Leveraging Up The World in Good Times -- The Madness of Modern Central Banking

From the WSJ:

The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy.

In two instances, the ECB has bought bonds directly from European companies through so-called private placements, in which debt is sold to a tight circle of buyers without the formality of a wider auction.

It is a startling example of how banks and companies are quickly adapting to the extremes of monetary policy in what is an already unconventional age. In the past decade, wide-scale purchases of government bonds—a bid to lower the cost of borrowing in the economy and persuade investors to take more risk—have become commonplace. Central banks more recently have moved to negative interest rates, flipping on their head the ancient customs of money lending. Now, they are all but inviting private actors to concoct specific things for them to buy so they can continue pumping money into the financial system.

The ECB doesn’t directly instruct companies to create specific bonds. But it makes plain that it is an eager purchaser, and it lays out the specifics of its wish list. And the ECB isn’t alone: The Bank of Japan said late last year it would buy exchange-traded funds comprising shares of companies that spend a growing amount on “physical and human capital,” essentially steering fund managers to make such ETFs available to buy.

Note that none of the criteria for the debt purchases is anything like, "the company has sensible plans for investing the money."  It is merely buying debt for debt's sake.  In the US, private companies are using most of their debt issues to buy back stock, a nearly pointless exercise that channels money from central banks to propping up equity valuations.  I wouldn't be surprised if European companies do the same.

Folks, it may not feel like it, but we are at the top of the economic cycle.   We have negative interest rates and central banks buying up every available debt issues in relatively good times, when these were formerly considered tools for the deepest point in a recession.  I am not a big believer in government stimulus, but these folks are.  What are they counting on in the bad times, when nothing will be left in the tank?

But now, we see central banks going one step further, encouraging private companies to lever up at the top of the business cycle.   Historically, this has been a formula for disaster.  The oil industry has been a preview of this.  Take ExxonMobil (XOM).  XOM, given its size, has never been very good at developing certain sorts of plays (e.g. the shale boom).  What it has done historically is use its size and balance sheet to swoop in during inevitable periods of low oil prices and producer losses to buy up developed fields at good prices.  But this time around, XOM has only had limited ability to do this, because it spent the boom years levering up its balance sheet and buying back stock.  Other large oil companies are in even more dire straights, facing real cash flow crises because, again, they levered up to repurchase stock when they should have been cleaning up their balance sheet.


  1. Bloke in North Dorset:

    Its yet another form of crony capitalism as favoured companies get access to cheap loans with very few covenants.

  2. mlhouse:

    I think the point you make the mistake on is the belief we are in relatively good times. While the "unemployment rate" is low and we havent collapsed in a recession, economic growth is stagnant and most government fiscal policy is totally monetary.

    We need to restore real growth in this country. Lower tax rates, regulation and other government burdens. With the creation of essentially energy independence in the United States, the prospects for supply side driven growth are tremendous. When you lower the taxes and regulations, THEN THE CORPORATION IS GOING TO HAVE SOMETHING TO INVESTS BOND MONEY IN, other than stock buy back.

  3. Matthew Slyfield:

    "What are they counting on in the bad times, when nothing will be left in the tank?"

    That they won't be around to have to deal with the mess they created.

  4. marque2:

    I don't know, it worked for Ford. Ford leveraged the whole company to the tune of 25 billion during the boom right before the 2007 bust, and managed to get a huge line of credit as well. It turned out fortuitous, because that is why Ford was the only US auto company to survive the downturn without going bankrupt.

    This is why so many companies are "hoarding cash" today, because they saw that Ford survived because it happened to have cash during the downturn.

  5. ErikTheRed:

    "What are they counting on in the bad times, when nothing will be left in the tank?"

    This has already been answered:

    "In the long run, we're all dead." - John Maynard Keynes

  6. SamWah:

    " XOM, given its size, has never been" what? Please to continue thought/sentence.

  7. marque2:

    OK, we may not be in good times, but the easy money certainly doesn't seem to be helping much, except to create a worldwide stock bubble.

  8. mlhouse:


  9. GoneWithTheWind:

    The 'true' unemployment rate is not low. We are in a recession and have been since late 2008. Except for the stock market, which is propped up by QE, most economic pointers are pointing the wrong way and pretty much have been for 8 years now. If real/raw data was used it would be possible to prove we are in a economic depression and not a recession. BUT the fed keeping interest rates low, borrowing and printing money and pumping up the economy are hiding the truth of our Potemkin/Obama economy. The fed is using everything at it's disposal and nothing is working. Sooner or later the next bubble will burst and there is no more resilience left in the economy to bring us back; the FED has no more cards up it's sleeve to play when it collapses. The facade of good times will collapse like an empty suit in the White House. It's over, it can't be saved (or at least won't be), if you aren't buying food and PMs you will become a footnote in history when this house of cards comes down.

  10. Maximum Liberty:

    I think the regulatory rollback is the key. Over the past few years, the fastest growing parts of most companies have been the compliance departments ... which produce nothing.

  11. mesaeconoguy:

    The most frightening aspect of what central banks are doing is the size of their participation – BOJ (Bank of Japan, their central bank)
    will own over half of the JGB (Japanese Government Bond) market in under 2 years. Not just 1 issue, the entire goddamn market, everything outstanding.

    That severely distorts risk pricing and behavior, in addition to driving down rates. It also masks the giant insolvency problem of Japanese banks who are sitting on piles of JGBs, just not quite as many as BOJ.

    In addition, BOJ already owns more than half of the Japanese ETF (Exchange Traded Fund) market, and is thereby indirectly the top equity shareholder of multiple Nikkei 225 companies.

