Has the Fed Bankrupted the Nation?

Has the Fed Bankrupted the Nation?

Volcker, Greenspan, Bernanke and Yellen. Which one does not belong? Logic dictates that Volcker should have been odd man out. After all, there is no legendary “Volcker Put.”

The towering monetarist made no bones about never being bound by the financial markets. The same can certainly not be said of his three successors. And yet, history contrarily suggests it is to Volcker above all others that the financial markets will forever be beholden.

Many of you will be familiar with Michael Lewis’ memoir, Liar’s Poker. Yours truly first read the book in a Wall Street training program much like the one Lewis survived to describe in his autobiographical work. The take-away then, in late 1996, was that Gordon Gekko was right — greed was good.

Recently, a second reading of Liar’s Poker, following nearly a decade inside the Federal Reserve, delivered a much different message than did that first youthful reading and was nothing short of an epiphany: Paul Volcker, albeit certainly inadvertently, created the bond market.

On Saturday, October 6, 1979. Volcker held a press conference and announced that interest rates would no longer be fixed and that further the Fed would begin to target the money supply in order to curb inflation and “speculative excesses in financial, foreign exchange and commodity markets.”

Alas, this new regime was not meant to be. In trying to introduce an alternative to interest rate targeting, the Fed replaced one guessing game with another. Predicting the demand for reserves and then buying or selling securities based on that demand proved to be just as dicey as a similar exercise to target a given level of interest rates had been.

Volcker’s experiment ended in 1982. But by then, the genie had escaped the proverbial bottle.

Michael Lewis explains: “Had Volcker never pushed through his radical change in policy, the world would be many bond traders and one memoir the poorer. For in practice, the shift in the focus of monetary policy meant that interest rates would swing wildly. Bond prices move inversely, lockstep, to rates of interest. Allowing interest rates to swing wildly meant allowing bond prices to swing wildly.

Before Volcker’s speech, bonds had been conservative investments, into which investors put their savings when they didn’t fancy a gamble in the stock market. After Volcker’s speech, bonds became objects of speculation, a means of creating wealth rather than merely storing it. Overnight the bond market was transformed from a backwater into a casino.”

What a casino. As Lewis points out in his book: In 1977, the total indebtedness of U.S. government, corporate and household borrowers was $323 billion. By 1985, that figure had grown to $7 trillion.

Volcker left the Fed in August of 1987 after handing the reins over to Alan Greenspan. Two short months later, there would be a celebrated birth, that of the Greenspan Put, a watershed that truly got the party started. At last check, that party’s still going strong though stress fractures have begun to show on the festive facade. Of course, you wouldn’t have noticed them with the celebration of credit continuing to party on.

By year’s end 2015, U.S. indebtedness had swelled to $45.2 trillion. Tack on financials, which few do, and it’s $64.5 trillion and unabashedly growing. We are a nation transformed.

There are many temptations that tantalize when it comes to delving into debt. Uncle Sam now owes a cool trillion more than the nation produces. In our history, only once before has the divide between debt and production been so wide. That time was right after World War II. The difference between now and then — the cost was great but the purchase of our freedom was priceless.

What has today’s vast store of debt purchased? Certainly not freedom.

American nonfinancial businesses are today in hock as never before, to the tune of $14 trillion. Sadly, most of their debt accrued since the crisis has been funneled into nonproductive endeavors that involve balance sheet tiddlywinks to pad earnings. Don’t believe a single economist who dares quantify the consequences of a foregone generation of capital expenditures.

(At the risk of digressing, there was a bittersweet irony to Greenspan’s lamenting a lack of productivity growth when record share buybacks occurred on his watch. Consider his tenure to have provided the training ground for today’s C-suite occupants.)

At the most fundamental level, it’s the household sector that has undergone the most tragic transformation. We of that sector are, after all, what this country is and what it will be tomorrow. And it was individual citizens who had the good sense and vision to found a democracy built on the tenet of government’s role being protector of our inalienable rights to life, liberty and property. We earned these rights through relentless hard work and proudly claimed them as our own. It was the American way.

But what happens when the incentive system that encourages the honest attainment of that very American Dream breaks down? What happens when people in positions of power add the forbidden fruit of debt to our nation’s recommended daily allowance of consumables cloaked as a bonafide food group?

Whether it’s margin debt, mortgages or car loans, Americans have been brainwashed into believing that living beyond their means will somehow get them ahead. Consider the data, which simply do not lie.

In 1984, disposable income, what we take home in the aggregate after we pay our taxes, was $2.9 trillion. That same year, total household debt was $1.9 trillion. Back then, we covered our debts and had a fair bit left over with which to fund savings and possibly pay for a trip to Disney or for our kids’ college educations.

Then along came ‘measured.’ The first era of ‘lower for longer’ interest rates arrived in the aftermath of the dotcom implosion. Baby boomers, while still years away from retirement, had nevertheless been shocked to see their retirement savings take such a huge hit. But rather than batten down the hatches, they whipped out their credit cards marking a turning point in our nation’s history.

