Thursday, November 14, 2013

Fed official admits failure

Apologies are becoming increasingly common these days.  From the ubiquitous “Twitter apologies” of celebrities to the mea culpas of scandalized politicians, the public has become used to hearing them on a daily basis.  It came as a surprise, however, when a former Federal Reserve official apologized for the part he played in the ultra-loose monetary policy known as QE.

“Confessions of a Quantitative Easer, the Wall Street Journal published the public apology by former Fed official Andrew Huszar.  The gist of the piece can be summarized in Huszar’s words: “We went on a bond-buying spree that was supposed to help Main Street.  Instead, it was a feast for Wall Street.” 

Huszar claims responsibility for executing the bond-buying experiment known as quantitative easing.  Despite his prior knowledge that the Fed’s independence from Wall Street was eroding, an observation that caused him to walk away from a previous Fed job, Huszar heeded a call to return in order to oversee the Fed’s mortgage purchases.  He described it as a “dream job.” 

After the first round of QE ended in early 2010, Huszar summarized the final results in these words: “While there had been only trivial relief for Main Street, the U.S. central bank's bond purchases had been an absolute coup for Wall Street. The banks hadn't just benefited from the lower cost of making loans. They'd also enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed's QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.

He freely admits that the Fed should have stopped QE after the first round, acknowledging that the “flash crash” in May 2010 prompted the Fed to continue with its QE experiment.  The relationship between Wall Street and the central bank was becoming more and more entrenched and it was simply too late to turn back, according to Huszar.  This is when he decided to return to the private sector, claiming he had been “demoralized” by the failure of QE to lift the economy.

Nearly four years later the large financial market intervention in world history has cost $4 trillion and still hasn’t resulted in the predicted boost for Main Street.  Wall Street by contrast continues to enjoy the liquidity bonanza, with stocks consistently making new highs on a monthly basis.  Pimco’s CEO Mohammed El Erian suggests that for its efforts the Fed may have received a return of only 0.25% of GDP in return for the $4 trillion spent.  Commenting on this, Huszar concedes that “QE isn’t really working.” 

Huszar concluding statement is candid: “As for the rest of America, good luck. Because QE was relentlessly pumping money into the financial markets during the past five years, it killed the urgency for Washington to confront a real crisis: that of a structurally unsound U.S. economy.

Now compare Huszar’s frank admission with the latest words from Janet Yellen, the heir-apparent to chair the Federal Reserve next year.  On Wednesday she stated that the Fed still has “more work to do” to stimulate the economy.  That of course was all Wall Street needed to hear in order to boost participant’s morale and push stock prices higher.  The S&P 500 Index (SPX) ended the session by closing at a new all-time high.

“I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” said Yellen.  These remarks led traders to believe that the Fed would continue its ultra-loose monetary policy well into 2014, which is extremely desirable to Wall Street.  This underscores that the Fed is committed to pursuing a continued aggressively loose monetary policy indefinitely.  Traders need not fear any attempts at “tapering” QE, either next month or in the next few months.  It will take considerably more “evidence” before the Fed is ready to scale back its asset purchases next year.

The bigger issue in Huszar’s confession is the failed relationship between the stock market and the economy.  Prior to the credit crisis it was widely assumed that the connection between equity market strength and domestic economic performance was relatively tight.  That relationship is now being questioned after the last five years of continued stimulus with little results for Main Street despite Wall Street’s record performance.  This isn’t to say the relationship is forever broken, only that the lesson from the Great Depression years is being repeated, viz. when the deflationary long-term cycles are down, stocks and the economy typically move at difference paces.