Thread by @gladstein

1/ I recently finished "The Lords of Easy Money," a superb new book from @CLeonardNews on how over the last three decades the @FederalReserve financially engineered a system of cheap borrowing and inflated asset prices with shocking consequences 💵 🧵

simonandschuster.com/books/The-Lord…

2/ Many people don't believe the Fed has much power over society, saying for example, they just "follow the market."

This book gives strong evidence to the contrary, showing how Fed decisions shaped the American economy--and American society more broadly--to a significant degree

3/ The book focuses on quantitative easing, showing how the Fed used QE post-GFC to basically take away savings accounts of banks by buying up tons of 10-year Treasuries, removing "safe" assets and forcing the economy farther out on the yield curve into riskier investments.

4/ "Long-term debt was Wall Street's equivalent of a savings account," Leonard writes.

"It was the safe place where investors tied up their money to earn a dependable return. With quantitative easing, the Fed would take that savings account away."

5/ Zooming out, the book looks at who laid the groundwork for the QE era:

Alan Greenspan, who as Fed chair chose to deal with a recession at the beginning of the 1990s by lowering interest rates.

Of key importance to Greenspan's strategy was "Fedspeak"

6/ Fedspeak "accelerated the long process that removed the politics of money from the center of American public life" -- by talking in highly-technical terms with a lot of word salad jargon, Greenspan helped move monetary policy out of the public conversation.

7/ The mechanics behind Fedspeak were simple:

Fight price inflation instead of asset inflation.

By 1998, Leonard writes, US asset inflation was out of control.

But this didn't raise much public concern.

People didn't call it inflation, they called it a boom.

8/ Share prices rose "at a level that would have been horrifying if expressed in the price of butter or gasoline"

The S&P rose by 19.5% in 1999.

NASDAQ jumped more than 80%.

The financial press "covered the activity in these markets in the way ESPN covered sports"

9/ What was less prominently discussed, of course, "was the relationship between these stock prices and the increase supply of money that the Federal Reserve was pumping into the banking system"

10/ In July 1998, the market panicked at bearish comments from Greenspan (who said stocks might be "unsustainably high") resulting in an 18% crash in the stock market.

In response, the Fed cut rates from 5.5% to 4.8%

11/ In 1999, shares in Qualcomm rose by 2,600%, boosted by "an enormous amount of relatively low-cost capital"

When signs of price inflation started to emerge later that year, Greenspan warned that more action was needed.

The Fed raised rates all the way to to 6.5%

12/ This, Leonard writes, "was the equivalent of hitting the emergency brakes on a subway train"

Tech stocks soon cratered.

$1.76 trillion of value was wiped out from 280 Internet stocks between March and November 2000.

13/ The Fed "played a decisive role in creating and then destroying the multitrillion-dollar bubble. But when the market crashed, bankers, traders, and politicians turned to the Fed for help. The disaster only seemed to enhance Greenspan's reputation as a financial rescue artist"

14/ Greenspan's actions around the dot-com bubble set the stage for Fed policy moving forward:

-Control price inflation
-Ignore asset inflation
-Step in and bail out the system when asset prices collapsed

15/ Fast-forward to 2007.

"For roughly six years, the American financial system arranged itself around the central, nourishing flow of cheap money...

When the Fed raised rates throughout 2006 and 2007, the effects rippled outward through the economic system and shook it apart"

16/ During the GFC "the average housing price fell by 10% in a year, a wrenching downward correction for middle-class wealth.

By the start of 2009, housing prices had fallen by 20% overall.

In two short years, Americans lost about $10 trillion in wealth."

17/ "The stock market," Leonard writes, "crashed in late 2008 when the banking wreckage became obvious, wiping out about $8 trillion in wealth over two years.

It was the worst economic downturn since the Great Depression."

18/ The Obama White House pushed a rescue package that added up to $862 billion, but this was "dwarfed by the Federal Reserve's actions...

The Fed had printed and disbursed more than $1 trillion while Congress was still arguing over the language of the stimulus bill."

19/ The fed bailed out the world, opening "swap lines" with foreign central banks, trading newly created dollars for foreign currency at a discount rate.

In 2008 the Fed also bailed out US banks and began QE, buying $600 billion of bonds from banks.

20/ The legacy of Fedspeak remained, as Fed actions were labeled with a "wild menagerie of incomprehensible acronyms"

TAF, TSLF, PDCF

In simple terms: the Fed created an unprecedented amount of "new dollars on Wall Street through the accounts of a small club of primary dealers"

21/ "Between 1960 and 2007, the Fed increased the monetary base by $788 billion.

During the bailouts of 2008, the Fed printed nearly $875 billion"

The monetary base was more than doubled in a matter of months.

22/ These actions, however, were hidden by the mainstream media.

QE and 0% interest rates were "the most important economic policy of the decade," Leonard writes, "while also being one of the least discussed"

23/ Analysis of 300,000 news stories between 2007 and 2011 later showed that the Fed's policies "barely made the news"

Obama was the lead in 8% of stories, while Fed chair Bernanke was the lead in just 0.13%

24/ Leonard points out something very interesting here, that the Fed (by their own admission in internal FOMC debates) *was trying* to devalue the dollar, but since the critics all cried hyperinflation, which never happened, this ended up dampening criticism of their actions.

