Response to Chris Whalen's Op-Ed in American Banker

(Wall St. analyst and frequent CNBC guest Christopher Walen wrote and interesting Op-Ed in American Banker today, focusing on how QE's effects are not as the mainstream believes them to be. In this article, Walen takes on a few MMT talking points, focusing on how the Fed's asset purchases remove interest income from the economy and are therefore more biased towards the deflationary side. The article is pasted below, with my comment in italics. )

Former Federal Reserve chairman Ben Bernanke argues in a new blog post that low interest rates are a reflection of the state of the economy and that a zero interest rate policy will somehow improve economic growth and employment. But he forgets the warnings of economists such as Walter Bagehot and John Maynard Keynes about the dangers of keeping interest rates too low for too long.

I assume those dangers are taken to be "misallocated prices or resources"? Seems to forget that rates were low during 40s, 50s, and 60s. 

In fact, both zero rates and quantitative easing, or QE, are actually making deflation worse. (Although the Fed officially ended its bond-purchasing program in October 2014, it continues to reinvest proceeds from the bonds it already owns.)

Agree.

These policies are also causing a precipitous decline in consumer demand, which is visible in lower prices for key commodities such as copper, oil and natural gas. And they come at a long-term cost to individual investors and financial institutions.

Obviously we have weak aggregate demand right now, which QE makes worse. But blaming low commodity prices only on QE goes to far IMO. 

In the fourth quarter of 2014, the total cost of funds for all U.S. banks was just $11 billion, versus over $110 billion in 2008. Meanwhile, as Kroll Bond Rating Agencyobserves in a research note, banks earned $119 billion in gross interest income in the same quarter — illustrating the huge wealth transfer from savers to debtors occurring under the Fed’s policy of financial repression. 

Ok, but what were bank gross interest incomes before QE? He doesnt say, so that 119 billion figure is out of context. And if banks are earning so much interest income, why are their earnings and share prices still so low? Also, I am hearing the opposite from the Credit union/ community bank world....they are saying that net interest margins are tighter than ever. Maybe it is different for mega-banks? True that whatever number it is demonstrates a shift of income from savers to debtors, but in a nation where most of the populace are net debtors, this is a GOOD thing. Lower rates on home mortgages, auto loans, consumer loans, student loans, etc. Most savers are the wealthy who are doing fine anyhow. 

Savers and investors do not live in the theoretical world of “equilibrium interest rates.”

Of all the theoretical worlds, I dont think one with 'equilibrium rates' is the one I'd chose. Something more like Middle Earth perhaps ;)

Net interest income for U.S. banks is higher than ever in dollar terms. But the negative impact of low interest rates is clearly reflected in falling returns on earning assets. U.S. banks earned $108 billion in net interest income in the fourth quarter, just 0.69% of the $15 trillion in total assets, versus 0.80% in 2010, when system assets totaled just $13.3 trillion, according to the Federal Deposit Insurance Corp. In other words, bank assets increased by 12%, but income per dollar of assets fell almost 10%.

Yes, but those asset prices have been propped up by QE...so the returns post QE will obviously be lower. When asset prices go up, rates go down. So while interest income streams may be lower, bank assets are also worth more which boosts their capitalization which is arguably more important. 

Bank earnings and asset returns are likely to continue experiencing pressure through 2015 and beyond as institutions try to offset declining net interest income with efforts to boost fee revenues and reduce operating costs. 

True. Banks now relying more on checking account fees/overdrafts for income.

But more importantly, the steady decline in bank asset returns provides a striking illustration of why the Fed’s policies of zero interest rates and quantitative easing are not working.

Depends what "working" is supposed to mean!

The decrease in banks' interest expense comes directly out of the pockets of depositors and investors. John Dizard of the Financial Times wrote recently that it has become mathematically impossible for fiduciaries to meet beneficiaries’ future investment return target needs through the prudent buying of securities.

Right, but borrowers save an equal amount that is lost to savers. Again most of the country are borrowers, not savers/investors so this is a net positive for most of the populace. Interest rates are like a see-saw since every dollar borrowed is a dollar saved: Raising rates hurts borrowers, lowering rates hurts savers-- in equal amounts, except for the $17 trillion in Treasury securities which are a NET asset for the economy. Lower rates on Treasury does represent a net loss for the economy, since the "savings" from lower Treasury rates are just disappear into the Treasury General Acount ie reduce the deficit. 

Since many pension funds are required to purchase mainly Treasuries I can see how lower rates hurt them. They may need to shift into riskier investments/change their prospectuses to meet growth targets in the future, since the Fed has corned the market of safe Tsy debt. 

The stated goal of the Fed's policies is to boost economic growth and employment. But in practice the policies fall short of the mark, because zero interest rates are taking trillions of dollars in income annually out of the global economy.

