The Fed Creates Another Moral Hazard and Ends Free
Markets
By the Curmudgeon with
Victor Sperandeo
Introduction:
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.
..
Under
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.
Other Voices:
James Dorn of the Cato Institute
wrote:
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.
Finally, Robert J. Samuelson wrote in the Washington Post:
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.
Curmudgeon's
Comments:
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.
.........................................................................
.
Victors Comments:
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.
..
End Quote:
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
...
The Curmudgeon
ajwdct@gmail.com
Follow
the Curmudgeon on Twitter @ajwdct247
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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