August 23, 2010
By now, you are probably more than familiar with the “backdoor bailouts” of the Wall Street Banks – the most infamous of which, Maiden Lane III, included a $13 billion gift to Goldman Sachs as a counterparty to AIG’s bad paper. Despite Goldman’s claims of having repaid the money it received from TARP, the $13 billion obtained via Maiden Lane III was never repaid. Goldman needed it for bonuses.
On August 21, my favorite reporter for The New York Times, Gretchen Morgenson, discussed another “bank bailout”: a “secret tax” that diverts money to banks at a cost of approximately $350 billion per year to investors and savers. Here’s how it works:
Sharply cutting interest rates vastly increases banks’ profits by widening the spread between what they pay to depositors and what they receive from borrowers. As such, the Fed’s zero-interest-rate policy is yet another government bailout for the very industry that drove the economy to the brink.
Todd E. Petzel, chief investment officer at Offit Capital Advisors, a private wealth management concern, characterizes the Fed’s interest rate policy as an invisible tax that costs savers and investors roughly $350 billion a year. This tax is stifling consumption, Mr. Petzel argues, and is pushing investors to reach for yields in riskier securities that they wouldn’t otherwise go near.
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“If we thought this zero-interest-rate policy was lowering people’s credit card bills it would be one thing but it doesn’t,” he said. Neither does it seem to be resulting in increased lending by the banks. “It’s a policy matter that people are not focusing on,” Mr. Petzel added.
One reason it’s not a priority is that savers and people living on fixed incomes have no voice in Washington. The banks, meanwhile, waltz around town with megaphones.
Savers aren’t the only losers in this situation; underfunded pensions and crippled endowments are as well.
Many commentators have pointed out that zero-interest-rate-policy (often referred to as “ZIRP”) was responsible for the stock market rally that began in the Spring of 2009. Bert Dohmen made this observation for Forbes back on October 30, 2009:
There is very little, if any, investment buying. In my view, we are seeing a mini-bubble in the stock market, fueled by ZIRP, the “zero interest rate policy” of the Fed.
At this point, retail investors (the “mom and pop” customers of discount brokerage firms) are no longer impressed. After the “flash crash” of May 6 and the revelations about stock market manipulation by high-frequency trading (HFT), retail investors are now avoiding mutual funds. Graham Bowley’s recent report for The New York Times has been quoted and re-published by a number of news outlets. Here is the ugly truth:
Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.
The pretext of providing “liquidity” to the stock markets is no longer viable. The only remaining reasons for continuing ZIRP are to mitigate escalating deficits and stopping the spiral of deflation. Whether or not that strategy works, one thing is for certain: ZIRP is enriching the banks — at the public’s expense.
Rampant Stock Market Pumping
It has always been one of my pet peeves. The usual stock market cheerleaders start chanting into the echo chamber. Do they always believe that their efforts will create a genuine, consensus reality? A posting at the Daily Beast website by Zachary Karabell caught my attention. The headline said, “Bells Are Ringing! Confidence Rises as the Dow – Finally – Hits 13,000 Again”. After highlighting all of the exciting news, Mr. Karabell was thoughtful enough to mention the trepidation experienced by a good number of money managers, given all the potential risks out there. Nevertheless, the piece concluded with this thought:
As luck would have it, my next stop was at the Pragmatic Capitalism blog, where I came across a clever essay by Lance Roberts, which had been cross-posted from his Streettalklive website. The title of the piece, “Media Headlines Will Lead You To Ruin”, jumped right out at me. Here’s how it began:
Lance Roberts provided some great advice which you aren’t likely to hear from the cheerleading perma-bulls – such as, “getting back to even is not an investment strategy.”
As a longtime fan of the Zero Hedge blog, I immediately become cynical at the first sign of irrational exuberance demonstrated by any commentator who downplays economic headwinds while encouraging the public to buy, buy, buy. Those who feel tempted to respond to that siren song would do well to follow the Weekly Market Comments by economist John Hussman of the Hussman Funds. In this week’s edition, Dr. Hussman admitted that there may still be an opportunity to make some gains, although the risks weigh heavily toward a more cautious strategy:
Economist Nouriel Roubini (a/k/a Dr. Doom) provided a sobering counterpoint to the recent stock market enthusiasm in a piece he wrote for the Project Syndicate website entitled, “The Uptick’s Downside”. Dr. Roubini focused on the fact that “at least four downside risks are likely to materialize this year”. These include: “fiscal austerity pushing the eurozone periphery into economic free-fall” as well as “evidence of weakening performance in China and the rest of Asia”. The third and fourth risks were explained in the following terms:
Any latecomers to the recent festival of bullishness should be mindful of the fact that their fellow investors could suddenly feel inspired to head for the exits in response to one of these risks. Lance Roberts said it best in the concluding paragraph of his February 21 commentary: