May 26, 2020
Stuart, Florida
Dear Adam,
They’ve done it again. The rich fucks have done it again. They are in the midst of stealing trillions of dollars from the rest of America, or maybe they’ve already stolen it. It’s hard to tell. Steal, I imagine they would argue, is a strong word. Earn would be better, but not even they could keep a straight face. Appropriated, maybe. It’s got the right government-sanctioned flavor.
Do you remember calling me in the fall of 2008? It was the height of the financial crisis, and it is fixed in my mind to this day. The sun was streaming into that little bungalow I was renting in Venice, California. Everything in the world seemed so clear and sharp. You asked me what I thought we (Americans) should do about the proposed bailout of the financial sector, of corporate America. You were skeptical. I was more sanguine. After all, it was in the air that Obama would win the election, and he had demanded the taxpayers be paid back and working families protected as part of the act. Despite the moral hazard (the idea that these investors, bankers, and executives were all too happy to reap the rewards when things went well, so they should be prepared to bear the losses when things turned sour), it seemed the civil thing to do. We were all Americans.
I remember it so vividly because I have never been so wrong in my life. The legislation, which would become TARP, actually ended up working well, far better than one would expect of a government program of that size and speed. Of the $700 billion authorized for it, only 60 percent or so was needed; and the government eventually got all of its money back, admittedly without the handsome profit a private investor would have demanded. The credit machinery slowly unfroze, as predicted, allowing the American economy to motor on. What I did not realize at the time, and what has become excruciatingly clearer to me with each passing year, was the following: that was, at least in our lifetime, the last opportunity we’d probably have to relevel the financial playing field and restore a sense of fairness in our economy.
What was less obvious, at least to me—maybe because there was no Congressional vote and no public debate about the shift—was the role the Federal Reserve would play from that point through the following decade. The Fed has a number of objectives and mandates, but in normal times its most conspicuous function is to set (technically moderate) interest rates. Over the course of the financial crisis, the Fed lowered the lending rate from a historically moderate 5.25 percent to essentially zero, and left it there for almost seven years.
Several problems arise as unintended (or at least unadvertised) consequences of pumping vast sums of money at low interest rates into the economy. First and most directly, it leverages and concentrates wealth and stifles competition. Trillions of dollars enter the financial system but are available only to those already established enough to borrow, allowing them to consolidate their positions, acquire or undercut competitors, and increase their ownership of the market. The rich get richer.
Second and more insidiously, such a massive infusion of capital (liquidity) tends to inflate the value of risk assets (stocks and bonds) beyond any merits of the underlying businesses. To understand why, it is useful to think of the various classes of risk assets as sitting along a continuum, from least risky to riskiest: cash, treasuries, investment grade bonds, junk bonds, equities (the stock market). Because cash has the least risk, it provides the least return (zero for cash in your pocket or some minimal sum for cash deposited in an FDIC insured account). Treasuries involve a modicum of risk and so pay a breath more in return. And so on, up to equities which provide the best returns (historically around 10 percent on average before inflation). The downside to this higher returning end of the continuum is that investors risk some or all of their money to attain those returns. This is why stocks and corporate bonds are called risk assets.
When the Fed lowers the interest rate, it puts downward pressure on the yields of both treasury and corporate bonds (the money you get paid when you own bonds). This has the counterintuitive effect of making previously purchased bonds increase in value. Since newly issued bonds (which you can buy directly from the government in the case of treasuries or a company in the case of corporate bonds) pay lower interest than older bonds, the older bonds (which pay a higher yield, one buyers can no longer find in original issues) become more valuable. So bond owners (the rich) get richer.
As it turns out, there are a lot of people who need to make a fixed return on their investments. In fact, the very warp and weft of part of our society’s safety net is fashioned on their ability to do so. Pension funds, for instance, might need to make 6 percent per year on average to fund their obligations. A retiree might need to make that same 6 percent to pay her mortgage and expenses, since that coupled with Social Security equal her only income. Insurance companies collect premiums and then invest the money to earn a target return to stay in business and turn a profit. In the past, a large portion of these returns came from investing in treasuries and investment grade bonds. The 10-year treasury bond, basically a risk-free investment, paid around 5 percent immediately before the housing crisis, in line with its historical average and far below its 1980s peak of 15 percent. At those rates, pension funds and retirees could keep much of their worth in government-guaranteed securities and still earn the interest or returns they needed. When interest rates were pushed to near zero, however, these investors could no longer do so. As a reference point, 10-year treasuries currently pay less than 0.7 percent.
