Sour Grapes Only For The Taxpayer

Sure, I’m tempted to complain about the Fed chasing us out of our best position of the year (the ETF that shorts junk bonds) last week (although they made its replacements “gold and, yes, cash” look more attractive) but it is what it is. Better to just manage the risk within whatever cards we’re dealt.

That said, I don’t think it sour grapes of me to recognize the sheer moral hazard of the Fed’s actions this go-round. In fact, I’d argue that the moral hazard resulting from the Fed’s actions the last go-round largely explains the current debt mess that would make any recession, regardless of its perceived catalyst, at least a rival to 2008’s. 

John Authers agrees:

“Already before the Covid crisis, the U.S. was stalked by a record number of zombies — companies whose total tangible assets aren’t enough to repay all their debt. They can only stay alive with the help of rock-bottom rates.

The economy would be more dynamic if they were allowed to fail, letting new companies arise. Moral hazard isn’t just theoretical — it leads to bad allocations of capital.” 

Anyone who was the least bit concerned about the Fed not doing the bidding of high-powered, politically-connected players has — per the Wall Street Journal’s Editorial Board below — absolutely nothing to complain about now. Ironically, while markets for the moment love it, as it is designed to quell market risk, in the long-run it’s the riskiest of propositions for the one whose always left paying such bills, the taxpayer:   emphasis mine…

“Thursday the Fed said it will now accept much riskier credits including commercial mortgage securities and collateralized loan obligations.

These are loan pools packaged into securities by Wall Street, which lobbied the Fed and Treasury hard for the TALF expansion. This means the Fed will in effect buy the worst shopping malls in the country and some of the most indebted companies. The opportunities for losses will be that much greater. Treasury is backstopping losses, but the taxpayer risks here are greater than what the Fed took on in 2008-2009.

The Fed may feel all of this is essential to protect the financial system’s plumbing and reduce systemic risk until the virus crisis passes, but make no mistake that the Fed is protecting Wall Street first. The goal seems to be to lift asset prices, as the Fed did after the financial panic, and hope that the wealth effect filters down to the rest of the economy.”

“All of this adds up to the following contrast: A company bought by a Wall Street firm and loaded up with debt that is part of a CLO security will now face far easier terms for liquidity relief than will a similar privately owned company in the Midwest that never took on too much debt. This is employing political discretion, and picking winners and losers, far more than the Fed did in 2008.”


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