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Fed Truthers

Cullen, great piece.

It is sad to see how many people believe in unfettered capitalism. They hate the government and their fellow citizens so much that they'd like to see the economy go through an occasional depression just to support their stupid political ideologies.

So many people are being hurt through no fault of their own and all these shallow people want to do is point fingers and blame the Fed. So sad.

Why do people always assume that if you are anti-government that you hate your fellow man?  Some of the worst atrocities in human history were done by governments under the guise of helping people. It is possible that they do care about others but just don’t believe that central planning is always the best way to go about solving problems that a lot of the time previous govt policies created.

Myself, I am sympathetic to some of their views; less so to others. But I would never assume they all hate other people or that all their views are born out of selfishness.

No, the Fed doesn’t have the authority to send people checks - nor do they have the physical system (central bank accounts for individuals). But having the physical system is well within today's technology & Congress could easily give them the authority - & there are so many advantages to doing so.

First, I’d like to start by agreeing that the Fed is doing what it can do (buy everything) in the absence of Congress doing what it should do (give $ to people). 

 

Second, as a new reader & commenter I would like to say that I’ve really enjoyed the topics you’ve discussed and the depth in which you cover them. Hard to find people doing this.

 

That said…

 

Why Doesn’t the Government Let the Cards Fall? 

I disagree with your home/fire department example. The Fed is not the fire department putting out the fire. The Fed is a (central) bank paying full price for the homeowner’s mortgage from a (private) bank while the kitchen is on fire. 

 

The Fed just bought a mortgage for less than the home is worth. Substitute mortgage for business and that is what is currently happening.

 

When the Fed was doing QE the past couple years, it was fine because they were buying only Treasuries at fair value (or so slightly below fair value that it’s irrelevant). Not the case today.

 

Isn’t This Just Another Asset Price Bailout?

            True, no one knows if there was a bubble before this began. At this point, it’s irrelevant. 

 

But at this point it is hard to deny that this isn’t an asset price bailout. Absent the Fed, the value of [asset] would be 80 cents. The Fed is buying for 100 cents. Not sure what else it could be called other than an ‘asset price bailout’. 

 

Isn’t This Another Corporate Bailout? 

“To some people this will always look like a bank and corporate bailout.” 

            

Because that is exactly what it is. Call a spade a spade.

 

Yes, this is the only course the Fed has because Congress is not doing its part. That doesn’t change the fact that the Fed’s actions amount to a corporate bailout.

 

Why Are We Bailing Out Firms Who Borrowed During the Boom and Bought Back Stock? 

If companies had a reasonably sized cash buffer, they wouldn’t need to be bailed out within one month of the economy shutting down. If companies are consistently relying on day to day revenue, that’s (generally) a poorly run business and its equity deserves to fold. 

 

“In any case, I’m not sure it’s fair to have a meteor hit the US economy and say “Why didn’t everyone hold an emergency meteor fund?”

 

Sure, it’s not fair but it’s a reality. It’s not as if the US economy would have any value whatsoever if a meteor hit the country. Good thing the Fed is on a remote island and can still pay full value for the US economy when it’s a smoldering crater!

 

 

What About All Those Nefarious Buybacks? 

I agree that ~95% of buyback criticism is wrong. However, the part that is correct is that it is to enrich executives. It’s much easier and safer for a CEO to buy back stock than it is for them to make successful investments. As Charlie Munger said “show me the incentives and I will show you the outcomes.”

To add, I’d argue that the economic results of buybacks (ie. Executives getting filthy rich for doing nothing more than moving up the corporate ladder – just look at Boeing’s most recent CEO) make the 95% of criticism being wrong to something more like 50% of the criticism being wrong. 

 

Conclusion

 

This is the game we all signed up to play (or were forced to play because we weren’t born in time). Equity is risk. This is risk manifested. Just because the players were unaware of its existence (false) or preferred ignorance is bliss (true) does not change the fact that it was always present.

 

The economy did not “stop” as is often said. It shifted - smaller in some places, bigger in others. 

 

If teleportation for all was discovered in 2021, what would happen to airplanes, railroads, cars, etc.? They’d all go bankrupt; the inventor of teleportation would be rich. But the rest of them did nothing wrong, besides thinking nothing would ever change.   

Hi Cullen,

Thanks for the insights. I have engineering background but interested to gain more understanding on what's happening in the financial realms.

I have several questions and am glad if you would clarify them:

1) When FED started to buy in secondary ETF, does it not an encouraging sign for market participants to take on more risks, as they understood that FED with seemingly unlimited bullets are tagging along? That said, it encourages more 'smart' people to take on more risk, which now  appears significantly less risky, and at the same time they gains more returns (higher the risk, higher the return)

2) Are there data to support the fact that increasing wages is a more expensive move than share buyback? When wages are increased, employees are in better position to build up their emergency fund, which means that they have better spending power during rainy day, which is utterly essential to get the enbattled economy to move again? Would you elaborate on how equity is more expensive than debt/bond, other than dividend payout? Are all companies which buy back shares pay dividend? (I supposed not)

3) Does QE not playing a part in the longest bull rally over the past 10 years? Where the liquidity goes to? How much of it goes to the real economy? Does it not disproportionally benefiting those who own equities? Supposedly the proportion of people owning equities are more commonly seen across the wealthy class, compared to main street.

Thanks for your clarifications and stay safe!

 

Regards,

Hilt

Hi @MST240,

Good comments.

I think what people are mainly missing here is that this recession is mostly self imposed. So, the govt is forcing businesses to close and then we're expecting them not to go bankrupt. It just doesn't make sense to me. If the govt is gonna mandate a shutdown then it's reasonable to ask the govt to hold them over for a bit.

I agree it's disproportionate, but the Fed has no choice. They can't send people checks. So, if the Congress doesn't do more and the Fed tries to do a lot then it's not the Fed's fault that Congress is inept.

No easy answers here. Honestly, I think the govt would be massively at blame if they mandated a shutdown and then let the economy just burn without doing anything. So the "let it burn" solution seems really silly to me.

Cullen

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hi @HILT,

1) Yeah, that's the goal. It's a wealth effect. I've studied this impact in Japan and other countries where it's been tried and it doesn't really work. Markets might not be efficient, but people don't just buy stocks because the Fed is buying stocks. They're smarter than that. This is part of why I am very much against the Fed buying secondary market assets.

2) It really depends, but equity is expensive for two main reasons. You have to pay out profits to other owners (dividends) and you cede a portion of profits to other owners. The more you consolidate the firm the less expensive equity is. But from a basic corporate finance perspective equity is potentially MUCH more expensive than debt so it's prudent to buy it back because you consolidate ownership and make that equity less expensive to the future owners.

The reason this is often more prudent than R&D or raising wages is because it has a higher probability cost. That is, R&D is really risky. You don't know if the ROI is high. But if you think your shares are undervalued then the ROI of a buyback is very high to future owners. So it's much more prudent and much more tax efficient than a dividend.

Buybacks mostly get a bad name because people misunderstand them and they're often tied to compensation. So if you think that wealth inequality is a problem then buybacks exaggerate the wealth gap. Of course, all executive comp does that, but it's easier to hate buybacks because they are often tied directly to share issuance.

3) I think people massively exaggerate the impact of QE. Japan did it for 20 years. Stocks went nowhere. Europe's been doing it as long as the US. Stocks went nowhere. The USA did it, but the gains all accrued in US tech stocks which have just massively outperformed everything. So, what made stocks go up? QE or corporate tech performance? It's obviously tech performance or Japan and Europe would have also had huge bull markets. But they didn't.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche