NY Times - An Aggressive Fed Faces Criticism on Wall Street

February 20, 2014, 3:52 pm

Mark Spitznagel, founder of Universa Investments, a hedge fund that profited during the 2008 crash, argues that by holding down interest rates, the Fed encourages companies to take up unhealthy habits, like borrowing to fund purchases of their own shares. “That’s outrageous behavior,” he said. “The Fed has entirely forced people to do this.”

Every time Janet L. Yellen, the chairwoman of the Federal Reserve, testifies in Congress, she can expect some senators to scoff and representatives to question.

But Washington’s critics pale next to Wall Street’s.

Since the financial crisis, the Fed has engaged in an aggressive stimulus campaign, which has helped lift stock and bond markets, greatly enriching Wall Street in the process. Even so, a surprisingly large number of investors and bankers remain deeply skeptical — and even angry — about what the Fed is doing.

Many of them say the central bank’s policies are causing harm — and they are confident that Ms. Yellen, who succeeded Ben S. Bernanke as chief this month and is extending his policies, will fail spectacularly. “I don’t really like the Fed very much,” said Jeffrey E. Gundlach, chief executive of DoubleLine, an investment firm. “I wish the Fed were not manipulating the market the way it is.”

In many ways, the Fed bashing, which remains widespread and undimmed five years after the crisis, is not surprising. Financiers have always weighed in on the economic policy questions of the day. And it is in character for certain top Wall Street figures to believe they are smarter than the government employees who have the actual job of fighting unemployment.

Yet, to hear the Fed’s critics tell it, their antipathy toward the central bank is not motivated by a reflexive opposition to government intervention, but by a desire to end the big booms and busts that have hurt the economy in recent
decades.

Some of them have backed progressive causes, and assert that the Fed’s policies are widening the divide between the rich and poor. “It does seem that in spite of all the rhetoric you hear, it is not stopping the polarization of wealth,” Mr. Gundlach said.

The Fed’s critics have gotten some of their biggest predictions wrong. The central bank’s stimulus did not create inflation or debase the dollar. The Fed’s supporters on Wall Street credit it with taking bold actions after the crisis that, they say, averted a terrible slump that would have made life far harder for people on lower incomes. The Fed itself has acknowledged that its easy money policies have costs as well as benefits. Fed officials have made it clear that they are on the lookout for new dangers like excessive speculation in the markets.  “I believe I am a sensible central banker and these are unusual times,” Ms. Yellen said in Congress this month.

Still, the detractors say that the Fed has learned little, and seems doomed to commit the same mistakes as in the past 30 years.  “My guess is that the Fed will play its usual game till we’re in good old-fashioned bubble territory,” said Jeremy Grantham, co-founder of GMO, an investment firm. He took umbrage at Ms. Yellen’s recent arguments in Congress for why the stock market is not particularly overvalued. “Either she is ignorant about the markets,” he said, “or on the other hand she is cynical and she is manipulating the market.”

One theory unites the faultfinders — and it conveniently allows them to keep issuing warnings even as the economy shows signs of strength. The critics contend the Fed’s near-zero interest rates and huge bond-buying programs have acted a lot like steroids, creating an artificial recovery that could wane as the Fed removes the stimulus. “This is the drug that masks the symptoms rather than treats the disease,” said Todd Harrison, a former hedge fund manager and the chief executive of Minyanville, an online financial media company.

One reason that low interest rates cannot create a lasting recovery, the critics said, is that cheap borrowing costs do very little when so many people are already heavily indebted. In this climate, according to the Fed’s opponents, it is wrongheaded, and perhaps futile, for the central bank to encourage people to take out more loans.

“Trying to solve an indebtedness problem by getting further into debt only compounds the problems,” said Lacy H. Hunt, chief economist of Hoisington Investment Management. “You have to clear the debt.”

Many of the Fed bashers promote alternative policies that can sound harsh.  They argue that the economy would have bounced back more robustly since the financial crisis if the central bank had done less, because, they assert, capitalism works best when it is allowed to purge itself of uneconomic activity. “The economy might have snapped back a lot more strongly,” Mr. Grantham said. By intervening less, he added, the Fed “would have broken the back of moral hazard, just as Volcker did when he broke inflation,” referring to Paul A. Volcker, a former Fed chairman who pursued tough policies in the 1980s.

Though there are many Fed baiters on Wall Street, most of the financial industry has a generally favorable view of the central bank. And the Fed’s supporters shudder when they hear their peers calling on it to do less.

The Fed’s sympathizers say that it would have risked a bigger banking collapse and a depression if it had not opened the floodgates after the crisis. Short of entirely changing the way in which the global banking system operates, which simply wasn’t going to happen, there was not much else the Fed could do to keep things afloat, they say.

“The Fed has been doing what it can to stabilize this inherently unstable system, but we are still left with the system,” Tony Crescenzi, a portfolio manager at Pimco, said. In addition, defenders of the Fed argue that its policies can foster the economic conditions that enable a lightening of the country’s debt load that is not dangerously jarring. Ray Dalio, founder of Bridgewater Associates, a hedge fund, calls this a “beautiful deleveraging.”

But James S. Chanos, of Kynikos Associates, a hedge fund, asserts that an important measurement of debt is actually higher than it was before the crisis. “That beautiful deleveraging has not happened,” he said. “We are more leveraged as a society than we were in 2007 at the onset of the financial crisis.”

The longer the Fed fuels borrowing, the worse things are becoming, the critics say. Mark Spitznagel, founder of Universa Investments, a hedge fund that profited during the 2008 crash, argues that by holding down interest rates, the Fed encourages companies to take up unhealthy habits, like borrowing to fund purchases of their own shares. “That’s outrageous behavior,” he said. “The Fed has entirely forced people to do this.”

It has come to the point where the Fed’s detractors wonder whether it has fallen victim to a school of thought that can only resort to easy money policies. “Sometimes you get a groupthink around a base assumption,” David Einhorn, president of Greenlight Capital, a hedge fund, said in 2012. “We’ve reached that point here with monetary policy.” Mr. Einhorn contends that the extremely low interest rates on savings are actually depriving people of income that could substantially bolster the wider economy.

The Fed’s supporters roll their eyes when Wall Street rushes to the defense of savers. Such remarks, they say, stem from ignorance about how the economy works during periods of adjustment. Mike Konczal, a fellow at the Roosevelt Institute, points out that John Maynard Keynes noted during the Great Depression that financiers expected unrealistically high returns on their capital. Testifying in Congress this month, Ms. Yellen herself said, “The rate of the return savers can expect really depends on the health of the economy.”

Still, many of the critics expect they will be proved right when, as they predict,
the Fed’s policies lose their power. When that happens, a big loss of confidence will occur, which will roil the markets and the economy, they forecast. “They’ve gotten themselves boxed into a corner,” Mr. Gundlach said.

Mr. Grantham said that he thought the Fed’s largess would drive stocks so high that they will become vulnerable to even the slightest nudge.
“We all feel like old-fashioned gramophone records,” he said. “It is the same
old game and we keep saying the same old things.”