Who Is the Fed Helping? Not the Little Guy
For more than five years the Federal Reserve has conducted an unprecedented monetary expansion. Over this stretch the Fed's balance sheet has tripled. Its key interest rate has been zero since December 2008, forcing down rates across the credit spectrum on everything from mortgages to municipal bonds. Various programs and objectives have been used to keep the ride going. What was conceived of as an emergency measure to provide liquidity to the banking system has morphed into a stimulus program that the Fed says is now supposed to heal the labor market. The real question is, who's benefited from this?
The answer is the economy's biggest borrowers. That starts with the government. Thanks to the Fed's bond-buying, Washington has been able to squeeze down interest payments as a percentage of the federal budget as it takes on record levels of debt. Last month Bloomberg reported that the Fed is absorbing about 90 percent of new issuance of Treasury and mortgage-backed debt. With the central bank as the ready buyer, Congress feels no market pressure to curtail its profligacy because paying for it has never been easier with the Fed's suppression of free-market interest rates. Why don't more "Tea Partiers" on Capitol Hill speak out against this?
Meanwhile, blue chip firms have seen their borrowing costs hit record lows. Bloomberg also reported that Disney sold three-year notes at a paltry 0.45% interest rate as part of a $3 billion offering that was its largest issuance ever. Overall, the market for top-tier corporate bonds is the frothiest in half a century. Investors who can't compete with the Fed for government debt are turning here for super-safe alternatives and bidding up prices. There is a similar story in municipal bonds which has hardly ruffled by rising unfunded pension liabilities and scattered local bankruptcies.
The downstream effect of the Fed's action doesn't end there. Three years ago, a tidal wave of unsecured debt associated with the pre-crisis leveraged buyout boom was coming due. Roughly $1 trillion of these loans had to be refinanced or face a painful work-out. If the capital markets couldn't refinance, widespread default would damage banks' loan portfolios and likely send notable American companies with inferior credit into bankruptcy. But the crisis was averted when the private sector enjoyed one of its best years for borrowing ever as the Fed solidified its commitment to easy money.
At what cost? The economy now exists in a murky place deprived of market input. The cost of credit has been leveled off. Big borrowers - whether governments or businesses - now raise money more on the basis of monetary policy than their individual credit profiles. Many large businesses probably still exist that would have gone extinct or reorganized under normal conditions. It's hard to see how that's ultimately good for their stakeholders. Are workers better off staying in chronically troubled industries? Would investors not have found better returns elsewhere? Certainly consumers won't find favor with brands living past their expiration date.
The Fed has constructed a safety net for government and big business. The upside is that hard calls implied by the financial crisis - to cut government spending, to reinvent an industry - don't have to be made because the status quo can continue fueled by easy credit. The downside is that we now live in an economy where it is increasingly difficult to distinguish between real economic growth and symptoms of another bubble. This is at the heart of what CEOs mean when they blame Washington for creating "uncertainty."
If that economic climate sounds familiar, it's because we lived through it during the Bush years. What was genuine and what was fake about the prosperity of that era? Not so easy to tell. The housing market we know was largely credit-built, but what about 65 straight months of job growth? What about the bull market in stocks that peaked in 2007? No doubt some of the jobs created then exist now as legacies of the bubble. The point is not that we live in a new century plagued by capitalism run amok - it always has - but that we are in a financial environment partially created by the Fed and only partially possessed by the market. It is increasingly difficult to tell where the central bank's influence ends and the market's begins.
The Fed's distortion of the economy makes it particularly tough for smaller businesses and entrepreneurial ventures to get financing. Lenders are either reluctant to offer credit at artificially low interest rates or are wary of new bubbles. Judging risk is hard when economic signals like interest rates and labor movements are compromised. Five years in, the Fed's help has mainly gone to big business and big government at the expense of economic growth. Will it take the implosion of still more bubbles for the Fed to consider these consequences?