The Gregorian calendar dictates that the first year of this young century was 2001. That also happens to be the first year Americans spent more than they cleared in disposable income by way of accumulating debt: they took in $7.74 trillion and racked up debts that totaled $7.82 trillion by year’s end.

Feeding the shift from those who once had rainy day funds to those who had been had were six words constituting a commitment from Alan Greenspan stating that interest rates would rise at a, “pace that is likely to be measured.” Stand and deliver the famous obfuscator among orators did. The good times lasted for so long that households began to get unsolicited offers for new credit cards and mortgages in the mail…for their children.

Was the Maestro warned of the disaster building? The answer to that is well documented in the terrible tale of Edward Gramlich, who pled with his boss to put a stop to the subprime madness before it claimed countless victims, the largest of which would be the entire U.S. economy.

And yet the borrowing binge continued, even in the darkest days of the foreclosure crisis as mortgage balances collapsed. Of course, by then, Greenspan had exited stage left, off to sign book covers and leave the cleaning up of the disastrous detritus to his successor.

What was the harsh medicine Ben Bernanke prescribed to wean the country off over-indebtedness? Why gasoline. Bernanke poured fuel on the fire in the form of seven years of zero interest rates making debt more accessible than it had been in 5,000 years of recordkeeping (as per Merrill Lynch’s math).

The result was that households never saw even one year in which they made more than they owed. Not one, even though the period of ‘beautiful deleveraging’ was supposedly underway.

From this and that dotcom IPO, bought on margin, no less…to liar mortgages…to super subprime car loans, the elixir of aspiration has simply been too strong to resist. Lost along the way is a culture that once valued waiting for the better things in life. In the wake of this wholesale surrender of a culture, households have slowly succumbed to a subpar existence. That’s the trouble with living beyond your means. It never lasts indefinitely and always leaves you worse off than had you refrained from the get go.

The latest household data for 2015: Disposable income, $13.4 trillion. Debt, $14.2 trillion.

The prognosis? Mortgage debt is rising, credit card usage is back in vogue and student debt continues to spiral upwards. Car lending meanwhile, may be taking its last gasp for this cycle as fresh reports show used car prices have fallen for four straight months, a classic precursor to a downturn in the auto sector.

As for the fair chair, Janet Yellen, by all accounts she is running scared, pulling out all stops to forestall a recession in the hopes that there is such a thing as The Great Moderation, Part II.

To say Yellen is just now waking to the dangers of over indebtedness would be disingenuous. She was President of the San Francisco Fed when the housing bubble literally inflated and burst in her backyard.

No, perhaps what she is now realizing is the deep trap she is in. Her cabal of economists have long since assured her that government, corporate and household debt service is so low that history itself has been rewritten. But therein lies the mother of all Catch 22s, wrought by nearly 30 years of central bankers encouraging, enticing and imploring debt-financed spending while punishing, penalizing and all but outlawing saving.

Yes, the debt service is at record lows, but the mountain of debt that’s been accumulated dictates that the only thing the economy can withstand is low rates in perpetuity. The alternative is simply unimaginable. There would be widespread ruin and perhaps even the bankrupting of a great nation.

If only we didn’t know how we got to this point. But we do. We were duped by Liar’s Brokers and now have to live with the consequences. To quote Michael Lewis one last time, “In the land of the blind, the one-eyed man is king.”

A Texan in King Arthur’s Court


Diamonds are said to be a girl’s best friend, but for all their beauty, they can’t impart wisdom? This season as my gift to you, I would like to share the true wisdom of a gift I received years ago, one whose value cannot be measured in carats and nestled in robin’s egg blue. The gift is a story that can be taken as a parable, featuring that iconic little box and a legendary banker. You will soon agree that it is a priceless gift that truly keeps on giving.

It will come as no surprise to any who have met him that the giver of the gift was Arthur Cashin, one of the greatest storytellers of all time. Over the past decade, I’ve had the honor to call him friend. His infinite wisdom and consummate knowledge of the history of the financial markets were hugely helpful in fulfilling my role as advisor to Richard Fisher. Bringing those two gentlemen together several months before Fisher retired was bar none the highlight of my career at the Federal Reserve.

It’s impossible to describe Cashin’s breadth of knowledge of the most historic moments in modern day stock market history. It’s an understatement to say that he has earned his stripes. One year ago, King Arthur, as Fisher and I are apt to call him, celebrated his 50-year anniversary as a member of the New York Stock Exchange. The NYSE commemorated the occasion by having Cashin ring the opening bell; the moment befitted the occasion perfectly.

Readers of Cashin’s Comments, a daily missive that delights his followers the world round, would agree that it’s hard to pin down the very best story he has told over the years.

Cashin’s recollection of the day that followed the 1987 crash is among my favorites. Though the Dow initially opened up 200 points, trading quickly turned negative. Adding fuel to the panic, were banks in the process of cutting off lines of credit to the specialists on the floor. What would have followed, if this had proceeded, could have been catastrophic.

Few recall that Alan Greenspan was on an airplane headed back to Washington DC at the time. The freshly appointed Federal Reserve chairman had landed in Dallas on Black Monday just in time to learn that the Dow had fallen by 22 percent while he had been in flight. This shocking news prompted Greenspan’s cancelling his Dallas engagement and heading back to DC. Unfortunately, for the markets, he was once again in the air as yet another historic sell off ensued.

As Cashin wrote on the 25th anniversary of the crash, news that Greenspan couldn’t be reached was of little comfort to NYSE Chairman John Phelan: Desperate, Phelan called the President of the New York Fed, Gerry Corrigan. He sensed the danger immediately and began calling the banks to reopen the credit lines. They were reluctant but Corrigan ultimately cajoled them. The credit lines were reopened and the halted stocks were reopened. Best of all, the market started to rally and closed higher on the day.”

The story of the day the NYSE didn’t crash harder is a classic. But it doesn’t resonate as much as it once did. Since 1987, the stock market has operated in an increasingly contained vacuum thanks in large part to overly-easy monetary policy. That makes the following story, generously gifted to me in its entirety by King Arthur, the most relevant of the day. The two main characters of this timeless tale are Charles Lewis Tiffany and John Pierpont Morgan.

Being the astute jeweler that he was, Mr. Tiffany knew that Mr. Morgan had an acute affinity for diamond stickpins. One day, Tiffany came across a particularly unusual and extraordinarily beautiful pin. As was the custom of the day, he sent a man around to Morgan’s office with the stickpin elegantly wrapped in a robin’s egg blue gift box with the following note:

“My dear Mr. Morgan. Knowing your exceptional taste in stickpins, I have sent this rare and exquisite piece for your consideration. Due to its rarity, it is priced at $5,000. If you choose to accept it, please send a man to my offices tomorrow with your check for $5,000. If you choose not to accept, you may send your man back with the pin.”

The next day, the Morgan man arrived at Tiffany’s with the same box in new wrapping and a different envelope. In that envelope was a note which read:

“Dear Mr. Tiffany. The pin is truly magnificent. The price of $5,000 may be a bit rich. I have enclosed a check for $4,000. If you choose to accept, send my man back with the box. If not, send back the check and he will leave the box with you.” 

Tiffany stared at the check for several minutes. It was indeed a great deal of money. Yet he was sure the pin was worth $5,000. Finally, he said to the man: “You may return the check to Mr. Morgan. My price was firm.”

And so, the man took the check and placed the gift-wrapped box on Tiffany’s desk. Tiffany sat for a minute thinking of the check he had returned. Then he unwrapped the box to remove the stickpin.

When he opened the box he found – not the stickpin – but rather a check from Morgan for $5,000 and a note with a single sentence – “JUST CHECKING THE PRICE.”

Ah, but for the days of old, for bygone times when markets operated as price discovery mechanisms.

Howard Silverblatt, the man behind the Standard & Poor’s 500 index, has not been on Wall Street for quite as long as Cashin. Still, as he nears the 40-year mark at S&P, he too has earned the distinction of a true markets veteran.

Silverblatt’s recent work on share buybacks has cast a harsh light on one of the unfortunate outgrowths of accommodative Fed policy. This year’s third quarter marked the seventh consecutive three-month period in which over 20 percent of the S&P 500 constituents “bought their earnings per share (EPS) via buybacks,” in Silverblatt’s words.

Drilling down leads to the discovery that one-in-five companies have juiced their EPS by a minimum of four percent over the prior year via buybacks. How does this work? The act of reducing share count by at least four percent by definition boosts earnings PER share by the same amount. Looking ahead using companies’ more recent activity as a gauge, this year’s last three-month period will mark an eighth consecutive quarter of similar share count reduction.

At $559 billion over the past 12 months, buybacks are up 1.6 percent over 2014. Still, barring an extraordinary fourth quarter, 2015 will not be one for the record books. For now, the 2007 record of $589 billion looks to stand.

Of course, there is hope for short-sighted investors, if hope is what you’d call it. As Silverblatt quips, “The combination of low interest rates, even as Yellen & Co increases rates, and high cash levels continues to give companies the ability to set record shareholder returns.”

Or, as Cashin has said of this corporate conduct, “Companies have raised financial engineering to a Botox state.” It won’t surprise you that I couldn’t agree more.

Perhaps we should all make a wish that the gift of price discovery is under the tree this year, symbolically wrapped in that beautiful robin’s egg blue. How lovely it would be to resurrect those wondrous words uttered so long ago by J.P. Morgan: “Just checking the price.”

Fittingly it happened that, Silverblatt and Wall Street’s most ardent and succinct Fed policy critic, Peter Boockvar, rounded out a merry New York gathering where Fisher and Cashin shared their stories whilst marinating an ice cube or two. This holiday season, I will count among my many blessings the friendship of such wise men, especially that of Wall Street’s very own King among Men.