Consequently, investors are forced further out the continuum (the yield curve) to the less sturdy and secure branches of junk bonds and equities to get just the 5 percent return they used to get without any substantive risk. This is what people mean when they speak of “chasing yield”—buying riskier and riskier assets just to attain the same investment returns. Many people are unaware that the bond market is actually a fair bit larger than the stock market. So all of this money that would, in an environment where interest rates weren’t being artificially suppressed by the Fed, be invested in bonds has instead flowed into equities and driven prices into the stratosphere. Those who owned the stocks before lower interest rates drove them up saw their wealth increase as a result of the high prices new investors needed to pay. And in many cases, so did the CEOs. In 2008, Jeff Bezos was worth just over $8 billion. Today that figure is approaching $150 billion.
It gets worse. Seventy percent of the US economy is driven by consumer spending. The trillions of dollars made available by the Fed through quantitative easing (repressed interest rates, liberal liquidity) following the 2008 financial crisis did very little to raise real wages for average working Americans and provide them with more money to spend, so not only did none of the money trickle down to the working stiff but it never even provided the fuel that our consumer-driven economy needed to grow. Instead, many large corporations availed themselves of the Fed’s largesse to buy back their own stock and drive the prices higher, resulting in record profits for their investors and executives but little movement in the real economy. It seemingly didn’t matter how much they borrowed, since they were paying such a pittance in interest. We don’t even need to look at derivative securities and the $5 trillion in hedge fund assets to see that once again: the rich get richer.
Remember, by the end of 2014 TARP had effectively ended and was fully repaid. The Fed’s quantitative easing, on the other hand, was never throttled back. At several points, the Fed tried to raise rates and slow lending over the past several years, but each time the market creaked and threatened to crash, the Fed backpedaled, further cementing moral hazard into the very structure of our financial markets. What was sold to America as a measure to help propel us out of the Great Recession has become a permanent method of wealth transfer from America as whole to the already wealthiest among us.
I’ve used interest rates here as an emblem/proxy for Fed action. But the Fed also lends money to support the financial markets. In 2008, the Fed had a balance sheet of $900 billion. By 2014, it had increased that to $4.5 trillion, pumping $3.5 trillion into corporate America over a six-year period, most of which was siphoned off into the hands of the wealthy. (Sing it with me: The rich get richer.)
Even if many hardworking Americans don’t recognize the structural forces that have been working against them for the last dozen years, they are certainly aware that they have been left behind, left on their own, or left for dead. I think the resentment, and in some cases rage, has driven the populism that has made political heroes out of Trump on the right and Sanders on the left. For better or worse, this movement seems rooted in our rotten financial system and its perverse outcomes.
Which brings me, finally, to the coronavirus. For all of us I think the pandemic and our government’s response to it has been alternatively terrifying, infuriating, and tragic. The discomposure of American life is alarming in ways both drastic and subtle. The single silver lining I see—or saw, and this is where it gets tricky, since my optimism is closely related to one of the greatest dangers ahead of us—is a second chance to relevel the financial and economic playing field in our country.
Very few people outside of the financial industry seem to realize how close our financial markets came to total collapse in mid-March. It was much worse than when you called me in 2008. And the Fed’s response was truly Olympian. What it did in the months and years following the 2008 financial crisis, it did on the spot this time—and then brought out the big guns. The Fed has pushed interest rates to zero and indicated that it will leave them there as long as it takes. It has already added trillions to its balance sheet, almost as much in the last two months as over a full seven years after the last financial crisis—and it has promised unlimited liquidity if necessary. Unlimited. It’s been enough to hold everything together so far.
At the same time, what we’ve seen at dizzying speed is how immunocompromised the economy is, how fragile and vulnerable to disruption when it is so geared toward the richest and the fewest. Maybe the time to act, to hold the rich accountable, was at the end of March when the CARES Act was passed. If so, I’m not optimistic for opportunity in America. We’ve seen what seven years of low interest rates and a few trillion dollars could do to concentrate wealth in our society. Indefinite zero interest rates and unlimited liquidity are almost inconceivable.
But the coronavirus, like any natural disaster, is likely to surprise us. It will certainly change our country. It already has. How we emerge from this pandemic, and this economic illness decades in the making, is unclear.
Be well,
Frank
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