The Fed Creates Another Moral Hazard and Ends Free Markets
By the Curmudgeon with Victor Sperandeo
Our U.S. tax dollars pay for critical services to maintain and improve our roads, schools, fire and police departments, subsidized healthcare and more. At this desperate time of need during the pandemic, our tax dollars should be supporting small businesses, unemployed workers, and families in need of financial assistance. NOT large corporations, especially those that have used up their "rainy day" reserves by buying back their own stock OR by moving their official headquarters overseas to reduce or evade U.S. corporate income taxes.
Sadly, the U.S. Federal Reserve Board did not get that message. It is buying billions of dollars of bonds of large corporations (most of which used profits to buyback stock) and High Yield Bond ETFs, while permitting tax dodging corporate inverters [1.] to receive financial aid if requested. Evidently, no lessons were learned from the 2008-2009 financial crisis. If thats shocking, read on.
The Feds corporate credit facilities are twofold: the primary market facility, which officially launched June 29th, allows the Fed to purchase bonds directly issued by large companies that apply for certification. The secondary market facility purchases already-issued bonds that fall within the index and are trading in the secondary market. The Fed has said that even as financial markets have healed significantly since March, the facilities should still be in place in case financial conditions deteriorate.
The Fed's Corporate Bond Buying Binge:
From June 1st through mid-June, the Fed bought $428 million in bonds of individual companies, making investments in household names like Microsoft, Visa, Home Depot, Walmart and AT&T as well as in major oil firms, tobacco giant Philip Morris International Inc, and a utility subsidiary of billionaire Warren Buffetts Berkshire Hathaway holding company.
According to Reuters, the largest Fed purchases were of bonds issued by AT&T and the United Health Group, with the Fed buying around $16.4 million of bonds from each of those two companies.
The Fed also bought $5.3 billion in 16 corporate bond exchange traded funds, including a newly added sixth high yield ETF.
The initial round of purchases included some 86 issuers, all bought on the secondary market. Yet that is just a drop in the bucket for the Fed, which has said that more than 790 bond issuers were eligible for purchase.
The new Fed bond buying stated purpose is to ensure companies can continue to finance themselves, and not be forced out of business due to problems raising cash during a pandemic. The program is backed by investment capital from the U.S. Treasury to absorb any losses should corporations default.
Moral Hazard Resurfaces in Spades:
I do think its moral hazard, said Kathy Jones, Director of Fixed Income at Charles Schwab. I think its something theyre going to have to deal with when things settle down. There will be accusations that they committed money in ways that didnt make sense and didnt help the average Joe, she added.
CNBC reports that Goldman Sachs sees the potential for moral hazard plus two other issues: misallocation of capital and a diminishing appearance of independence for the Fed.
William Slaughter, senior portfolio manager at Northwest Passage Capital Advisors, tweeted: It is exceedingly hard to fathom what public interest the Fed is serving by buying bonds of [Apple], [Microsoft] and [Oracle]." Pointing to the foreign automakers that came in near the top of the index, Slaughter asked, should the Fed really make it easier to lease your next Porsche? (The luxury car company is owned by Volkswagen.)
Aaron Klein, policy director of the Center on Regulation and Markets at the Brookings Institution, told the Washington Post that its unclear why the central banks bond buying extends to companies that werent as vulnerable to national shutdowns such as shuttered hotels, casinos and retail stores.
Why is the solution buying Apple, Microsoft and Comcast debt? Or eBay or Google? Is the problem in America that the holders of Apple stock need more help? Is the problem that investors in Google debt are likely to suffer catastrophic and unexpected losses from the covid shutdown? he said.
Some of the above expressed concerns are by now very well known. They were voiced during the Feds last aggressive foray into the markets during the 2008-2009 financial crisis.
-->Yet the beat goes on... .