    This is outright nationalization of an entire economy and market via monetary policy.

    This does not end well, and these central bankers are mostly clueless about the ramifications of their irresponsible actions.

  12. Zachriel:

    Coyote: What are they counting on in the bad times, when nothing will be left in the tank?

    There are few reserves left for monetary stimulus. The problem is that inflation is still low. The banking system has been attempting to stimulate the economy, but it's like pushing on a string. Fiscal stimulus would have been much more effective.

  13. Orion Henderson:

    I'm no expert, but I have been observing, and supplying products to, the luxury property market. Specifically, very high end homes that mostly sit empty.

    It seems to me that the very rich are parking their money in real estate at an incredible pace. It is very different than the housing bubble leading up to 2008. That housing bubble was driven by middle and upper middle income people overextending themselves in hopes of getting in on the gains. This time it's the very rich buying up high end real estate and sitting on it. In the markets I see there is a lot of international investors as well-buyers, and small buying groups, from Asia and Europe are parking cash in US real estate. The question is: Why?

    Do they know something I don't? Probably. My hypothesis is two part: 1. There is minimal return on investment without massive risk available to the rich. Real estate represents a tangible asset that may go up or may go down, but always has intrinsic value. 2. Real estate cannot be taxed or legislated out of existence. Unlike financial instruments, which can be victim to legislative zeal, a piece of land with or without a home cannot be legislated into oblivion.

    Are the very wealthy cashing out on all this free debt and buying hard assets? Is that where the money is coming from? Or are they simply trying to protect their cash for a crash they see coming? Or more likely, it's a little of both.

    To a certain extent, the rich always buy real estate. It goes with the territory. But this seems different.

  14. Orion Henderson:

    Very true. I just had a discussion about this the other day. The economy sucks if you're in the middle or below. There aren't jobs available for the skills most people have. Anecdotal evidence? My employees aren't looking for raises. I have no competition for their labor. Clearly, my pay rates are at or above market. Sure, they whine on occasion. But in a zero growth environment there isn't any more money coming in. The only extra cash comes from cost savings.

  15. Mr. Generic:

    To go with the metaphor, there is a lot of slack in the world economy and central banks keep spilling out line. Inflation is low, but the central banks keep pumping out cash. When things heat up again, there will be far too much cash in circulation and we should expect to see very heavy and very sudden inflation.

  16. Matthew Teague:

    International buyers and small buying groups are trying to protect their assets from their own governments. European buyers are protecting their savings from negative rates. Chinese are trying to protect against capital controls.

    The problem will be, that in a real crisis this investment is illiquid

  17. Orion Henderson:

    I'm thinking these folks are far more worried about protection than liquidity. It's not like they're going to be destitute-just less well off than before.

  18. ColoComment:

    I'd really like to see Warren (or anyone else) comment on the consequences of this circular payments scheme:

    "When the Treasury makes interest payments on outstanding federal debt, much of it goes to the Fed because of its large portfolio of Treasury-issued debt.

    The returns the Fed earns on its Treasury and MBS assets are used to fund the bank's operating costs and to cover the expenses of the Consumer Financial Protection Bureau, created in Dodd-Frank. Beyond that, the excess "profits" can be returned, at the discretion of the Fed, to the federal Treasury to lower the government's annual budget deficit. In 2008, the Fed paid just $32 billion to the Treasury. Over the period 2009 through 2015, the central bank paid the Treasury a total of $584 billion, including $117 billion in 2015 alone."


  19. jdgalt:

    That's not circular so much as it is a "black hole" payment scheme, because the Federal Reserve Bank has the unique, legal power to pull new money out of its own ass.

    When the Fed buys Treasury securities, or any other asset, it is creating new money (also known as inflating). Since 2008 (including in the last year of the Bush admin) the Fed has increased the money supply from about $6T to $13T: a factor of two.

    The reason that almost none of that inflation has shown up as increased prices yet is that the Fed has been keeping its interest rate very close to zero, thus giving the banking system next to no money to lend; that policy (and overregulation of business) is why business has stagnated and the number of jobs has decreased so much during that period. But in the last month or two, interest has begun to increase again, and I'm expecting price inflation in the 10-15% range over the next eight years no matter who is the next president. Variable rate loans will go up too. This is not the time to sign up for one.

    If the high federal spending continues -- and it will under either Trump or Clinton -- we can expect true runaway inflation. This is how healthy economies turn into banana republics, folks, and every poor country in the Americas did it the same way: a legislature that can't say no when its people demand more welfare. I only hope the crisis doesn't produce the results it did in Germany after 1923.

  20. jdgalt:

    It's fixed, sort of, but it should read "dire straits."

  21. jdgalt:

    There isn't any easy money. The Fed is keeping its official rates low because Obama doesn't want the government having to pay hundreds of billions in interest, but the Fed is encouraging banks to park their money with the Fed itself rather than lend any out, because an "overheated" economy (that is, a real recovery) would cause all that inflation to reveal itself to the lay public.

    After November he won't care if that happens, since it will be his successor's problem.

  22. Benjamin Cole:

    The Federal Reserve is conducting a reverse repo program as we speak and is actively sopping cash out of capital markets. It could be fairly said that the Fed is artificially holding interest rate high, at this point.

    additionally, few contend that central bank can control long-term interest rates, which are also in the toilet.

    What may be described as an activist policy, such as helicopter drops, may actually be a suitable policy under the circumstances.

    In any event, I find the ideological Dogma that attaches to monetary policy discussions to be dispiriting. Helicopter drops work in the Great Depression era of Japan. Why not helicopter drops, if they work?