By Shah Gilani
Here’s how screwed we really are.
The economy is growing – imperceptibly. It’s like trying to watch grass grow, but it’s growing. How do you feel about that?
Still, unemployment is down. How do you feel about that?
Before you give me your answers, keep reading, because I’ve got many more questions…
It’s All on Tape
Interest rates are down. They were cut to the quick and quickly, there’s no disputing that. So, how do you feel now that you’re older and have shifted your savings out of equities and into fixed income, so your retirement future would be less subject to the market’s volatility and comfortably accumulating all that safe interest?
How do you feel about the stock market rising to the moon because low interest rates allowed speculators to leverage up their risk exposure and allowed companies to borrow cheaply to buy back their shares to lift their stock prices? After all, you’re mostly out of the market because you were shaken out or wiped out back in 2008.
How do you feel about getting back into the market? You did get back in, didn’t you?
You were supposed to. The Federal Reserve told all of us to do so. It openly articulated a zero-interest rate policy, commonly known as ZIRP.
Da ZIRP was designed, so they say, to drive investors out of saving and into the malls and into equities to lift the stock market.
Why drive investors into the stock market, you ask?
You knucklehead. It was obviously to make everybody rich by means of the extraordinarily brilliant policy prescription known as the “wealth effect.”
So, are you feeling wealthy yet? Are you any wealthier? Or is this all a dream?
Here’s where I give you all good news I’m famous for delivering.
You’re screwed. We’re all screwed.
That’s because the folks at the Fed, the kingmakers and economy breakers who run the country, who are the emperors of our time, have no clothes.
These naked fools have exposed us to a leveraged-up stock market, lifted on the backs of broke savers whose forsaken paydays were shifted over to hedge funds, big banks once again, and corporate CEOs and CFOs who ZIRPed markets higher in spite of economic realities.
And now we’re about to see how naked they really are and how exposed we are.
The Fed is the primary regulator of the players in the wealth feeling stealing game. And, not that we didn’t already know it, but once again, they are demonstrating that it’s not us they’re here to protect.
They’re protecting Wall Street‘s moneymaking machinery.
Two not-so-little items will prove my point about how screwed we are.
First, there’s “The Goldman (Sachs) Tapes,” which were first broadcast on NPR’s This American Lifelast week. Carmen Segarra, a former Fed examiner in the bowels of Goldman Sachs, secretly recorded some of the goings-on there.
Here’s what USA Today said about the tapes:
- What these tapes depicted were bank regulators who were timid and equivocating, deferential in the extreme to the bank they were supposed to keep in line, especially after Wall Street’s flagrant disregard for law and ethics led to the financial crisis that crippled the world economy.The New York Fed is the lead regulator for the main Wall Street banks and even has supervisors embedded in the offices of Goldman Sachs and others.
What emerges in the tapes is that the team embedded in Goldman is the very definition of regulatory capture – when regulators become more oriented to the institution they are supervising than to representing the public interest.
These sessions were taped by a member of that Fed team, Carmen Segarra, who was fired after seven months on the job and is suing the Fed, claiming it was her refusal to go along with this timorous form of bank supervision that led to her dismissal.
In one session on tape, as the examining team was discussing tactics for probing a Goldman deal one of them characterized as “legal but shady,” this timidity was on full display.
“I think we don’t want to discourage Goldman from disclosing these types of things in the future,” said one male participant who remained unidentified in the transcript, “and therefore maybe you know some comment that says don’t mistake our inquisitiveness, and our desire to understand more about the marketplace in general, as a criticism of you as a firm necessarily. Like I don’t want to, I don’t want to hit them on the bat with the head [sic], and they say screw it, we’re not gonna disclose it again, we don’t need to.
How’s that for comfort?
Fed examiners are coddling the biggest, baddest Wall Street titan of all time. The richest, most powerful investment bank the world has ever known – whose awesome moneymaking prowess is only outdone by the audaciousness of its global scheming to make mountains of money – in a very real sense, owns the Fed.
And Goldman Sachs isn’t the only owner. All the big banks are part owners of the Federal Reserve System, literally.
The Leverage Bubble
Secondly, there’s the whole leveraged loan thing.
Last year the Fed demanded big banks, including Goldman Sachs, to tighten up on the “leveraged loans” they were making, issuing and selling to investors.
Leveraged loans are loans made to companies that already have relatively high debt loads. In other words the borrowing companies are already leveraged. These are relatively high-interest rate loans (relative is a relative term), which means investors want to buy them, because they can get better yields on the pass-through of those interest payments, many of which are floating-rate loans.
Floaters have the interest rates that float higher as an underlying benchmark rises. (Can you say Libor? As in the famously manipulated London Interbank Offered Rate.)
Leveraged loans, because they are in such demand by yield-hungry investors, are increasingly “covenant lite” loans. Borrowers tell investors: If you want the interest my loan affords you, come and get it, but I’m not going to give you any of the standard protections usually embedded in loan agreements. You’ll be at higher risk, but, hey, you want the yield, don’t you?
The Fed gave the banks it sent letters to 30 days to comply with its supervisory requests that the banks not make loans to companies where subsequent leverage would exceed six times earnings before interest, taxes, depreciation and amortization (EBITDA).
The banks in turn gave the Fed the finger.
Not only are 70% of leveraged loans made this year covenant-lite loans, according to Barclays – incidentally, one of the banks that got the Fed’s letter. Debt-to-EBITDA levels on leveraged loans have risen steadily. In the first half of 2014 the average debt-to-EBITDA multiple was 5.89x. In the third quarter it rose to 6.26x. Standard & Poor’s notes that compares to the 6.23x on leveraged loans in 2007.
Those are averages. One deal TravelClick leveraged itself on over a $560 million loan came out to 9.7x. Another deal Acosta Sales & Marketing did on a $2.7 billion term loan came out at more than 8x.
What was the money being raised for?
For private equity companies Thoma Bravo and Carlyle Group, respectively, to buy out the companies.
That’s right. The companies leveraged themselves up with loans to give the money to private equity buyers to buy them. Who bought the leveraged loans? Why investors in mutual funds and exchange-traded funds (ETFs) and institutional investors, of course.
Here’s a small extraction from an American Banker article: “‘Terms and structures of new deals have continued to deteriorate in 2014,’” Todd Vermilyea, senior associate director at the Fed Board’s Division of Banking Supervision and Regulation, said in a May 13 speech in Charlotte, North Carolina. “‘Many banks have not fully implemented standards set forth in the inter-agency guidance.’”
Of course they haven’t. They know the Fed is naked, so they just kick it where they want.
The Fed is afraid to regulate their masters, who have been leveraging up markets with the ZIRP money the Fed has fed them for six years now.
And we’re supposed to be comfortable with the high stock market and the wealth effect we’re supposedly feeling?
We’re screwed, again.
Courtesy Shah Gilani at Wall Street Insights & Indictments (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.
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