Agree with the theory, but I don't see how trillions are removed. At most, the Fed sends about $100 billion back to Treasury. The rest is reflected in savings for borrowers, which is not a loss to the economy. Any macro difference would be due to difference in propensity to spend between savers and borrowers. 

While the Fed pays banks 25 basis points for bank reserve deposits, the remaining spread earned on the Fed’s massive portfolio of Treasury and agency securities purchased via quantitative easing is still being transferred to the U.S. Treasury. This policy does nothing to support private credit creation or job growth.

Agree completely. This is a dumb policy that acts as a tax. But it does reduce TEH DEFICIT, which is supposed to increase confidence and job growth duh!!

Indeed, the Fed should increase the rate paid on bank reserves immediately and thereby neutralize transfers to the Treasury.

This would require raising IOR which means increasing the FFR target, something that may happen later this year but gradually at best. I dont see the public purpose of raising rates just to boost bank income... Remaining transfers to Treasury should be offset by payroll tax cuts in any case, or at least be credited to the SS Trust Fund. 

Moreover, zero rate policy as practiced by the Fed and now by the European Central Bank is actually depressing private-sector economic activity by taking money out of the hands of consumers and businesses.

Only those that are NET savers/fixed income, which is minority. 

And by using bank reserves to acquire government and agency securities via QE, the Fed has been artificially pushing up the prices of financial assets around the world even as income and GDP stagnates.

Only because Treasury has been selling its "debt" at a discount in the first place. No public purpose to this. 

Public companies are using low interest rates to fund stock buy-backs instead of making new investments.

But QE has lowered rates all through the term structure, making it cheaper for business to borrow money/issue their own securities, which is a good thing! No reason for US government to be competing in the capital/paper markets with private businesses which actually need the money!

Higher asset prices due to purchases by the Fed and ECB under QE are clearly a temporary phenomenon. Without a commensurate increase in national income — impossible with zero interest rates — the elevated asset prices resulting from QE cannot be validated and sustained.

Not true. Umm, ever heard of fiscal policy? We can easily boost national income by just spending more/taxing less! Appropriate fiscal policy can support any level of asset prices. 

Thus with the end of QE in the U.S. and the possibility of higher interest rates, global investors face the decline of valuations for both debt and equity securities. This reality is already weighing on global financial markets.

Except rates have continued to go down post QE, and weak growth means this will likely continue...

Zero rate policy and QE do not address the core problems of hidden off-balance-sheet debt that caused the 2008 financial crisis. That is, banks and markets globally still face tens of trillions of dollars in on- and off-balance-sheet debt that has not been resolved.

True. Does anyone know what happened to all those CDOs?

Bad debt is a drag on economic growth, from German banks' loans to Greece to underwater mortgage loans in the U.S. Governments in the U.S. and EU refuse to restructure the bad debt because doing so would force banks to take losses and incur further expenses for already cash-strapped governments. 

Eurozone governments are cash strapped, ours is not!

But no matter how low interest rates go and how much debt central banks buy, the fact of financial repression in which savers are penalized to the advantage of debtors has an overall deflationary impact on the global economy.

"Financial repression" is a loaded term. With a fiat currency with a natural rate of zero, any rate above zero is a subsidy to passive savers that only occurs because of central bank intervention to support this rate! So the Fed's current ZIRP is just the end of a subsidy, not repression of any sort. 

To be clear, the Fed was right to aggressively lower interest rates after the 2008 crisis. But continuing with zero interest rates and quantitative easing for seven years after the crisis is in conflict with the goal of increased employment and growth. By robbing individual savers and financial institutions of income, and artificially boosting asset prices, the Fed and ECB are unwittingly creating the circumstances for the next financial crisis.

Nothing is 'artificial' about one public policy versus another. Both are just policy choices--see my previous blog post on Bernanke! Savers arent being robbed, just no longer subsidized. People who have saved in the stock market instead of bank accounts/CDs are doing very well. 

The Fed and ECB should therefore abandon zero rates and quantitative easing and move to gradually increase interest rates to restore cash flow to the financial system. Mr. Bernanke and his former colleagues on the Federal Open Market Committee ought to recall Adam Smith's famous dictum that the “great wheel of circulation" is the means by which the flow of goods and services moves through the economy. If the Fed really wants to fight deflation and eventually hit a 2% inflation target, then we must embrace policies that make the proverbial wheel turn faster, not slower. We can do this by gradually ending financial repression and restoring balance to global monetary policy.

So we agree that QE does not help the economy, but dont agree on way forward. I think ZIRP should be made permanent, and economic growth should be run through fiscal policy, which not only works better but is more closely in line with our Constitutional principles (spending for the "general welfare").