The Trickle-Up Bailout

It’s early days, but the Federal Reserve “bazooka” has mostly impacted the 1%

Take a look at some contrasting sets of headlines. First, from planet earth:

Weekly Jobless Claims Hit 5.425 Million, Raising Monthly Loss To 22 Million Due To Coronavirus (CNBC)

Worst Case Fears Of 20%-Plus U.S. Jobless Rate Are Now Realistic (Bloomberg)

Then from Wall Street:

Private Equity-Owned Companies Sell New Bonds in Credit Rally (Bloomberg Law)

Fed’s Historic Move Spurs Rally in Junk Bonds: 6 ETF Picks (Nasdaq.com)

As we head into the second month of pandemic lockdown, two parallel narratives are developing about the financial rescue. 

In one, ordinary people receive aid through programs that are piecemeal, complex, and riddled with conditions.

A law freezing evictions applies to holders of government-backed mortgages only. “Disaster grants” are coming more slowly and in smaller amounts than expected; small businesses were disappointed to learn from the SBA early last week that aid would be limited to $1000 per employee. 

A one-time “economic impact payment,” reportedly delayed so recipients could experience the thrilling visual of Donald Trump’s name on the check, might help make half a rent payment. Unemployment insurance amounts have been raised, so tip and gig workers can now be ineligible for $600 a week more than before! The cost of a coronavirus test might be free, but you test positive, you could up paying $50,000 or more in hospital costs even with insurance. And so on. 

Meanwhile, “relief” programs aimed at the top income levels were immediate, staggering in size and scope, and often appeared as grants rather than loans. One of the biggest layouts of the Covid-19 rescue was a political carrying charge that members of congress extracted just to get the larger bailout out the door – a pre-bailout bailout, if you will.

Although the $2 trillion coronavirus rescue was approved unanimously, a set of tax breaks was stuck in by Republicans, in the original version of the CARES Act put forward by Mitch McConnell.

When Donald Trump signed his whopper Tax Cuts and Jobs Act two years ago, the bill contained clauses to offset the loss of revenue that would entail from shaving down the top individual tax rate relatively a little (from 39.6% to 37%) and slashing the corporate tax rate a lot (from 35% all the way down to 21%). 

One of those changes limited the amount of losses that could be used to offset taxable income in any given year. Another limited the amount of losses from so-called “pass-through” businesses (i.e. businesses that don’t pay corporate taxes) that wealthy individuals could use to offset taxable income. These provisions particularly impacted real estate developers (!), hedge fund managers, and other high net worth individuals with volatile revenue profiles. 

The second provision only affected people making at least $250,000, or couples earning at least $500,000.

The CARES Act sought to wipe out or alter both provisions. Republicans also tried to include tax relief for multinationals who offshore profits, but that provision was stripped out in favor of these first two loopholes, seemingly reflecting their importance to the caucus. 

As Steve Wamhoff of the Institute on Taxation and Economic Policy points out, the changes on the use of “pass-through” losses only benefit a select group. “It has to be stressed that this exclusively helps wealthy people,” Wamhoff says. “It only has an impact on people already making over $250,000.”

Because the CARES Act was rushed to the floor, members didn’t have all of the information they might have wanted before the vote. After the bill passed, Democratic staffers sent these tax provisions in the CARES Act, sections 2303 and 2304, to the Joint Committee on Taxation, to be scored. They were stunned to learn they would cost $195 billion over ten years.

In other words, what seemed like a run-of-the-mill offhand legislative pork provision ended up dwarfing the airline bailout and other main parts of the bill.

 “The cost of caring for this small slice of the wealthiest one percent is greater than the CARES Act funded for all hospitals in America,” says Texas Democrat Lloyd Doggett. “It’s greater than CARES provided for all state and local governments.”

The JCT analysis found that 80% of the benefit of the bill went to just 43,000 taxpayers each earning over $1 million a year. The average tax break for those 43,000 individuals was $1.6 million, an interesting number when one considers the loudness of the controversy over $1,200 relief checks for everyone else.

