A few weeks ago we had a blog post highlighting some of the ways that the Fed’s ZIRP and QE policies are violating Bernanke’s maxim for Congress of “first do no harm.” Jeffrey Snider’s RCM column from two weeks ago (you can tell I’m a bit backed up on my to-read pile) lays out the argument much more eloquently:
In 2001, the Fed funds rate target was brought all the way down to 1%… For some reason, this is still thought of as capitalism even though the quantity and cost of money is set by a central mechanism for reasons other than individual market opinions (and often contrary to market opinions).
Most commentators (myself included) have focused on the financial fallout from this economic/financial schematic, but it is extremely important to not lose sight of the real economic context into which this intervention projected. Plentiful money meant companies were less constrained in their approach to operations. Market discipline was relaxed, meaning profitability fell in relative importance (this is not to say that profits were disregarded, but with plentiful funding the focus on sustainability gets muddied and papered). Easy access to cash can allow business lines and whole businesses to operate unprofitably longer than they really should meaning the relative importance of innovation and/or productivity is diminished. Efficiency gets lost in the euphoria of asset prices, as stock prices reflect quantities of money rather than true expressions of value.
The primary example of this dangerous imbalance was the massive surges in stock repurchase plans and leveraged merger activity during the middle part of the last decade, right up until the wholesale repo markets first froze in 2007. So much of overall marginal business resources in the last decade (and really for the past twenty-five to thirty years, such as the junk bond bubble in the mid-1980’s that used an outsized proportion of business resources on leverage buyouts) were focused on financial schemes to boost share prices. Share repurchases and mergers, particularly leveraged takeovers, are nothing more than ownership changes conducted at premiums to current prices, competing with real productive endeavors for monetary resources. Since the price effects of ownership changes are instantaneous, whereas productive projects are a net cost up front and often take many years to bear fruit, the systematic skew toward the short-run favors asset manipulation over operational innovation and improvement. True investment is discarded in favor of financial “investment”.
He then goes on to skewer the Fed for taking a backwards approach to its goals of price stability, financial market stability, and tighter regulation on executive pay:
Of course, the fact that so much of corporate management pay is directly tied to share prices only enhances the incentives for this kind of financial activity. That, again, is short-term thinking due to easy credit terms. In fact, during the last decade companies often borrowed cheap money in order to directly finance these kinds of equity extractions (the weighted average cost of capital calculation at work). How much of that financing would have flown to more real economy, productive endeavors will never be known, but I certainly believe it is non-trivial. In other words, this focus on short-term financial manipulation likely, in my opinion, crowded out both market discipline (and its focus on innovation and productivity) and real productive expansion, the very purpose of the Fed’s cheap credit initiatives in the first place.
Read the whole column here.