Main Street buckles under market stress while zombie corporations float to safety on their golden parachutes.
The Federal Reserve has announced that it will be moving away from its previous ETF purchasing program in favor of directly buying corporate bonds. This announcement begins what some individuals have termed the Japanification of the United States economy. The term is accurate; the Japanese central bank, the Bank of Japan, or BOJ, currently owns over 73% of all ETFs listed on the Japanese stock market. This disproportional ownership makes the price action in the Japanese stock market anything but natural. The central bank is considered the lender of last resort for its respective country. The BOJ owning almost three-quarters of the entire Japanese ETF market demonstrates the degree to which natural price discovery has become completely removed from the Japanese market. The United States seems to be on the same trajectory.
"The Fed has obliterated true price discovery mechanisms" - Bruce Wiles
These massive market distortions have a definitive impact on asset valuations. They support what are known as "zombie corporations," keeping entities such as Hertz barely solvent (for a while) and without a clear path to profitability. The size of these market distortions is why many individuals have termed this unprecedented market intervention on the part of central banks the "Everything Bubble." A recent statement from Fed chair Jerome Powell shows the disconnect between Federal Reserve stated intent and the material impact on asset valuations.
"I would say that we're tightly focused on our real economy goals. And -- and again, not -- we're not -- we're not focused on moving asset prices in a particular direction at all. It's just, we want markets to be working and I think partly as a result of what we've done, they are working and -- you know, we hope that continues."
It is difficult to discern whether this apparent misunderstanding by the head of the world's most influential central bank is genuine naivety or rather gross incompetence by the individuals tasked with managing the world's largest economy.
These zombie corporations could not exist without the Federal Reserve's direct market intervention. For the Federal Reserve to be seemingly unaware of the impact that their market intervention has on these entities' ability to subsist beyond their natural means is concerning for all participants in the global economy. In March, Jerome Powell stated there is no limit to the Fed’s emergency lending ability, further demonstrating the Fed's commitment to providing ample market liquidity, merited or otherwise. This willingness to supply any qualifying market actors with unlimited support is hardly a sentiment that incentivizes wise long term capital allocations by otherwise struggling firms.
Many of these companies have no path to sustainable profitability and ultimately pay very little in taxes. Very few of these entities offer living wages to their employees yet are more than willing to cut their executives’ substantial bonuses in the form of golden parachutes when the seemingly inevitable occurs and the directionless firm files for Chapters 7, 9, or 11 bankruptcy.
Even more glaringly, many of these entities rely heavily - some entirely - on accommodative central bank policy and low-interest rates for their business activities. Should the Fed raise rates, some of these corporations would be unable to service their debts, and a Hertz-like implosion would result. The Federal Reserve's intervention in the corporate bond market has a definitive impact on these companies' valuations and the ability to persist past what would otherwise be their natural expiration dates.
The obverse of this accommodative situation is that of the average American worker. When these zombie corporations file for bankruptcy, their employees experience mass layoffs, such as the 16,000 Hertz employees who now find themselves without a job during the worst pandemic in over 100 years. It is hard to overstate how contrasting the average Joe and Jill on Main Street's situation is to that of the average Wall Street executive. The former is being bled dry by the Federal Reserve and central bank policies in favor of the later. Treasury Secretary Steve Mnuchin highlighted this reality with his recent refusal to release information regarding Payroll Protection Program (PPP) loan information.
The PPP act targeted small and medium businesses with Federal support during the Covid-19 outbreak and served as a much-needed lifeline for small businesses in the United States. At a time when over 40 million average Americans had filed for unemployment, significant corporations like Shake Shack and Ruth's Chris dipped into this fund pool and received roughly $20 million in PPP funding each.
These corporations did not pledge to return the money until after being publicly shamed for accepting these funds in the first place. Shake Shack's CEO, Randy Garutti, receives an annual salary of $2.3 million. Even starker, Ruth Chris' CEO Cheryl Henry, received a 327% salary raise in 2018 for a whopping $6.1 million annual paycheck. While the CEO of a company is a critically valuable asset, one wonders if their value exceeds the equivalent of over 300 prep cooks, especially given that the entity in question is a restaurant. There is no way to know how many similar situations have occurred without full disclosure as to who received PPP loan money. There very well could be even more significant corporations that have dipped into these funds explicitly allocated for small businesses when they needed it most. Illustrating how difficult this situation is for your average American, over 1.5 million individuals applied for unemployment benefits just last week.
In just a matter of months, the national deficit has seen an addition of trillions of dollars. Unfortunately, it seems that the vast majority of these funds are going to support ever-increasing stock market prices and zombie corporations, along with the executives that inhabit them, rather than assisting the backbone of any economy: the average working-class citizen. According to The Wall Street Journal, these endless streams of loans are prescient in several ways:
"In one way, guaranteeing lending is a stroke of genius. Money quickly gets into the real economy, unlike with Fed bond buying. Sure, people and companies end up with more debt. But that just ups the political incentive for governments to invent new lending programs to refinance each round of debt; Mr. Napier suggests reconstruction loans will come next, then environment loans, maybe even equality loans. Extend and pretend and the bad debts are never realized."
These bad debts are "never realized "... until they are. While corporations can dissolve and leave shareholders with lousy debt, individuals that take on bad debts during a time when they need them most are saddled with these debts indefinitely. While some c-suite executives of major corporations are slowly gliding downward in the comfort of their million-dollar golden parachutes, average Main Street Joe's and Jills' are forced to confront life-altering decisions such as: do I close my business and lose the livelihood of myself and my employees? Do I compete for these loans with unclear terms? How will I make ends meet? During times of crisis, questions regarding the long term impact of these sorts of Wall Street-friendly policies are less opined. What will the long term impact of rampant central bank stimulus be for the average American's retirement pension? How will these policies impact consumer inflation over the next decade or more?
Jared Dillion of MarketWatch said it eloquently:
"At the time, the Fed was concerned that markets had 'ceased functioning,' and they needed to provide liquidity. Liquidity would have returned over time. Double-digit yields have a tendency to attract courageous capital. Everything the Fed has done has benefited the big over the small. The top 10 companies in the S&P 500 Index will be the top 10 companies in the S&P 500 10 years from now. Nothing will change, and discontent will grow."
This unreality in which the gross misallocation of capital to zombie corporations and executives, while millions on Main Street end up jobless and footing the bill over the long term, is perverse. The notion that this misallocation of capital will somehow never negatively impact the real economy is simply fantasy. Eventually, the birds come home to roost, and unfortunately, the flock fomented by the Fed are all Black Swans.