25/ QE had a big impact on the economy because, as Leonard writes, "the primary dealers were not just selling the Treasury bills and mortgage bonds that they happened to have on hand" -- instead there was a conveyor belt which used the primary dealers as middlemen.

26/ During QE hedge funds would borrow money, buy Treasuries, and sell them via a primary dealer to the Fed.

"This way the hedge funds could borrow and buy billions of dollars in bonds, and sell them to the Fed for a profit."

27/ "Once the conveyor belt was up and running," Leonard writes, "it began magically transforming bonds into cash. The cash didn't stay safe and sound inside the reserve accounts of primary dealers. It started flowing out into the banking system, looking for a place to live."

28/ With QE and ZIRP, the Fed "was essentially coercing hedge funds, banks, and private equity firms to create debt and do it in riskier ways... The primary goal was to make sure the long-term benefit of saving money was lower with each passing month."

29/ The Fed achieved this by buying 10-year Treasuries, not just short-term bills.

This was "like closing the one safe deposit box where Wall Street could stash money"

Pre-2007, the reward for saving into a 10-year Treasury was 5%. By late 2011, the reward was just 2%.

30/ "The overall effect of ZIRP," Leonard writes, "was to create a tidal wave of cash and a frantic search for any new place to invest it...

The economists called this dynamic the search for yield, a once-obscure term that became central to describing the American economy"

31/ The people who had "real money, meaning billions of dollars, were set on the search for investments that yielded anything more than 0"

Now even pension funds, who would be fine if rates were at 4%, were "taking a hard look at fracking wells and luxury condo developments"

32/ QE and low rates "drove up the price for corporate bonds, stocks, real estate and even fine art."

"The asset price inflation was not an unintended consequence of QE," Leonard writes.

"It was the goal."

33/ As of 2012, "the richest 1% of Americans owned about 25% of all assets.

The bottom half of all Americans owned only 6.5% of all assets.

When the Fed stoked asset prices, it was helping a vanishingly small group of people at the top"

34/ Leonard points out that the people who benefited most from ZIRP didn't talk about it in public.

Those who know, don't show.

So the public conversation remained around the scepter of price inflation, which didn't happen, and largely ignored asset inflation.

35/ "By the summer of 2011, the value of excess cash reserves in the banking system reached $1.6 trillion, an increase of 96,000% from precrisis levels"

The sea of cheap debt led to a new phenomenon of companies buying back their own stock instead of investing in job creation.

36/ The Fed predicted that despite its policy, rates would reach normal levels of around 4.5% again by 2018.

"In reality, the Fed Funds rate stayed at 0.4% until the end of 2016. By the middle of 2018 the rate had only risen to less than 2%, or half the rate that was forecasted"

37/ Leonard explains that QE was presented as an emergency action which would "quickly boost growth and create jobs, and which could then be repealed so everything could return to normal"

But the truth is that the program, once employed, "was essentially never-ending"

38/ Whenever the Fed hinted they would buy fewer 10-year Treasuries, allowing the yields on those bills to rise, "the money started to move back over to the safe end of the seesaw, and away from the risky assets"

The result was a "Taper Tantrum" and a sudden decline in stocks.

39/ In a 2012 FOMC meeting, a Fed economist explained that ZIRP did three things:

-Made debt cheaper
-Stoked asset prices
-Devalued the dollar

Greenspan's legacy worked, as long as the public didn't notice any significant price inflation.

40/ Leonard spends a good deal of the book covering how ZIRP encouraged companies to borrow money for mergers or private equity takeovers, benefitting the people with access to capital, but not sparking innovation, creating new jobs, or giving pay raises to working people.

41/ Traditionally pension funds would shy away from leveraged loans because they were considered risky.

But in 2010 this changed when the Fed kept rates at 0 and pumped QE.

This hugely expanded the leveraged loan markets.

Traditionally "safe" investors were lured into CLOs.

42/ Junk debt "was sliced and split like cord wood and then stacked into a wide variety of funds that were sold to investors" ending up in offerings by companies like Credit Suisse with names like the High Yield Bond Fund or the Floating Rate High Income Fund

43/ "The rush to extend, package, and sell corporate debt," Leonard writes, "was unstoppable"

Non-financial corporate debt rose from $6 trillion at the end of 2010 to $10 trillion by 2019.

44/ The system "depended on the ability to roll over the debt at a decent price, before it expired and the full amount had to be paid off...

This worked fine, as long as the Fed helped to suppress interest rates and keep the financial system afloat on new money"

45/ For companies "the abundance of cheap debt, the rise in asset prices, and the desperate search for yield" meant financial, not product, engineering.

This was hugely profitable for executives.

Leonard profiles one CEO whose salary jumped from $2.5M in 2010 to $8.7M in 2012.