Corporate Inversions Qualify for Fed Aid:
For many years, a "tax inversion" loophole has allowed large multinational corporations to do a paper shift of their official citizenship (i.e. Corporate home) from the United States to a low-tax foreign country jurisdiction, while keeping their executives and headquarters right here in U.S. Astonishingly, these corporations, which have skirted their U.S. tax obligations for years, may still qualify for federal assistance under the CARES Act.
In an article titled Firms That Left U.S. for Tax Reasons Could Qualify for Feds Aid, Bloomberg's Laura Davison wrote:
American companies that moved their official headquarters offshore to avoid U.S. taxes could qualify for coronavirus aid from the Federal Reserve, tax lawyers say, raising new questions about which firms should get access to public money.
Under guidelines published by the Fed, companies that engaged in so-called corporate inversion [1.] transactions while maintaining meaningful U.S. operations appear to be eligible for two new programs designed to provide credit to large employers by purchasing new or outstanding corporate bonds.
Note 1. Corporate inversions permit multinational corporations, whose executives still run and operate the corporation in the U.S., to avoid paying their fair share of taxes here at home by making it look like their huge profits are being earned offshore. See Curmudgeons Opinion below for more on this fiasco.
no circumstance should a company that has moved overseas to avoid U.S. taxes
get a bailout, said Senator Ron Wyden of Oregon, the top Democrat on the
Senate Finance Committee. The Fed is kicking dirt in the face of American
workers with this move, he added.
New Bill Aims to Prevent CARES Act Aid to Corporate Invertors:
For years, inversion loopholes have allowed American companies to evade their tax obligations. These companies, which have schemed their way out of paying U.S. taxes, should not get a dime of American taxpayer funded CARES Act financial relief, said Senator Dick Durbin (D-IL).
These multinational corporationsthat (effectively) renounced their American citizenshipwant to be treated as foreign when it comes time to pay for our national security and vital public services upon which they rely, but claim they are as American as apple pie when it comes time to line up for a handout paid for by the American households actually suffering, said U.S. Representative Lloyd Doggett (D-TX-35).
On June 24th, Senator Durman and Congressman Dogget introduced the American Assistance for American Companies ActΈ a bill to ensure that inverted corporations cannot benefit from federal COVID-19 financial assistance under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Although the Fed's intent is to provide temporary liquidity to large U.S. firms, the promise of supporting corporate bond prices and making loans to highly leveraged companies undermines corrective market forces: real markets are supplanted by pseudo markets in which the central bank will be subsidizing distressed companies and politicizing the allocation of capital.
The Fed's financing of those purchases will further expand its balance sheet and make it difficult to exit the corporate debt market without creating additional financial turmoil. Those who value private, free markets recognize that the Fed's promise to revitalize corporate debt markets is, in reality, a step toward market socialism.
Ray Dalio of Bridgewater Associates (the world's largest hedge fund with $138 billion in assets) told Bloomberg in a video interview:
The capital markets are not free markets allocating resources in the traditional ways. There are markets that are driven by central banks not only their actions but their desire to be an owner of those assets. Their priorities about that ownership when they buy and when they sell are not the same as the classic free-market allocations. And as a result, the capital markets are not free.
Tax avoidance schemes have hurt Uncle Sams bottom line for years. Let us not add insult to injury by allowing hardworking Americans tax dollars to go to unpatriotic inverted companies. Public Citizen urges Congress to quickly pass this legislation and include these limitations in upcoming pandemic aid packages.
To repeat: The national debt is out of control. This raises many dangers, including a run against the dollar. Investors, traders, multinational firms, insurance companies and pensions lose confidence in the dollar as a medium of exchange or a store of value. There is no law of nature prohibiting massive selling of dollars, which would trigger instability of interest rates, exchange rates, commodities, stocks and bonds.
Please refer to Victors Comments below for Fed financing of U.S. debt.
The Feds corporate bond buying not only is a moral hazard, but it has destroyed free markets as Ray Dalio so eloquently notes above.
