“The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth (The Fed). Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying…
…The only way to return the assessment of risk to something resembling normalcy is to stop the manipulation. That requires nothing less than serious intestinal fortitude from the Fed and a willingness to raise interest rates in the face of determined opposition from Wall Street.”, William D. Cohan, “Show Some Spine, Federal Reserve”, The New York Times, August 29, 2015
Show Some Spine, Federal Reserve
By WILLIAM D. COHAN
THE financial markets and the Federal Reserve Board have been playing out a tragicomedy in three acts. Here’s how it works: Initially, a flurry of news stories appear about how, a few months hence, the Fed intends to raise short-term interest rates for the first time in years. Second, the predictable market swoon, as Wall Street traders ponder the fact that the morphine drip of free money that they have been enjoying since the aftermath of the 2008 financial crisis might be pulled out of their arms. Finally, the Fed backs away from its much-overdue policy change, causing traders to rejoice and the artificially stimulated bull market in both stocks and bonds to continue. The curtain comes down, and the audience roars its approval.
A similar drama occurred in the spring of 2013, during what has been called the Taper Tantrum. And now it’s happening again.
Some background: At the end of 2008, the Fed dropped its benchmark short-term interest rate to around zero. It also began a program with the Orwellian name of quantitative easing — buying huge sums of bonds to suppress long-term interest rates and stimulate lending and spending. Thanks to Q.E., the cost of borrowing money was pushed to next to nothing. This was a bonanza for those who make money from money — hedge-fund managers, private-equity moguls, banks — and a disaster for savers, retirees and anyone on a fixed income. (Have you checked the interest your bank pays you on your savings account? Mine: .06 percent per year.)
The Taper Tantrum began in May 2013, when Ben S. Bernanke, then chairman of the Federal Reserve, announced in congressional testimony that later in the year the Fed would most likely start slowing — hence, “tapering” — its monthly bond buying. On June 19, in a news conference, Mr. Bernanke reaffirmed that decision: The Fed, he said, “currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” Before the afternoon was out, the Dow Jones industrial average had fallen more than 200 points, or 1.4 percent, and the bond market tanked as the yield on the 10-year Treasury bond rose to 2.36 percent, its highest level since March 2012. The Fed quickly backed down and the rallies in the stock and bond markets resumed.
The third round of quantitative easing ended last fall. And all of this year, the markets have been chattering about an expected announcement that the Fed will finally — after nine years — raise short-term interest rates in September, by a modest 0.25 percentage points.
Yes, it would be a little painful to start having to pay a little more for short-term borrowing and, yes, the net worth of Wall Street billionaires might increase at a slightly lower rate, but it looks as if the moment is at hand to end the morphine drip.
The case for raising rates is straightforward: Like any commodity, the price of borrowing money — interest rates — should be determined by supply and demand, not by manipulation by a market behemoth. Essentially, the clever Q.E. program caused a widespread mispricing of risk, deluding investors into underestimating the risk of various financial assets they were buying.
The only way to return the assessment of risk to something resembling normalcy is to stop the manipulation. That requires nothing less than serious intestinal fortitude from the Fed and a willingness to raise interest rates in the face of determined opposition from Wall Street.
Sadly, the Fed, under Mr. Bernanke’s successor, Janet L. Yellen, seems to be caving. The worsening economic news from China, combined with uncertainty about the Fed’s plans, contributed to the recent sharp declines in stock markets around the world.
All too predictably, the powerful advocates of the Fed’s zero-interest-rate policy have raced to its defense. Under the headline “The Fed looks set to make a dangerous mistake,” Lawrence H. Summers, the former Harvard president and Treasury secretary, wrote in The Financial Times, “At this moment of fragility, raising rates risks tipping some part of the financial system into crisis, with unpredictable and dangerous results.” He then tweeted, “It is far from clear that the next Fed move will be a tightening” (a raising of rates).
Around then came a leaked note to clients from Ray Dalio, founder of Bridgewater Associates, one of the world’s largest hedge funds, agreeing with Mr. Summers’s assessment. He warned that the Fed might be so wedded to its “highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required.”
This elite pas de deux reached a crescendo on Wednesday when William C. Dudley, the president of the powerful Federal Reserve Bank of New York, said that, upon reflection, September was not the time for the Fed to raise short-term interest rates. The argument for doing so, he said, seemed “less compelling to me than it was a few weeks ago,” noting that “international developments have increased the downside risk to U.S. economic growth somewhat.” Once the news of Mr. Dudley’s words got out, the markets rocketed upward. Crisis averted?
Thursday was also the first day of the annual central-banker retreat in Jackson Hole, Wyo. The gathering’s theme is the boring-sounding “Inflation Dynamics and Monetary Policy,” but it’s the perfect setting for these supposedly brilliant economists to figure a way out of this perennial Catch-22 once and for all. The right answer is self-evident: End the easy-money addiction, raise rates in September and begin the healing.
William D. Cohan is the author of three books on Wall Street.
A version of this op-ed appears in print on August 29, 2015, on page A19 of the New York edition with the headline: Show Some Spine, Federal Reserve.