Desperation is like stealing from the Mafia: You stand a good chance of attracting the wrong attention.
-- Douglas Horton
In November of 2010, Ben Bernanke shocked the world with an unprecedented editorial in the Washington Post
(November 4, 2010). In it, he presented the “virtuous” case for an extended period of quantitative easing (emphasis mine):
“This approach [QE] eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
I remember reading this paragraph over and over again that morning, wondering if I was misinterpreting its message. But there was no mistake about it: For the first time in history, a Fed Chairman was openly admitting to pursuing a policy to pump up the stock market. By itself this would be shocking, but Bernanke was not stopping there. Following the largest housing bubble and collapse in US history which was in large part predicated on the easy monetary policy of his predecessor, Bernanke was essentially advocating the creation of another bubble in housing through lower mortgage rates.
So as of November 2010, we have had explicit Fed policy to re-create the twin bubbles of the late 1990s and mid 2000s in the stock market and housing market. The justification for this policy, of course, was a “virtuous” wealth effect that would “promote economic growth” for all to benefit from. Fast-forward three years and what do we have to show for a Fed funds rate still at 0% and a Fed balance approaching $4 trillion?
The Fed has largely succeeded in pumping up the stock market, with the Russell 2000
(NYSEARCA:IWM) at an all-time high, up over 57% since the Bernanke op-ed.
The housing market has also improved, but far less so than the stock market, with the S&P/Case-Shiller 20-City Index Home Price Index up 12% since the Bernanke op-ed but still 21% below its 2006 peak. In recent months, as rates have risen sharply (rates are higher today than at the time of the Bernanke writing), there have been some signs of slowdown. A price ratio of homebuilder stocks relative to the S&P (ITB:SPY) (NYSEARCA:ITB) (NYSEARCA:SPY) illustrates this slowdown, declining since May and below the QE3 announcement last September. As a reminder, a rising price ratio means the numerator/ITB is outperforming (up more/down less) the denominator/SPY.
As for the virtuous “wealth effect” leading to economic growth, well, you be the judge. Year-over-year real GDP is running at 1.6%, a level more typically associated with the beginning of a recession rather than four years into an expansion (see the first chart below). Real median household income tells a similar story, up less than 1% from the Bernanke op-ed and still well below levels over 13 years ago (see the second chart below).
Source: Doug Short
Source: Doug Short
What's the bottom line of all this?
In 2010, we were told by Chairman Bernanke that QE would spur a “virtuous circle” where higher stock and housing prices would lead to increased spending and economic growth. The evidence since then has supported only one-third of this circle: significantly higher stock prices. This, of course, has disproportionately helped the wealthy, who own the vast majority of financial assets. Bizarro Robin Hood is causing the wealth gap to widen to extremes, leaving many disenchanted by stock market gains.
While the housing market has improved from historically depressed levels, it remains over 20% below its 2006 peak, and there have been signs recently of a renewed slowdown. Also, in spite of unprecedented buying of mortgage bonds by the Fed, mortgage rates stand higher today than in November of 2010.
As for the real economy, growth remains anemic and the average household (real median income) is still faring worse today than at the supposed end of the last recession. As Stan Druckenmiller said on CNBC in September after the Fed’s no taper decision, "This is fantastic for every rich person. This is the biggest redistribution of wealth from the middle class and the poor to the rich ever."
Perhaps this is the Chairman’s definition of virtuous.
No positions in stocks mentioned.
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