With respect to the Fed lending to corporate inverters, readers should note that multinational corporations have already realized huge tax advantages by shifting their operations and profits offshore. That is because the 2017 GOP tax bill slashed the tax rate on U.S. corporate profits earned offshore to approximately 10.5 percent, half the 21 percent tax rate on profits earned in the U.S. And that 21 percent domestic rate was far below the 35 percent rate corporations paid before the GOP tax bill (which GREATLY raised personal income taxes for those living in high tax states, like CA where the Curmudgeon lives).
Corporations who do not pay their fair share of taxes in America should not get bailed out by U.S. taxpayers.
I have discussed the negative effects of what the Fed does in these Curmudgeon blog posts for years. Here is my latest assessment, but first a bit of history.
When the Federal Reserve act was passed, surreptitiously on the day before Christmas Eve, December 23, 1913, it was blatantly an unconstitutional law (see Article 1 Section 8 and 9 of the U.S. Constitution). Yet no one complained, except for a few Congressman at the time (e.g. Charles A Lindbergh), because the Fed served the wealthy and those in power.
In the early 1930s, Congressman Louis T McFadden (who was Chairman of the House Banking and Currency Committee for 12 years) attacked and exposed this wicked enterprise. For example:
We have, in this country, one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board. This evil institution has impoverished the people of the United States and has practically bankrupted our government. It has done this through the corrupt practices of the moneyed vultures who control it.
Current Fed Assessment (Victor):
The Fed is loved by the wealthy and political power brokers for obvious reasons rounds of money creation (QE and now corporate bond buying) which have propped up financial markets (risk is now a thing of the past) such that the rich become ever richer!
Far worse than a moral hazard, the Feds asset buying allows the system to perpetuate itself until it blows up! Thereby, it helps the rich immensely until it likely destroys the nation in one fell swoop.
Ever increasing U.S. budget deficits and national debt would not be possible without Fed intervention in fixed income markets.
Fed buying of U.S. government debt (since 2008) has enabled humungous U.S. government deficits to be financed without crowding out corporate debt issuers, whose debt the Fed is now buying. The Congressional Budget Office (CBO) has predicted that the COVID-19 pandemic would raise the FY 2021 deficit to $2.1 trillion. The FY 2020 deficit will be $3.7 trillion, according to the CBO that says the U.S. national debt will reach 108% of U.S. GDP by the end of 2021.
-->Does anyone think that this Ponzi scheme of U.S. deficit financing by the Fed is sustainable? See above remarks by Robert J. Samuelson.
Is the U.S. Constitution Still the Law of the Land? (Victor and the Curmudgeon):
The end of the U.S. (as it was founded in 1787) can best be understood by our recent Presidents trashing of the U.S. constitution.
1. In November 2005, President George W. Bush met with Republican Congressional leaders to talk about renewing the controversial USA Patriot Act. Bush said: I dont give a goddamn, Im the President and the Commander-in-Chief. Do it my way.
Mr. President, one aide in the meeting said. There is a valid case that the provisions in this law undermine the Constitution.
Stop throwing the Constitution in my face, Bush screamed back. Its just a goddamned piece of paper!
2. In a Cato Institute commentary, Ilya Shapiro wrote that Obama consistently violated the Constitution during his Presidency: The 44th presidents sees himself as professionally above the law, ignoring the executive branchs legal limits and disrespecting constitutional bounds like federalism and the separation of powers.
3. This June, former Secretary of State Colin Powell told CNN's Jake Tapper: "We have a Constitution. And we have to follow that Constitution. And President Trump has drifted away from it.
-->We thought the U.S. Constitution was the law of land that men died for. If our Presidents ignore or violate it, the future for the U.S. is quite gloomy.
The decline of the U.S. can best be summarized by a founding father (a member of the convention that drew up the U.S. Constitution in 1787.
No people will tamely surrender their Liberties, nor can any be easily subdued, when knowledge is diffused, and virtue is preserved. On the Contrary, when People are universally ignorant, and debauched in their Manners, they will sink under their own weight without the Aid of foreign Invaders.
Samuel Adams U.S. Founding Father
Be well, stay safe, good luck and till next time ...
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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