What does it actually mean to have negative interest rates? Why is it bad? What caused this? Specifically who is responsible?

by Ilogy

QE is far more than simply the Fed buying Treasuries in mass quantities. After all, that was already how the Fed set interest rates prior to 2008, through the buying and selling of short-term Treasury bonds.

Why QE was so controversial was because the Fed was given the power, by congress, to print money in order to purchase non-governmental bonds, i.e., private sector debt. This represented a tremendous change from the historic role of the central bank and allowed it to manipulate capital markets in ways it was never meant to.

The reason people often say that QE was a program to buy government bonds on a massive scale is because in addition to allowing the central bank to buy private sector assets, QE also gave the Fed the power to buy long-term government bonds in order to influence interest rates further out on the yield curve. But focusing on this aspect of QE kind of misses the more important motive of QE, which was to bail out the commercial banks.

The main goal of the Fed using QE was to buy the toxic assets—the mortgage backed securities—that led to the insolvency of the commercial banks. Since the Fed could not legally buy this private sector junk they had to go to congress in order to change the law. It is interesting to consider why historically it was illegal for the Fed to have this power, but that is another topic. The bottom line is that the government bailout of the banks was extremely unpopular, and yet the banking system required much more than the US government provided. Consequently, the government turned to the Fed to bail out the banks silently, without public scrutiny, but the only way to allow them to do that was to give them extra powers which resulted in QE.

These extra powers, QE, allowed the Fed to manipulate the capital markets, primarily through the massive purchasing of private sector debt in order to artificially inflate the value of all the junk everyone was running away from and thereby bail out the banks who were holding all of that debt. The end result of this was that there was a massive influx of liquidity into the capital markets more broadly and a resulting explosion in the stock market.

This is why we had the greatest bull market in stock market history during one of the worse economic periods of US history. It makes no sense on the face of it, and that should be a warning of sorts, and yet the impact of this massive market manipulation persists today. The market has become so dependent on the Fed’s manipulation, that in some sense how well it does has become unhinged from the real economy. Today, bad jobs reports means the market rallies, because a weak economy means the Fed will have to inject more liquidity. Tariffs mean the stock market goes up because a weak economy means the Fed will have no choice but to inject more liquidity. Federal investigations into big tech companies means the stock market goes up because a weaker economy is good for the stock market. Etc. And, conversely, when the Fed was attempting to raise interest rates, which traditionally is an indication of confidence in the broader economy, the stock market flattened and eventually began to keel over leading to the panic we saw in December. This only reversed course when the Fed caved and indicated to the market that it was going to cease tightening.

So you have this situation where the stock market has become unhinged from the real economy, and the Fed has no ability to tighten monetary policy without crashing the markets.

2008 was caused by an excess of lending that caused malinvestment and mortgage backed securities to become overvalued, but QE and low interest rates may have, in a sense, doubled down on the conditions that gave rise to 2008 and now there appears to be no way to reverse course, like a car without breaks turning onto the on ramp of a freeway.

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