird markets. Options volatility has been too low. Hmmm. There seems to be a solution in all of this, which the Fed has telegraphed for a long time: take on more risk; particularly equity risk. The Fed has helped ensure the stock markets have fully recovered the losses from 2008, so patient investors haven’t been harmed in the process. Now that we’re back to black…maybe the Fed should step away?
OK, enough soap box. I’m more sanguine about the Fed’s policies in the past several years, if only because I very clearly remember the utter fear and uncertainty whether the Fed could do enough to save the economy in 2008. It did; it has. The more relevant question going forward is: how dependent have we all become on unconventional policies to stabilise confidence in financial markets? Will the end of QE, and the beginning of ‘normal markets’, mean even fewer individual investors? If so, I’m even more fearful of the pension situation.