Yesterday Stephen D. Williamson, vice president at the St. Louis Federal Reserve Bank, made the following comment: "There is no work, to my knowledge, that establishes a link from Quantitative Easing (“QE”) to the ultimate goals of the Fed -- inflation and real economic activity."
I strongly disagree with Mr. Williamson’s statement.
In an effort to jump start the facilitation of credit after the insolvency of many mortgage brokers, banks and the collapse of companies like Lehman Brothers, the US Treasury launched the well documented Troubled Asset Relief Program. “TARP”, as it is better known, was signed into law in October 2008 to handle the massive subprime mortgage mess.
I was never a supporter of TARP when it was proposed or enacted. I felt that it was nothing more than a bail out of the major financial institutions which, with the help of government policies imposed since 1994, ruined the mortgage lending system while allowing the recipients to make obscene amounts of money. Yet had the government not changed the long-term, conservative lending standards and subsequently put a “gun to the head” of the lenders in an effort to increase home ownership, the financial crisis of 2007-2009 probably would not have occurred. (I do not exonerate the complicity that a number of financial institutions and their leaders had in this process. Yet a great deal of the blame should lie on the doorstep of the Federal Government).
Despite my trepidation that we have been subjected to too much intervention by the Treasury, Federal Reserve and government agencies over the last 20+ years the evidence supports we might have been at a point of no return. It appears that then Fed Chairman Ben Bernanke eventually surmised that the implementation of TARP was not enough to get the economy and markets to grow. He led the Federal Reserve to begin and continue the process of implementing multiple QEs.
Many economic purists were skeptical of the intervention they were embarking on. Yet the tools put in place were fundamentally responsible for the further stabilization and subsequent increase in asset prices (real and paper). The upturn in the value of residential and commercial real estate allowed a large number of individuals to breathe easier. This began the process where many decided to maintain their homes rather than walking away from a mortgage which was significantly underwater.
One cannot underestimate what was occurring during the 2009-2010 timeframe once the housing bubble popped. The psychology of the individual (consumer) was ominously damaged. How many people would have been willing to feel confident of their long-term situation had home prices not recover partially or fully from a 20, 40 or 60% decline? Instead they would have been in a perpetual mental funk while they waited for their homes to appreciate to levesl that made them feel comfortable to spend again. This may have taken a generation, if ever. The effects of the multiple QEs repaired, if not healed many of the scars associated with the massive decline in the real estate market.
The second direct benefit of QE was the increase in stock and fixed income (bond) prices. Many pundits and commentators claim that only Wall Street benefitted from the policies and created a growing level of income inequality. In my opinion, their analysis is deeply flawed.
Even if an individual did not invest in the market, they indirectly received a substantial benefit from rising stock and bond values. The increase in prices in the bond market allowed interest rates to fall for new home buyers and those that were able to refinance. It even helped those that were part of the sub-prime, Alt-A and “no doc” loan crisis as many were given a fresh start where they could receive interest rate and principal relief.
In addition, decreasing rates helped those wanting to purchase cars, trucks and other big ticket items. Obviously the lower cost of borrowing didn’t allow all home owners to recapture the entire losses they suffered during the staggering downturn in prices, but it did reduce the cost of borrowing, debt service and anxiety for a large percentage of home owners.
The implementation of the multiple QEs also had a direct effect on the increase in stock prices. Despite conventional thought, rising stock prices benefitted nearly all members of society.
Step back and reflect on the landscape of the stock market and economy during 2009. After the horrific downturn from October 2007 through the end of 2008, many investors hoped the staggering decline was over. Unfortunately during the early part of 2009, the market was down approximately another 26% from the beginning of the year. Combining a decline of that magnitude to what we witnessed from October 2007 through December of 2008 meant the market dropped by an astounding 60% from peak to trough. Many would admit we were teetering on the precipice of a depression. Some even thought it would have been worse than the Great Depression of the 1930’s.
At that point the Federal Reserve and US Treasury had to realize that if the decline continued to spiral any further, the risk of national and global insolvency was highly probable. They also must have comprehended that had the stock and bond market just stabilized but not appreciated to any such magnitude, it would still create substantial problems of its own.
In making the decision to institute multiple QEs, the appreciation that followed in the bond and stock markets allowed the portfolios of so many pensions, 401(k)’s, foundations and endowments to heal. This in turn allowed benefits to be paid, confidence to continue, saving for retirement to be restored, charitable work to continue without interruption and scholarships to be paid. It also helped embolden consumer confidence for those that did not participate in the financial markets as many watched them for cues as to how the economy was doing.
We should also realize that a QE won’t keep an economy from having a recession, a market from correcting or entering into a “bear market” sometime in the future. Instead we must recognize that historical, conventional methodologies of dealing (such as the lowering of the Fed Funds rate) with severe economic shocks and imbalances might not be enough. The Fed has experimented with a policy tool that was not used before and those that invested in the markets as well as those that did not received a great deal of benefits. Hopefully we won’t need that policy tool implemented again and the economy and markets can perform on their own.
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Thanks for reading!!!
Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.