“QE 2” or “Ben’s Titanic”?
Federal Reserve Chairman Ben Bernanke seems to want desperately to prove Warren Buffett wrong.
He is, in fact, betting the U.S. economy on it.
Bernanke, as all the financial world knows, is pushing the Fed into a multi-billion dollar buying spree of Treasury securities at a time when Treasury securities are at all-time record high prices.
Here’s how he justified it this past Friday:
Oct. 15 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke said additional monetary stimulus may be warranted because inflation is too low and unemployment is too high. “There would appear — all else being equal — to be a case for further action,” Bernanke said today…. Bernanke and his central bank colleagues are considering ways they can stimulate the economy as the unemployment rate holds near 10 percent and inflation falls short of their goals. After lowering interest rates almost to zero and purchasing $1.7 trillion of securities, policy makers are discussing expanding the Fed’s balance sheet by purchasing Treasuries…
—“Bernanke Sees Case for ‘Further Action’ on Inflation,” by Caroline Salas and Joshua Zumbrun. Ben’s theory is that the Fed can drive the price of Treasury securities even higher than the market has, on its own, priced them; that this, in turn, will cause the interest rate on those securities to drop (even further than interest rates have already dropped); and that this, in turn, will somehow prompt companies to start hiring again.
It is called “quantitative easing,” and since this is the second round of the Fed’s monetary efforts to restart the economy, it is known, cutely, as “QE2.”
We hear at NotMakingThisUp, however, think a far better—and more accurate—model of Ben’s recipe for success is The Titanic, not the venerable QE2.
After all, in the real world (as we described in “Memo to Bernanke: Listen to a Conference Call Once in a While”) companies hire new employees when they are confident enough in their future prospects to believe that adding a full timer will pay off—not when the cost of borrowing drops a few more basis points.
And you would think Ben would have figured this out, since interest rates have dropped a whole lot this past year, and yet unemployment remains, in the current shopworn phrase, “stubbornly high.”
The real problem, as most business people know, is not that interest rates weren’t already low enough. The problem, at least initially, was that taxes were set to rise next year, which made businesspeople leery about hiring new full time employees, despite rising order books.
Then along came so-called healthcare reform, which opened another big can of uncertainty on American business at exactly the wrong time.
And that’s when you could kiss the “V-shaped” recovery good-bye.
(People get touchy about this stuff, and we’ll no doubt get comments from thin-skinned political types about all manner of irrelevant why-this-isn’t-Obama’s-fault rationalizations, which is not the issue: in investing you deal with the world as it is. And if you want to learn about the world as it is, go ask a business owner—any size, big business or small—about how they’re feeling these days. You’ll get an earful.)
But Bernanke isn’t letting the facts confuse him. He’s going ahead with his “QE2,” which, as we already noted, involves buying hundreds of billions of dollars of Treasury securities at all-time, record-high prices.
Now, Warren Buffett has a different opinion on the value of such fixed income securities—i.e. bonds—than Ben Bernanke. In fact, Buffett recently told his friend, ace Fortune Magazine editor Carol Loomis, the following:
“It’s quite clear that stocks are cheaper than bonds. I can’t imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities.” And when Warren Buffett—who never gives stock tips and rarely comments directly on the merits of buying or selling asset classes such as stocks or bonds—speaks this directly about the lousy prospects for what Ben Bernanke wants to buy, well, attention must be paid.
After all, Buffett is no One-Way-Johnny when it comes to the merits of bonds versus stocks: indeed, for his personal account, Buffett owned only low-risk Treasury securities in the pre-crisis, bull market mania bubble years, even while self-promoting Buffett-followers such as Bill Miller were stuffed to the gills with financial stocks such as Bear Stearns and Fannie Mae in their funds.
And when the stock market began to collapse in 2008, Buffett famously began selling his Treasuries in order to buy stocks—a few months too early, as it turned out, but not as early as the poor shlubs who owned Bear Stearns and Fannie Mae and watched them evaporate.
So it has come to this: Warren Buffett says he “can’t imagine anybody having bonds in their portfolio,” while Ben Bernanke is determined to buy government bonds until the cows come home, or the unemployment rate starts to decline.
Who would you rather have making investment decisions for the Fed?
Now, readers might well be thinking, “Okay, wise-guy, what would Warren Buffett be doing if he was in Ben Bernanke’s shoes?”
And while we haven’t asked Buffett this question—if we did he’d very likely give a disarmingly amusing and self-deprecating response, along with a verbal pat-on-the-back for Mr. Bernanke (Buffett adheres to the Dale Carnegie school of making friends and influencing people)—we do have a thought about what Buffett might well think would make more sense.
Before we explain, we wish to reprint excerpts from a highly topical news story which appeared on our Bloomberg at the very same moment Ben Bernanke was reiterating his vow to pay top-dollar for U.S. Treasury securities:
Oct. 15 (Bloomberg) — Washington policy makers, who moved swiftly to calm markets during the subprime mortgage crisis in 2008, have resisted calls for similarly broad steps in response to concern that banks may have acted illegally to seize homes. President Barack Obama and the federal agencies that share responsibility for housing finance are opposing calls for a nationwide foreclosure freeze, fearing further damage to the housing market. Even as bank stocks tumbled yesterday on concern that the mishandled loans will increase costs for lenders, the White House and federal regulators avoided any grand gestures designed to reassure investors. Obama this week endorsed a coordinated investigation by attorneys general from all 50 states into whether lenders used false documents to justify foreclosures…. “There are 2.3 million loans that are out there in foreclosure,” said John Courson, chief executive officer for the Mortgage Bankers Association. “The administration has in fact made the right decision by not pressing for an overall moratorium. They see the debilitating effects that could have from the standpoint of the entire economy.”
—“Washington Resists Calls for Big Fix in Foreclosure Crisis,” by Lorraine Woellert and Phil Mattingly How encouraging 50 state attorneys general to investigate the banking system will help un-freeze the housing market is beyond us.
Rather, we wonder, why doesn’t the Fed use its purchasing power to buy houses in foreclosure?
If 2.3 million loans are in foreclosure, and if the average house in that pool could be bought for $100,000 (a number we are making up for lack of specific data), that amounts to a quarter trillion dollars the Fed could “put to work,” as money managers like to say, in a market that—quite unlike the Treasury market—is suffering from a lack of buyers and an overload of sellers.
A Resolution Trust Corp-type entity could then mass-market the properties to entrepreneurs and capitalist pigs who would maintain them and resell them at reasonable prices.
By thus providing a highly liquid market beneath a seemingly bottomless housing foreclosure pit, the Fed could kill many birds with one stone: a) re-liquify the banks, b) re-liquify underwater homeowners, c) stop the slow-bleeding in housing, and d) start the healing process.It wouldn’t necessarily make businesses feel better about impending tax increases and healthcare cost increases, but it might make homeowners feel a whole lot better than another reduction in the interest income on their savings account.
Of course, the Fed wouldn’t exactly be the right vehicle for this: it’s a job for the FDIC with some strict legislation behind it from Congress.
Still, instead of buying treasuries at record-high prices in a futile attempt to get companies to hire people, we think Ben ought to consider the merits of buying foreclosed housing at record-low prices.
After all, Warren Buffett’s been buying low for, oh, 60 years now, and it seems to work okay for him.
Jeff Matthews I Am Not Making This Up © 2010 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.
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