Asset Price Appreciation as a Policy Tool

I sort of had an epiphany today. I was getting all upset about how manipulated today’s rally appears to be – 200 point gap up open, above obvious resistance and a 200-point rally in the last hour. All on Election Day for that great headline of the largest Election Day rally since 1984…

That got me thinking about the President’s Working Group on Financial Markets and as I read some articles today, all the pieces finally fell together for me.

I started to realize what a policy tool asset price appreciation has become. I started to see how prices going up made it easy for the government to avoid the tough public policy decisions required to create jobs domestically and get us back to real economic growth.

I’m not here to debate whether or not the “Plunge Protection Team” exists. I am merely going to quote a gentleman who was around when the “Working Group” was formed and opined about how the Fed could use their powers to manage the stock market, former Federal Reserve Governor Robert Heller.

A few days after the October 1989 market crash, Mr. Heller wrote the following in an op-ed, “Have Fed Support Stock Market. Too” in the Wall Street Journal (10/27/1989) –

“The stock market correction of Oct. 13, 1989, was a grim reminder of the Oct. 19, 1987 market collapse. Since, like earthquakes, stock market disturbances will always be with us, it is prudent to take all possible precautions against another such market collapse. In general, markets function well and adjust smoothly to changing economic and financial circumstances. But there are times when they seize up, and panicky sellers cannot find buyers.”

“(A)n appropriate institution should be charged with the job of preventing chaos in the market: the Federal Reserve. The availability of timely assistance -- of a backstop -- can help markets retain their resilience... The stock market is the only major market without a market-maker of unchallenged liquidity or a buyer of last resort. “

“Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying market averages in the futures market, thus stabilizing the market as a whole... The stock market is certainly not too big for the Fed to handle.”

“In 1987, (The Fed) pumped billions into the markets through open market operations and the discount window. It lent money to banks and encouraged them to make funds available to brokerage houses. They, in turn, lent money to their customers -- who were supposed to recognize the opportunity to make a profit in the turmoil and buy shares.”

“The Fed's stock market role ought not to be very ambitious. It should seek only to maintain the functioning of markets -- not to prop up the Dow Jones or New York Stock Exchange averages at a particular level. The Fed should guard against systemic risk, but not against the risks inherent in individual stocks. It would be inappropriate for the government or the central bank to buy or sell IBM or General Motors shares. Instead, the Fed could buy the broad market composites in the futures market. The increased demand would normalize trading and stabilize prices. Stabilizing the derivative markets would tend to stabilize the primary market. The Fed would eliminate the cause of the potential panic rather than attempting to treat the symptom -- the liquidity of the banks.”

“The old saying advises: "If it ain't broke, don't fix it." But this could be a case where we all might go broke if it isn't fixed.”

I am speechless. And that doesn’t happen often.

In his 1989 Op-Ed, Mr. Heller lays out how the Fed can use its money to keep stock markets from falling. It is a very simple formula – buy stocks futures and the prices of stocks will follow.

What scares me is how all the terminology he uses to describe the stock markets are now being applied to so many different asset classes – mortgages, money market assets, commercial paper, bank stocks...

Somewhere in the last 20 years, those in power went from using an emergency tool as a last resort to save the markets from turmoil to using the power as a policy tool to drive up asset prices to make Americans feel rich and consume a lot more they could actually afford.

These days, the Fed has become the only buyer. Period! They are buying stocks, bonds, foreign currencies and soon real estate.

I think this election is more about the construction of the economy than anything else. I think the voters have figured out that the Wall Street/Washington connection has led to an economy based only on asset price appreciation. That’s great if you have assets, but if you don’t then your future looks like you’ll be working for minimum wage at Wal-Mart. I don’t know about you, but to me that seems to be a pretty terrible way to construct an economy.

The $700 billion bailout was just the final nail in the coffin for the Wall Street/Washington alliance. People are just sick of this stuff.

I am writing about this because it is amazing to me how all it takes is a rally to get everybody switched from being afraid of going bankrupt to being afraid of missing the “New Bull Market”. People are addicted to price moves!

What most concerns me now is what does Obama do? Does he take the easy road and continue the game, only to see yet another bubble blow up in 8 years? Or does he do the heavy lifting and change the economy for the betterment of the next generation.

If Obama picks another former CEO of Goldman Sachs to be his Treasury Secretary, then I know nothing has “changed” in Washington and all we will be stuck with is a bunch of Socialists with a redistribution agenda and a willingness to manipulate asset prices to further their agenda. Then, the only thing that will have “changed” is the tax rate I pay.

I hope he really is different, because we need it.