FOMC Chair Powell answers a reporter’s question at the March 3, 2020 press conference. Photo courtesy of the Federal Reserve.
Howard Marks, the notable distressed debt investor, is out with a memo questioning the Fed’s decision to intervene in credit markets. The Fed panicked when it saw investment-grade bonds sell off a few percentage points last month. It decided to intervene under the auspices of providing liquidity to the market, but liquidity was not the problem. Bond prices were down because there were questions of solvency. Shutting down the economy for an indeterminate time will do that.
There was and is plenty of liquidity in the bond market at the right price. We were an aggressive buyer of corporate bonds during the sell-off, and so was Howard Marks as well as many other investors. There is also close to $2 trillion in dry powder in private equity funds looking for a home. I’m sure some of that would have found its way into the corporate bond market.
The Fed’s intervention was simply a bailout for leveraged investors and overly leveraged companies. Yes, the virus wasn’t their fault, but 9-11 wasn’t any American company’s fault, either, and the financial crisis caused by 9-11 wasn’t the fault of thousands of small businesses that failed during that downturn.
A well-functioning free market requires failure. The over-leveraged and imprudent are supposed to suffer the consequences of their decisions in a downturn. When they get bailed out, the system becomes less stable. The moral hazard created by the Fed’s decision will do much more harm to America than the bailout will do good.
Why worry about risk any longer when the government will be there to bail you out at the first sign of trouble?
As we come out of this crisis, expect more leverage, more risk-taking, and yes, an even bigger bailout during the next downturn.
“Lever up and lobby” has apparently become America’s motto in the 21st century.
Howard Marks has more:
“What’s the Fed’s purpose in buying non-investment grade debt?” Marks, the co-founder of Oaktree Capital Group LLC, wrote in a memo to clients Tuesday. “Does it want to make sure all companies are able to borrow, regardless of their fundamentals? Does it want to protect bondholders from losses, and even mark-to-market declines?”
The way Marks sees it, regulators have taken over the role of the free market, protecting investors and companies from the consequences of their actions when they take on too much leverage.
“Markets work best when participants have a healthy fear of loss,” he wrote. “It shouldn’t be the role of the Fed or the government to eradicate it.”
