Does history make the man, or the man make history? That is a question investors should ask about Jay Powell.
When he was named chairman of the US Federal Reserve two years ago, some observers, me included, suspected he might be distinctly dull. Unlike his immediate predecessors, Mr Powell was no economics luminary; nor was he much of a performer, or “maestro”, as author Bob Woodward dubbed Alan Greenspan.
Mr Powell had forged most of his career in the camera-shy world of corporate law. Colleagues described him as “pragmatic”, “self-effacing”, “genial”, “humble” and “cautious”.
However, Mr Powell is fast becoming the least cautious — or dull — Fed chair in history. As the coronavirus pandemic shuttered the global economy, he scrambled to deploy and build on tools created by his predecessors to fight the 2008 crisis: cutting rates, buying Treasury and mortgage bonds and supporting the commercial paper market.
Now the Fed is moving into new territory: it has pledged to purchase municipal and corporate bonds, along with exchange traded funds, and organise a so-called Main Street bank-lending programme for the first time. Mr Powell is not just crossing traditional red lines, but deliberately sprinting over them.
What is even more startling is his apparent freedom to innovate. That is partly because Mr Powell has forged a close working relationship with Steven Mnuchin, the Treasury secretary. Both worked in the private sector and view life as a set of trade-offs that need to be weighed, if not priced, in a pragmatic, nonideological way.
But Mr Powell’s freedom also reflects another historical accident. US president Donald Trump is so busy using the Covid-19 daily press briefings to wage his re-election campaign that he shows scant interest in the complexities of Mr Powell and Mr Mnuchin’s plans. That is a relief to both men.
So how will history eventually judge Mr Powell? In one area, Fed officials have already scored a huge success: they narrowly averted a market meltdown last month. As historian Adam Tooze tweeted, they “flattened the curve” of the initial coronavirus financial panic.
The scale of this achievement is outlined in a new Bank for International Settlements report. It describes in chilling detail how much stress was created when leveraged hedge funds stampeded for the exit in the Treasury market and threatened to create cascading shocks. That Treasury prices are now relatively stable is a big victory. So is the easing of conditions in the municipal, corporate and mortgage markets.
However, this achievement has come with two gigantic costs. The sheer scale will reduce the Fed’s future firepower in the face of any fresh financial and economic shocks that might be unleashed by the pandemic. These wild experiments are also creating unprecedented moral hazard; or, more accurately, amplifying the hazard that has haunted the financial system since 2008.
After all, the main reason why hedge funds had amassed crazy risks before the virus hit was that money was ridiculously cheap. Similarly, the Fed has had to scramble to prevent a corporate credit freeze precisely because so many weak companies are so loaded with debt that they could barely service even before a shock.
Ironically, Mr Powell previously warned of the dangers this debt posed. And now it will be fiendishly difficult to help worthy US companies — by supporting corporate bond prices and extending loans — without also aiding corporate zombies and the investments of wealthy private equity funds. This will potentially unleash a political backlash worse than that after 2008.
Senior Fed officials say they understand these risks. But they insist they would rather face future reputational damage, and personal political attacks, than let the financial system freeze up, or a recession turn into a depression.
Is this brave? I think yes. It is wise? Probably, given the ghastly alternatives, but if — and only if — Messrs Powell and Mnuchin mitigate some of this moral hazard. They should create a formal system of external oversight for the Fed’s credit risk, and do everything possible to prevent any private equity bailouts. Mr Powell must also start talking about how the Fed will stop its support once the impact of the virus subsides, say by selling corporate bonds.
But that is for the future. Right now, investors need to understand why the normally sober Mr Powell is taking these stunning gambles. Fed officials fear that the looming potential economic shock could be worse than the US public and equity investors expect. That is scary. Sadly, it is also realistic.
gillian.tett@ft.com
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Source: Economy - ft.com