Doggett joined Rhode Island Senator Sheldon Whitehouse in sending a letter to the Trump administration, demanding to know the provenance of these tax breaks. “This irresponsible provision must be repealed,” he says. It’s possible we’ll find out someday whose idea it was to insert those breaks. By then, however, other windfalls from the Covid-19 rescue might have rendered the $195 billion bailout appetizer quaint.

With the Fed’s announcement on April 9th of a $2.3 trillion program that includes purchases of junk bonds, the toolkit for support of the financial economy now encompasses nearly every conceivable official response apart from subsidy of stock markets. The sheer quantity of money raining down on the finance sector appears transformational, a “joyful noise” heard around the world. 

“POW!#* @  BAM&$# SMASH! @#$% KABOOM*#!@?% That’s the sound of the Fed’s big bazooka,” reads Forbes in a typical financial news report. 

The Fed deployed many of the bailout tools it used in response to the 2008 crisis at the end of March. These were radical enough, but still confined to the finance version of safe sex: buying investment grade debt, U.S. treasuries, government-backed mortgages, etc. 

On April 9th, the Fed took a walk on the wild side, announcing a spate of new facilities that dramatically expand its footprint in the economy.

Some programs are less controversial, like a Municipal Liquidity Facility providing aid to states and localities.

Others however steer money to “fallen angel”companies with declining credit ratings, longshot problem horses at the global racetrack. As a Wall Street Journal editorial put it in awed tones, “the Fed will in effect buy the worst shopping malls in the country and some of the most indebted companies.”

The WSJ went on to dissect the logic of the bailout (emphasis mine):

The Fed may feel all of this is essential to protect the financial system’s plumbing and reduce systemic risk until the virus crisis passes, but make no mistake that the Fed is protecting Wall Street first. The goal seems to be to lift asset prices, as the Fed did after the financial panic, and hope that the wealth effect filters down to the rest of the economy.

The coronavirus rescue is a “trickle-down” plan. Many of the Fed programs don’t appear even secondarily concerned with maintaining employment. The basic idea instead has been to hurl money at “assets,” underscoring the bizarre dualistic nature of this rescue.

If the ordinary person during the crisis dreams of being relieved from market stresses like housing and medical costs, only to receive (at best) one $1200 check, it’s Wall Street actors who are seeing the tyranny of markets fundamentally overthrown, replaced by a giant financial happy face called the Federal Reserve that appears to want to simulate real buying and selling, only with the downside removed. Party on, Wayne!

As Marcus Stanley of Americans for Financial Reform puts it, “the Fed’s perspective on this is, they want to create normalcy” in financial markets. What “normalcy” means, however, at a moment when many businesses are closed or careening toward bankruptcy, is not clear. This heads-I-win, tails-the-Fed-loses economy is resulting in win after win across the financial sector, some more malodorous than others.

In late March, for instance, Citigroup bought nearly $2 billion of AAA-rated securitized commercial loans from PGIM, the investment management business of Prudential, at roughly 90 cents on the dollar. According to Bloomberg, Citi then turned right around and sold those bonds “closer to par,” i.e. nearer to 100 cents on the dollar, a nearly instant $100 million windfall. It appears the CLOs were pledged to the Fed’s Primary Dealer Credit Facility. The reader should be able to do the math on who knew what, and when, in that story.

It’s hard to know what is ordinary front-running of this type and what is sincere worship at the altar of the Fed’s new “limitless” purchasing power. Investors are now chasing Fed decisions with seemingly real zeal, causing private money to flow directly into the very risk-laden sectors of the economy they probably would be fleeing absent government intervention.

In one of many hallucinatory headlines from this week, the head of the global allocation team for BlackRock – the company that’s administering Fed buying programs – said his company would henceforth be betting on the Fed’s bets.

“We will follow the Fed and other DM central banks by purchasing what they’re purchasing, and assets that rhyme with those,” said BlackRock’s Rick Rieder.

Other companies are employing the same strategy. “The stimulus seems to be endless,” said Dirk Thiels of KBC Asset Management in Brussels. “Buy what the central bank has been buying and in the short-term it’ll be a good strategy.”

It’s one thing for the Fed to step in and help important companies that have been unduly damaged by coronavirus, firms like Ford, whose debt was downgraded to junk in late March (but which is eligible for support under the Fed programs announced on April 9th).

