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Fed Reserve's Program of "Quantitative Easing" Drives Speculation But Won't Help Working America

If private equity firms bring a money-losing company saddled with debt to market, investors are eager to snap it up. Thank the Federal Reserve.
 
 
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Across the world, there are booms. Chinese Internet companies are flourishing. Energy companies are finding new sources of power. Commercial real estate is coming back.

Unfortunately, this isn’t happening in the real world, which is still crippled by sagging economies, but in the investing one.

If there’s a dodgy stock, a dodgy loan or a slice of a complex credit security made to a questionable borrower -- hedge funds want it now. Companies with junk bond ratings are flooding the markets with new issuance. If private equity firms bring a money-losing company saddled with debt to market, investors are eager to snap it up.

Thank the Federal Reserve. The central bank has embarked on its program of “quantitative easing,” a second round of experimental monetary policy in which the Fed buys up assets -- like longer term government bonds -- to bring down interest rates, which is supposed to spur lending and borrowing, thus reigniting the economy.

Nobody knows whether it will work to bring down the intractable rate of unemployment. But it has already worked in one significant way: the speculative juices of the markets are flowing.

What’s going on? As a Fed official explained it in a recent speech, one supposed benefit of the Fed policy is that it will add to “household wealth by keeping asset prices higher than they otherwise would be.”

So it’s levitation-by-decree. When the Fed moves, financial assets receive the opposite of collateral damage: universal blessing, deserved or not. Lower rates may or may not help more people find work. But there’s no doubt that the central bank has already helped the Henry Kravises and Lloyd Blankfeins of the world.

The Russell 2000 stock index, which is made up of smaller companies, has risen about 21 percent since September, when investors started to anticipate that the Fed would intervene in an aggressive fashion. A tiny Chinese Internet stock, China MediaExpress Holdings, is up more than 250 percent since mid-September. The private investors that own Harrah’s, the money-losing casino company, are bringing it public, and investors are going to gamble on it despite a crushing debt load.

Then there are something called B notes, bonds backed by commercial real estate loans. B-note holders are on the hook for the early losses if the loans go bad. They are as hot a commodity as everything else. Never mind that there’s a huge oversupply of commercial real estate in this country. Or that Wall Street just went through a disastrous episode for complex structured financial products of exactly this sort.

Without knowing a thing about finance, here’s how to tell it won’t work out well. Wall Street is the great master of the euphemism. The Street doesn’t call them junk bonds; they are “high yield.” Here, something isn’t just Triple A. It’s “Super Senior Triple A.” So when the best investment bankers can do is to dress something up with a lowly “B,” you know it’s trash.

Leverage, meanwhile, has made a glorious return. Interactive Brokers, a discount brokerage firm, has been running an advertising campaign that displays money spewing from printing presses. The firm will lend (for certain special customers) $566,000 for every $100,000. Ah, borrowing heavily for the purposes of trading in volatile markets. Maybe some Bear Stearns or Lehman Brothers bankers can explain the wisdom of this.

All of this is Finance 101. The cheaper money is to borrow, the more it makes sense to take a bigger risk with it.

But that doesn’t make it more palatable. It feels like an ominous replay of recent Federal Reserve emergency actions, which led to bigger and bigger bubbles. The Fed brokered the rescue of Long-Term Capital Management, bailing out the investment banks that had lent to the collapsing hedge fund. The Fed pumped money into the economy to save us from the Y2K computer bug. The Fed tried to rescue the economy from the bursting of the Nasdaq bubble, helping to create the housing bubble.

 
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