As investors, speculators, hedge funds and other sectors of finance capital try to gauge where the Federal Reserve will move interest rates next, a study released last month provided some important data on how the Federal Reserve created the conditions for a fiscal crisis .
The report from Better Markets, an organization working to improve governance of the financial system, focused on what it called “systemic instability.”
It began by noting that while most media reports focus on how long and how quickly the Fed will hike rates, the “focus also needs to be on the role of the Fed’s past actions in getting us here and creating the… There are serious risks that we now face.”
Federal Reserve Chairman Jerome Powell, center, takes a coffee break with attendees at the annual Federal Reserve Symposium at Jackson Lake Lodge in Grand Teton National Park in Moran, Wyo, Friday, August 26, 2022. [AP Photo/Amber Barsler]
The fundamental effect of Fed monetary policy over the past 14 years, pumping trillions of dollars into the financial system, “decoupled asset prices from risk and unleashed an historic credit and debt frenzy.” Now, in many ways, the Fed is “fighting problems of its own making.”
The implication is that the outcome could have been different if only different policies had been followed. But an examination of the two major crises of the last 14 years – the global financial crisis of 2008 and the March 2020 market freeze at the start of the pandemic – shows that a full collapse of the global financial system was only prevented by the Fed’s massive monetary intervention.
These interventions have only set the stage for another, even deeper crisis. As the report puts it, this is because “the US and the world are facing an unprecedented series of multiple, simultaneous and consequential economic, financial and geopolitical shocks, causing stress in financial markets while weighing on consumers and businesses in the real economy .” In this environment, the “room for error is vanishingly small”.
The crisis did not start with the pandemic or the Russian invasion of Ukraine, but was rooted in the Fed’s response to the 2008 crash.
When the pandemic triggered a crisis in early 2020, the Fed redoubled its quantitative easing policy, which had already created a mountain of debt and notional capital after 2008.
Comparing the pre-pandemic era to the pre-2008 crash, growth in US publicly held debt was nearly 500 percent greater, growth in non-financial corporate loans and debt securities was about 90 percent greater, and growth in consumer debt, excluding mortgages , was about 30 percent larger.
Overall, a “debt culture” prevailed after the crash due to the Fed’s zero interest rate policy and its large-scale asset purchases. This meant that “the increase in debt in the 10 years before the pandemic was significantly greater than in the 10 years before the 2008 crash.”
This debt frenzy accelerated after March 2020. The immense pace and scale of the Fed’s action in March 2020 is illustrated by the fact that the Fed “purchased $2.1 trillion in Treasuries [US government Treasury bonds] and MBS [mortgage-backed securities] in just the first 90 days of the pandemic stress, an amount that took the Fed nearly four years to buy after the 2008 crash.”
In the two years after the pandemic hit, the Fed bought $4.6 trillion in securities, about $800 million more than in the 8.5 years after 2008.
The effects of the low interest rate regime and the purchase of securities meant that the yield on safe government bonds fell to zero. Consequently, investors had to allocate their money to riskier assets to get the same returns.
This process was compounded by the Fed’s actions to remove massive amounts of safe assets from the markets and place them on its books, leaving investors with cash but less safe assets to invest in. They had “no choice but to turn to riskier assets and earn returns that were much further off the risk spectrum than before.” This was particularly true for investors holding short-term assets.
They did so with an experience-based belief that “the Fed would just bail out everything.” This guarantee was expanded in scope and scope when the Fed intervened in the corporate bond market in March 2020.
This intervention had a broad impact despite the relatively small amount of money that the Fed actually provided in this area. The mere announcement that the Fed was effectively the lifeline for the corporate bond market had a second-order effect that far exceeded the impact of outright purchases.
As a result, “companies with poor credit ratings and poor financial performance — and often worsening prospects — have been able to sell debt they otherwise would not be able to, or sell more debt than they otherwise could.”
Not only has the Fed incentivized unbridled risk-taking, it has effectively rewarded, and indeed bailed out, “the most extreme pre-pandemic risk-taking, however irresponsible or even poorly managed. These included so-called zombie companies with earnings lower than the interest on their then-current debt. The Fed literally kept these zombies and created many more.”
The Fed’s move to higher interest rates – a policy designed primarily to stifle the working-class struggle for wage increases in response to rampant inflation – has serious implications for the financial system.
The Better Markets report warned that as debt and credit risk reassesses, companies are facing reduced demand for their products and the “potential impact could be dramatic.”
Banks are by no means excluded. It was often said by the Fed and other officials that banks were a “source of strength” during the March 2020 crisis. But that conclusion was “incomplete and misleading at best” because it was only two weeks before the Fed stepped in with trillions of dollars, effectively guaranteeing all markets. In other words, had this not happened, the vaunted “strength” of the banks might have been sorely tested.
The report concluded by observing that as the Fed tightens monetary policy, we are “getting closer to a potentially devastating realization of some of the risks that Fed policies have created or exacerbated over the past 14 years.”
It pointed out that “the Fed, while monitoring and attempting to address risks to financial stability and the banking system, has simply failed to see itself as a potential source of these risks — or has not viewed or considered it” .
This is something like a misjudgment of the situation. Undoubtedly, the Fed didn’t want to look too closely into the future when it bailed out the financial system. However, it was at least partially aware of the risks of its actions and made attempts to “normalize” monetary policy in 2013 and 2018.
But on both occasions it faced a violent market reaction — the so-called “taper tantrum” of 2013 and the big market sell-off of December 2018 — that forced it to pull back.
The Fed’s role reflects not so much a lack of oversight and awareness as a reflection of a more fundamental problem, as underscored in the World Socialist Web Site’s New Year’s Perspective. It declared that the dynamics of the capitalist crisis had exceeded the ability of governments and their agencies to contain it, and that their policies had “an increasingly reckless and irrational character”.
Sign up for the WSWS email newsletter
Comments are closed.