The Fed’s Policy Nightmare: How to Raise Rates Without Killing the Big Banks

By Pam Martens and Russ Martens: April 7, 2016 

Logos of Wall Street BanksIf anyone needs one more reason to break up the mega banks on Wall Street, simply look at what happened following the Federal Reserve’s quarter of a percentage point rate hike on December 16 of last year. On that date, the Fed moved off its seven year zero interest rate policy (ZIRP), which had been a bonanza for the banks and a starvation plan for seniors living on fixed income investments like Treasury notes and CDs, and raised its benchmark rate by a quarter of a percentage point to between 0.25 percent and 0.50 percent from its former 0.0 to 0.25 percent.

The following then happened in short order in 2016:

By Friday, January 15, Citigroup closed down on the day a gut-churning 6.41 percent, bringing its share price losses to a whopping 30 percent from its July 2015 high. Citigroup had been the largest recipient of bailout funds from the government in 2008 as well as the largest bank bailout in the history of finance, receiving $45 billion in equity infusions, over $300 billion in asset guarantees, and more than $2 trillion cumulatively in secret loans from the Fed. It could ill afford to be bleeding off its equity capital as banking regulators were attempting to convince the public that they had fixed the too-big-to-fail problem.

By the close of trading on January 18, Morgan Stanley had lost 37 percent in share value from its July high; Goldman Sachs had lost 29 percent since the prior June; Bank of America was down 22 percent from July with JPMorgan Chase down by 19 percent in the same period.

By January 20, a mere 35 days from the Fed’s quarter point rate hike and promise of more to come, the U.S. domestic crude, West Texas Intermediate, was trading at a new 12-year low of under $28 a barrel; globally, stocks had lost $15 trillion since the prior May; the 10-year Treasury note which had closed at a yield of 2.29 percent when the Fed announced its rate hike and plan to begin gradually normalizing rates back up, had gone rogue from the Fed and moved in the opposite direction. Instead of moving up in yield, the benchmark 10-year Treasury was trading on January 20 at a yield of 1.97 percent. (This morning it’s at 1.74 percent.)

On that same day, January 20, Howard Silverblatt, the Standard and Poor’s Dow Jones Indices Senior Index Analyst, tweeted that as of 10:30 a.m. that morning, the Dow Jones Industrial Average’s loss of 10.03 percent year-to-date was the worst ever start to a new year since 1897.

Howard Silverblatt Tweet on January 20, 2016

Howard Silverblatt Tweet on January 20, 2016

By the close of trading on January 27, Citigroup, Bank of America, JPMorgan Chase, Morgan Stanley and Goldman Sachs had cumulatively lost a total of $219.7 billion in market capitalization over the prior seven months as the Obama administration was attempting to convince the public that the banks had become so much stronger as a result of his Dodd-Frank financial reform. The declines in market cap were as follows: Citigroup, down $60.74 billion; Bank of America, down $53.3 billion; JPMorgan Chase, down $47.7 billion; Morgan Stanley, down $30.3 billion; and Goldman Sachs, a decline of $27.7 billion.

On February 3, four of the mega Wall Street banks traded at their 12-month lows during the trading day. Those four were also among the top five holders of derivatives: Bank of America, Citigroup, Goldman Sachs and Morgan Stanley.

Since the Fed began backing off its narrative of more imminent rate hikes, the Wall Street banks have recovered a little of their lost ground but are still dramatically below their 2015 highs.

The Fed now finds itself in the following nightmare policy scenario. It desperately needs to reload its monetary policy bazooka by getting its benchmark rate to a level where it could actually effectuate an easing policy in the next recession or financial crash. But corporate earnings are now in serious decline and even quarter point rate hikes spawn both a perception and the real impact of tightening. On April 1, FactSet reported that earnings declines in the S&P 500 for the first quarter of this year are estimated to be a negative 8.5 percent, noting that if there is another decline this past quarter, it would “mark the first time the index has seen four consecutive quarters of year-over-year declines in earnings” since the financial crisis in the fourth quarter of 2008 through the third quarter of 2009.” (Lately, comparisons to 2008 and 2009 have been popping up like crocuses in spring.)

What played out in the second half of last year and earlier this year is that the Fed’s incessant talk of coming rate hikes sent the price of the U.S. dollar up and crude oil prices skidding. The market perceives the ability of the Fed to raise rates as a signal that the U.S. economy is improving, which means the U.S. dollar will strengthen further as foreign money seeks a U.S. haven for higher rates of return without worry of losses when that foreign money wants to convert back into its own currency. Unfortunately, a higher U.S. dollar negatively impacts the price of oil which is priced in U.S. dollars, as the market perceives that foreign currencies that are declining against the dollar will be able to afford less oil purchases.

Oil price declines feed into share price losses for the major banks. As we reported on February 24, the five largest Wall Street banks have over $203 billion exposure to the energy sector and there is growing concern that the banks are extending and pretending – that is, failing to take adequate reserves for losses while extending out the maturities on dubious loans. The trading action on February 23 was further testimony to this. As we reported, “oil prices dove, the broader stock market swooned, but the mega Wall Street banks took a worse beating than the broader stock market averages. The Dow Jones Industrial Average lost 1.14 percent yesterday while Bank of America, Citigroup and Morgan Stanley were off by more than 3 percent. In an unusual twist, JPMorgan Chase, the bank that analyst Mike Mayo has preposterously called the Lebron James of banking, performed the worst among its peers yesterday, down 4.18 percent.”

Has the Fed backed itself into a policy conundrum in which it is damned if it does and damned if it doesn’t? On September 17 of last year, Reuters reporter Ann Saphir asked Fed Chair Janet Yellen at her press conference if it could be that the Fed would never escape its zero bound range. Yellen’s answer was not particularly reassuring. (The full exchange is below.) Mull all of this over carefully and then ask yourself if the country would have been better off today had it reinstated the Glass-Steagall Act after the crash of 2008 and separated the FDIC-insured deposit-taking banks from the globe-trotting, derivatives-trading, dark-pool casinos on Wall Street.

Ann Saphir: “Ann Saphir with Reuters. Just to piggyback on the global considerations, as you say, the U.S. economy has been growing, are you worried that given the global interconnecting this, the low inflation globally, all of the other concerns that you just spoke about that you may never escape from this zero lower bound situation.”

Janet Yellen: “So, I would be very– I would be very surprised if that’s the case. That is not the way I see the outlook or the way the committee sees the outlook. Can I completely rule it out? I can’t completely rule it out. But really that’s an extreme downside risk that in no way is near the center of my outlook.”

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