46/ Many more companies would go the way of stock buybacks, where they could meet the earnings-per-share target and enrich big stockholders "without doing things like winning new customers, innovating new products, or improving operations"

47/ Leonard explains how @McDonalds borrowed $21 billion between 2014 and 2019 to finance $35 billion in stock buybacks, paying out $19 billion in dividends, giving owners more than $50 billion during a period when the company earned only $31 billion in profit.

48/ The ZIRP legacy in sum:

"Banks that were too big to fail in 08 were now even bigger and even less able to fail. The top banks controlled far more of the nation's assets than they ever had controlled before, and the federal government seemed intent on keeping things that way"

49/ "Between 2007 and 2017, the Fed's balance sheet nearly quintupled, meaning it printed ~5x as many dollars as it printed in the first hundred years of its existence. All those dollars were forced into a zero-interest-rate world, where anybody was punished for saving money"

50/ During that same decade, households trying to save were penalized about $360 billion through lost earnings on interest rates, while pension funds and insurance companies lost about $270 billion, just as corporate borrowers got hundreds of billions in subsidies

51/ QE "was designed and initiated with the specific goal of inflating stock market prices.

The plan worked... The value of stocks rose steadily during the decade after 2010, in spite of the weak overall economic growth, the broad-based wage stagnation...

52/ "and the host of international financial problems that the Fed cited as justification for its interventions.

The value of the Dow Jones Industrial average rose by 77% between 2010 and 2016."

53/ Another characteristic of the post-GFC era were negative interest rates, which essentially didn't exist before 2012.

Shockingly, by 2016, 29% of all global debt carried negative interest rates, about $7 trillion worth.

54/ Asset inflation, savings-punishing tactics, and emergency bailouts became the norm.

When the Fed injected $400 billion into the banking system during the 2019 repo crisis, it was reported on as a "matter of normal maintenance"

55/ A few months later, during the March 2020 financial crisis, Powell's Fed "would do virtually everything that Ben Bernanke's had done in 2008 and 2009, but this time in one weekend, rather than over several months"

Back to aggressive ZIRP, swap lines, QE, and SPVs

56/ SPVs allowed the Fed to buy corporate debt.

"People who traded stocks assumed that the Fed would step in with a rescue package if the stock market ever crashed," Leonard writes.

"Now people who traded corporate bonds and leveraged loans would have the same assurance"

57/ "Now that the Fed had stepped in and become a major buyer of corporate debt, providing a floor for the market, it changed the very nature of interest rates on the debt...

Every time the Fed intervened, its future intervention was assumed"

58/ Leonard also describes a "wildly experimental" program that would allow the Fed to buy the debt of midsize businesses that were too small to get leveraged loans or corporate bonds: the Main Street Lending Program.

59/ In about 90 days, the Fed created $3 trillion, "as much money as the Fed would have printed in roughly 300 years at its normal pace, before the 2008 financial crisis"

And yet, there was "virtually no public opposition to the Fed's actions"

60/ The Fed started a program to buy junk debt, known as "fallen angels" -- as well as big chunks of risky CLO debt.

All of this was "cloaked in language that was obtuse and incomprehensible" like the SMCCF and the TALF

61/ Leonard sites one analyst as saying "fundamentally, we have now socialized credit risk. And we have forever changed the nature of how our economy functions...

The Fed has made it clear that prudent investing will not be tolerated."

62/ Leonard argues that while some of the Fed's programs, like the Main Street Lending Program, weren't used much, the "real bailout" was for people who owned assets.

For example, stock owners were "made entirely whole within about nine months of the pandemic crash"

63/ The bailout of 2020, Leonard writes, was "the largest expenditure of American public resources since World War II" and "solidified and entrenched an economic regime that had been quietly and steadily constructed, largely by the Fed, during the previous decade."

64/ The bailout "went to large corporations that used borrowed money to buy out their competitors; it went to the very richest of Americans who owned the vast majority of assets; it went to the riskiest of financial speculators on Wall Street; it went to the very largest banks"

65/ Under the regime that Greenspan created, the middle 20% of American households saw their median net worth rise by only 4% between 1989 and 2016.

During the same period, the net worth of the top 20% more than doubled and the top 1% nearly tripled.

66/ At the same time we saw the rise of American zombie companies, whose profits weren't enough to cover loan costs and could only survive by rolling debt perpetually.

During 2020 nearly 200 major publicly-traded companies became zombies, including Boeing, ExxonMobil, and Macy's

67/ Leonard highlights the disconnect between politics and financial markets by noting that the day after the January 6th, 2020 riots, the Dow Jones Industrial Average jumped by 1.4%, closing at a record high.

68/ Looking back average real GDP growth rose at an average of 3.8% in the 90s, and only 2.3% during the ZIRP decade. Real median weekly earnings for wage employees rose by 0.7% in the 90s, and only .26% during ZIRP.

But the stock market more than doubled in the ZIRP era.

69/ Leonard concludes with the choices that face the Fed today:

Let the risky structures built on leveraged loans, stocks, and CLOs fall... or intervene with more QE and emergency programs.

70/ The likely scenario that the Fed will continue to provide life-support to a levered-up, financialized economy is the outcome of decades of easy money policies that Leonard describes in his book.

I would definitely recommend a full read!

simonandschuster.com/books/The-Lord…