The US Fed Denies Investors Their Returns and Their Freedom

It was another wild night for markets.

After a dismal performance yesterday, Wall Street is back in the driver’s seat. Along with a slight rebound in oil too.

That doesn’t mean the battle between the bulls and the bears is over just yet though.

Far from it, actually. If anything, it seems markets may be preparing themselves for their next big test. Whether it be a surge in second waves of the ‘rona’ or repercussions from the initial economic impact.

Either way, the volatility is likely here to stay. At least for the foreseeable future.

Well, that is, unless Jerome Powell has something to say on the matter.

As you’re probably well aware, Powell is the poster boy for the bulls at this point. A man who has singlehandedly propped up the market by throwing money at it. Money that has been printed from thin air.

Effective or not, what the Federal Reserve has done to markets is unsettling. Normalising a systemic bailout of businesses (bad or good) under the guise of QE.

It’s central bank interventionism at its most egregious. Or at least, I thought it was…

Overnight the Fed released an update on its latest bank ‘stress tests’. A measure that was devised in the wake of the GFC.

Long story short, it’s the Fed’s way of assessing how the banks will hold up under crisis. Analysing the level of capital at their disposal should the worst come to bear. And given we’re in the midst of a pretty big crisis, this test was obviously going to be significant.

What a shame then, that the outcome has been another blow for free markets.

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Caps, bans, and limitations

Needless to say, however these stress tests were conducted, the outcome was bad.

The Fed clearly stated that they’re worried about bank capital if things don’t improve. Even with the billions they keep pumping into the system every quarter.

So, Powell and co decided to do something about it. Something that is not going to please shareholders of these banks.

Here is the statement from the Fed themselves:

In light of these results, the Board took several actions following its stress tests to ensure large banks remain resilient despite the economic uncertainty from the coronavirus event.

For the third quarter of this year, the Board is requiring large banks to preserve capital by suspending share repurchases, capping dividend payments, and allowing dividends according to a formula based on recent income.

They’re restricting the returns banks can give to shareholders. Forcing them to limit dividend payouts, and halt share buybacks altogether.

For reference, in recent years share buybacks made up about 70% of shareholder payouts from major banks. A popular process for rewarding investors in the US market. Now though, it has been put on hold.

Naturally, the market reaction (after hours) for bank stocks has been sour. And in my view, shareholders have every right to be upset.

Sadly though, the Fed won’t care.

As the US banking regulator, they’ll do anything and everything to keep the game going. Even if it means burning the very people who have their wealth at stake.

But of course, that’s all part of the game, isn’t it?

Despite throwing billions at these banks to save the economy, the Fed doesn’t want to see a dime go to ordinary people. Though I’m sure we’ll still see plenty of fat bonuses and maybe even a few golden parachutes when all is said and done.

After all, this isn’t really about preserving capital, it’s about preserving their private profits while screwing over those who are really entitled to it.

We saw it happen in 2009, and we might be about to see the sequel.

Conflict and control

Now, I’ll be honest, I really don’t care all that much for dividends of buybacks.

I much prefer to see a company reinvest in itself. Using excess profit to continue to grow and develop their operations.

Recently I even criticised our own banks for going ahead with dividend payments at all. Arguing that they should have held off from paying out shareholders until they shore up their balance sheets.

Sounds a lot like what the Fed is saying, right?

The difference is that my opinion is just that, an opinion.

I don’t have any ability to enforce my view on our banks. It is simply a course of action that I believe would net investors better long-term outcomes.

The Federal Reserve though, can enforce their views. And even if they believe they are doing it for the greater good, that doesn’t diminish the fact that intervention can be harmful.

As I alluded to at the beginning, this is directly undermining the idea of a free market.

The banks should have the freedom to decide to pay a dividend or conduct a buyback if they want to. It shouldn’t matter if that ends up being the right or wrong decision.

After all, we must remember the Fed has taken this course of action on a whim. Putting in place these restrictions just in case the worst comes to pass. Meaning even if everything pans out fine, shareholders still won’t see the returns they are entitled to.

You could even make the case that this could lead to a self-fulfilling prophecy. Locking up vital liquidity that would be paid out to ordinary people inside the banks’ coffers. I’ll save that argument for another day though…

Conversely, I would even argue it is better for the banks to make the wrong decision than put up with the Fed’s meddling. At least then we would be able to deal with it. I don’t think anyone wants to see banking rot and fester into another toxic mess like 2009.

The era of ‘too big to fail’ can’t be repeated.

Because at the end of the day, what the market needs is freedom.

Freedom not just from the Fed, but every meddling policy that there is.

As Milton Friedman famously put it:

One of the great mistakes is to judge policies and programs by their intentions rather than their results.

I pray that the result isn’t as bad as I fear it will be.


Ryan Clarkson-Ledward,
Editor, Money Morning

Ryan is also the Analyst of Australian Small-Cap Investigator, a stock tipping newsletter that hunts down promising small-cap stocks. For information on how to subscribe and see what Ryan’s telling subscribers right now, click here.

Ryan Clarkson-Ledward is an Editor at Money Morning.

Ryan holds degrees in both communication and international business. He helps bring Money Morning readers the latest market updates, both locally and abroad. Ryan tackles all the issues investors need to know about that the mainstream media neglects.

Ryan is also the Editor of Australian Small-Cap Investigator, a stock tipping newsletter that hunts down promising small-cap stocks by dissecting the latest events affecting the world.

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