Money Does Grow on Trees! The Fed Goes to 0%.
In the past two weeks the Fed made a remarkable policy decision by moving the federal funds rate to zero, and the market made a remarkable move to push the U.S. treasury yield on a 4 week note below 0%. These stories are an important fear indicator. The Fed has taken the position that they are willing to flood the market with dollars. With not even a whisper of inflation the policy is to literally give money away for free. But instead of throwing money out the backs of armored cars, banks and a broad range of investors are giving it back by buying short term treasuries at a loss, saying thanks, but no thanks, the market risk just isn't worth it.
The treasury yield story is history in the making. Both the Times and the Wall Street Journal have various economists weighing in, both suggesting that this has not happened since the Great Depression. The interesting nuance now is we supposedly have safety measures in place that would curb the kind of risk one assumed when keeping cash in a simple bank account during the Great Depression. This treasury yield signals that a bank/investor/hedge fund would rather give
their money to the federal government for safe keeping rather than holding it in cash. There is so little faith in the U.S. Banking system in the year 2008 that there are people making rational choices to have the Federal Government hold onto their money, at a loss, for the protection from a financial collapse over the next 4 weeks. If this all sounds very grim, it is because there is no
other rational explanation. Many of the articles site the fear of other riskier options like the broader stock market that have driven higher demand for these safe treasuries, but such a mounting demand that it actually pushed the yield negative is shocking.
The story on the federal funds rate seems to be a last stand, it is the Fed’s Alamo. What more can the Fed do to try to spur lending again? They have literally left the vault open and no one has shown up to take the money. There have been some early reports that this, along with moves by other major central banks to cut their benchmark rates, have helped curb some investor fears, but these are unchartered waters and no one really knows how long it will take for credit to flow again.
This all circles back to the uncertainty in the real estate market. I see the majority of lending in the U.S. as a house of cards with real estate as the base. Most loans are secured on a real estate asset. Small - medium businesses rely on the real estate market to leverage capital improvements and individuals rely on their real estate stability to access credit and build wealth. We are in a time where no one is really sure when the real estate trough will be. As a result, the base of the house of cards has collapsed. No one wants to take on additional risk lending or borrowing when the value of the securitizing is completely unknown. It creates the circumstance we see today, the Fed can offer money for free but with lenders and borrowers sitting on the sidelines there seems to be little interest to be the first one back into the pool.
These two stories indicate that the recession still has a way to go to find its bottom. Even with the fund rate at 0% and the Fed pumping dollars into banks to sure up their balance sheets (See "Throw in the Kitchen Sink" for a description of all government infusion programs) lending continues to be sluggish and the market seems extremely risk adverse overall.
Because every story has a silver lining, these two represent a unique advantage to the President elect. The government now essentially has zero cost to capital. Even the 10 year treasury is at an all time low, settling just over 2% today. With such inexpensive borrowing this is an excellent time to make the kind of infrastructure investments Barack Obama has suggested. This approach will indirectly stabilize the housing market by putting dollars directly into the hands of consumers and our nations infrastructure will get a much needed face lift at the lowest possible cost. Maybe a massive government driven stimulus is exactly what this free market needs to get back on track.