If It Pecks Like a Chicken...

“It took a viral invasion to unmask the weakness of American finance. Distortion in the cost of credit is the not-so-remote cause of the raging fires at which the Federal Reserve continues to train its gushing liquidity hoses. But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised the U.S. economy’s financial integrity.” – Jim Grant

How long should a Doomberg piece be? This is a question I think about a lot. There’s a perfect length for them – people only have so much attention span, after all – but it can be hard to judge when enough is enough and when more would be too much. In general, the core Doomberg brand rules are simple: each piece should be funny without being silly, provocative without being polarizing, and thoughtful without being self-indulgent. If I’ve achieved those three things, shorter is better. I can always put it in the next piece.

Take the most recent article titled How the Fed Printer Goes BRRR. In its original (and ultimately unpublished) incarnation, the piece was framed as a debate between two people with polar opposite views of the Fed’s impact on stock prices. I had intended to include Gerard Minack’s case that the Fed is essentially irrelevant and elevated stock prices can be explained by other forces, which he articulated in Episode 19 of The End Game – that endlessly wonderful podcast hosted by Grant Williams and Bill Fleckenstein (Mike Green’s view, which became the heart of How the Fed Printer Goes BRRR, came from Episode 3 of the same podcast series).

Halfway through writing that version, it became apparent that doing so would have made the piece much too long, so I decided to reframe it as a one-way explanation (i.e., Green’s position) that I happen to believe is true. I was expecting criticisms of the piece to align with Minack’s views that loose regulation on leverage and the ability of US companies to deliver outsized growth in the past decade better explains why US stocks are so elevated.

That’s not the criticism I got. On Twitter, several users objected to this sentence, which I frankly assumed was an axiom at this point – something everybody could agree on:

“When the Fed buys bonds, thereby suppressing interest rates, the market value of bonds goes up.”

Forget elevating stock prices. Intelligent people objected to the assumption that quantitative easing (QE) suppressed interest rates. In a late-night Twitter exchange (is there any better time or place to argue online?), I countered by saying let’s run the experiment – turn off QE tomorrow and see what happens. The counter to my counter was a question: what did I think would happen to the 30-year treasury yield without QE?  Ahh… that’s when I realized something has been lost in brevity.

I’m neither an economist nor an academician. I grew up in the corporate world and now I’m a business owner. I borrow money, lend money, refinance things, invest in startups, build new businesses, close others, and so on. I do these things in the real economy and I prosper or struggle in part based on the availability and cost of credit and the decisions I make within those markets. When I say interest rates, I don’t mean the long-dated US government bond. I mean the price of credit charged to private actors in the economy.

I believe the credit markets are heavily distorted by the Fed, that interest rates are lower than solvency risk of borrowers would otherwise indicate is appropriate, and that these facts could even explain sluggish loan growth on the part of the banks. Let’s take mortgage rates as an example. Does anybody believe the 30-year fixed rate would be even lower than the incredibly low 3% rates we see in the “market” today if the Fed stopped buying $40 billion worth of agency mortgage-backed securities each month? I sure don’t and I think I can prove it by a personal example.

As a doomer, I’m not a huge fan taking on excessive personal debt. As such, I worked hard early in my career to pay off my mortgage as soon as I could – sacrificing potential future stock market gains for the comfort and safety of putting a literal and financial floor beneath my family that nobody could take away. If I wanted to express my belief that mortgage rates are now too low, I could – at least in theory – refinance and use the funds borrowed to create value above the ~3% cost of capital that my home equity should fetch in the credit markets.

Except I can’t.

I’m self-employed, you see, and that means I am not a “W2 borrower,” which makes my refinancing documentation non-conforming, which means it can’t be offloaded by the banks to government-sponsored entities like Fannie Mae and Freddie Mac, who then package up conforming mortgages into mortgage-backed securities and sell them to… the Fed (among others, of course). The reason home buyers and W2 borrowers can access housing credit at such low rates is because the Fed essentially removes the risks from the banks. They aren’t doing that for borrowers like me (self-employed refinancers), which basically means it can’t be done.

Despite having excellent credit, no bank in town will even consider refinancing my home. I could sell my home and buy a new one, in which case banks would happily lend to me, but refinancing? Not so much. Why risk it? By lending to me, they would be taking and most likely keeping credit risk. In the Fed-approved lanes, the banks are playing an arbitrage game. With the Fed put, it’s free money. Could I search beyond the bankers I normally deal with and find somebody to refinance my home? I’m sure, but it won’t be anywhere near 3%.

Looking beyond mortgages, does anybody believe corporate junk bond yields would be below 4% today if the Fed hadn’t stepped in last year and indicated a willingness to backstop that market when things almost collapsed?

Would insolvent basket-cases like Illinois and New Jersey be able to access the municipal bond market at astonishingly low rates if market participants were merely assessing their credit risk in isolation? Would Greece be able to borrow for 10 years at 0.5% interest without the actions of the European Central Bank? Everywhere I look, I see obvious distortions of interest rates to the lower side. None to the higher.

The actions of the central banks suppress interest rates. It’s undeniable. Central bank balance sheets are exploding, yields are incredibly low, and stock market bubbles abound. If it looks like a chicken, walks like a chicken, and pecks like a chicken, it’s a chicken, not a duck.

Anyway, this piece is probably long enough.

If you enjoy Doomberg, subscribe and share a link with your most paranoid friend!