It’s another thing for the Fed to create fresh bull markets around its own investments in the debt of basket-case companies, especially since it’s not clear how, say, the continuous propping up of junk bond Exchange-Traded Funds (ETFs) addresses issues like unemployment, or anything else for that matter.

“These financial bailouts are unconnected to any real-world crisis strategy,” is how one market analyst puts it. 

Brian Chappatta of Bloomberg added a similar criticism this week, asking, “How exactly do high-yield ETF purchases help Americans get jobs or pay rent?” 

The Bank of England last summer identified the state of such “open-ended funds” as a potential systemic problem:

More than US$30 trillion of global assets are now held in open‑ended funds that offer short‑term redemptions while investing in longer‑dated and potentially illiquid assets, such as corporate bonds…

The Bank added, “the mismatch between the liquidity of a fund’s assets and its redemption terms can create incentives for investors to withdraw funds ahead of other investors.”

It went on to say that under a “severe but plausible set of assumptions,” there could be a rush of redemption requests that could “overwhelm the capacity of dealers to absorb those sales,” causing “market dysfunction.”

This is a fancy way of saying that investment banks and asset managers have been making big bucks trading collections of longer-term, potentially hard-to-sell corporate bonds as highly liquid and relatively safe products. In a crisis, the Bank of England warned, these would suddenly be hard to sell, at which point the possible underlying dogshit-ness of these debt instruments might be exposed, causing further market panic. 

When the Covid-19 crisis hit, exactly this “severe” scenario seemed to take place. Several of the world’s biggest corporate bond funds plummeted in value, and buyers were suddenly scarce. A $30 billion bond fund managed by (again) BlackRock, the iShares iBoxx $ Investment Grade Corporate Bond ETF or “LQD,” went into freefall, only to rebound spectacularly once the Fed announced its first bond-buying program (managed by Black Rock, of course) in late March. 

“A $33 billion ETF sees most cash in 18 years on Fed-fueled rally,” read the cheery Bloomberg headline on March 25th. LQD at this writing is up 23.7% since the Fed announced its bond-buying program. Another troubled BlackRock fund, the $15.8 billion HYG – the world’s largest junk bond fund – now looks like an ascendant product as well.

All of these issues come on top of others inherent with the Fed programs. As Stanley’s Americans for Financial Reform has pointed out:

… the announced terms for these facilities would seem to permit public financing of leveraged buyouts, public financing of share buybacks to enrich already wealthy executives, public support for corporations that are simultaneously engaged in laying off their workers, and a range of other highly problematic outcomes…

Again, there are some restrictions in parts of the CARES Act, and in some of the Fed programs, that take aim at layoffs, buybacks, executive bonuses, and other issue. But the bond purchasing programs in particular have few restrictions on executive compensation, on buybacks, on layoffs or offshoring of labor, on payments to private equity owners, etc. There isn’t much point in restricting the spending of bailout money on handouts with one hand, if you can do it freely with the other hand, yet this is how the coronavirus rescue is structured.

This is in addition to the near-total lack of oversight. To date, the only person assigned to the Congressional Oversight Commission with purview over these programs is former adviser to Elizabeth Warren, Bharat Ramamurti. Ramamurti has no staff, no office, nothing except — this is not a joke — a Twitter account. I asked him if more resources had come his way since early Swiftian news stories identified him as a quixotic “lone” regulator attempting to watch and oversee trillions in spending by himself 

“Nope,” he said. 

Ramamurti has however sent Fed chair Jerome Powell a letter, “to respectfully request that the Federal Reserve publicly release detailed and timely information about each individual transaction” made under the new lending programs.

Remember, much of the Fed’s rescue lending is backed by Treasury dollars, which means the taxpayer is eating what otherwise would have been the market risk of many of its investments. 

However, the Fed has shown no inclination to release any information about its activities. Thus this is a brave new world not just in terms of economics, but also oversight. Essentially, the spending of huge amounts of taxpayer money has been outsourced to the Fed, whose ideas about disclosure suck even worse than those of congress.

It’s early, but the Main Street and Wall Street rescues are looking increasingly disconnected from one another. One looks like it doesn’t work, while the other might work way too well. If only we could see enough to know for sure.