New York Federal Reserve Drives the U.S. Expansion
(Bloomberg) -- Nine years ago this June, the worst recession since the Great Depression ended, after the unprecedented collapse of home prices, America's biggest bankruptcy, the highest unemployment rate in 25 years, and a stock market that lost almost 50 percent of its value. The U.S. government was a driving force behind that recovery, especially through the Federal Reserve system. Then as now, there was one bank to rule them all: the Federal Reserve Bank of New York.
Among the 12 regional banks created by the Federal Reserve Act of 1913, the New York Fed has the unique responsibility of executing monetary policy, supervising and regulating financial institutions, and helping to maintain U.S. payments at home and abroad.
Immediately after Lehman Brothers filed for Chapter 11 bankruptcy protection on Sept. 15, 2008, the mood was so uncertain that Mohamed A. El-Erian, then chief executive officer of Pimco, manager of the largest bond fund, asked his wife to "go to the ATM and take as much cash as she could." El-Erian, who is now a Bloomberg Opinion columnist, explained: "I didn't know whether there was a chance that banks might not open."
That's where the New York Fed comes in.
Its controversial initiatives during the final quarter that year helped not only to reverse the largest-ever plunge in American gross domestic product, but also to foster the ensuing 108-month expansion that has all the signs of becoming the longest in U.S. history.
It's no accident that interest rates and inflation still are well below their combined level preceding every downturn since 1955 and that American companies, measured by their debt ratios, are the healthiest since such data was compiled by Bloomberg in 1995.
For the first time since its inception, the Fed masterminded the acquisition of myriad financial assets that were frozen after the Lehman default while keeping overnight borrowing costs at zero. This coincided with government interventions to prop up Bank of America and Citibank, insurer AIG, mortgage originators Fannie Mae and Freddie Mac, General Motors, and Chrysler.
The Fed introduced "stress tests" for U.S. financial institutions in 2009, conceived by Treasury Secretary Timothy Geithner, a former New York Fed president, to show how much capital the 19 largest banks needed to survive an economic debacle.
Determined to invigorate the economy with greater access to credit, the New York Fed embraced large-scale asset purchases known as quantitative easing, which became the template for rescuing Europe from recession.
During the aftermath of the financial crisis, the New York Fed evolved into a more transparent agent of the public, reducing the scope of conflicts of interest and other risks addressed by the 2010 Dodd Frank Wall Street Reform and Consumer Protection Act.
All of these policies enabled the current expansion to have longer legs and fewer obstacles than the record 1991-2001 boom when Bill Clinton occupied the White House. At this point in the previous economic cycle, the Fed was a month away from completing six interest-rate increases to 6.5 percent, when inflation was 1.66 percent and dozens of dot-com companies perceived as a financial bubble were crashing.
Since 2015, the Fed has raised interest rates six times to 1.75 percent. The Fed's preferred measure of inflation, the Personal Consumption Expenditures Chain Type Price Index, hovers at an annualized 1.9 percent. At the same time, the big and small companies included in the Russell 3000 index show their net debt to Ebitda ratio — or total debt minus cash divided by earnings before interest, taxes, depreciation and amortization — diminished to the lowest on record in 2015. It remains 2.3 percentage points below the Russell 3000 debt ratio of 2000.
While the New York Fed was carrying out its QE initiative, academics, billionaires and politicians denounced the policy as ruinous in a public letter with 23 signatures. The group, led by Stanford University Professor John Taylor, billionaire hedge fund manager Paul Singer and U.S. House Speaker John Boehner, predicted the monetary stimulus would incur runaway inflation, damage the dollar's special role as the world's reserve currency and send bond prices plummeting.
The initial stress tests also were met with derision. Wells Fargo Chairman Richard Kovacevich called them "asinine" in a speech at Stanford in 2009, because they provided opportunities for short-sellers to drive down bank stocks. Two years later, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon asked Federal Reserve Chairman Ben S. Bernanke whether regulators had gone too far in supervising U.S. banks and complained that the new rules were holding back employment growth.
Just the opposite happened.
The unemployment rate tumbled from 10 percent to 3.9 percent, the lowest since 2000.
Among the five recessions since 1980, the most recent recovery turned out to be the most aggressive with the rebound in growth making the U.S. the only developed economy to attain record GDP by 2015, according to data compiled by Bloomberg.
The dollar appreciated 25 percent, the most of any developed economy's currency during the past nine years.
After the crash of 1929, it took 22 years for the stock market to recover its losses. The S&P 500, which lost 47 percent of its value in the bear market from September in 2008 to March 2009, was making new highs within four years and is up 366 percent from the recession low, according to data compiled by Bloomberg.
As for the Fed's naysayers, they missed a bonanza of more than $1.5 trillion from owning U.S. government securities during the period of quantitative easing. U.S. Treasuries produced a 24 percent total return (income plus appreciation), or 2.6 percent annually, since 2009. The rate of inflation, meanwhile, averaged 1.6 percent, which means traditional savers who kept their money in Pimco's Total Return Fund easily beat inflation, with a total return of 36 percent, or 4 percent a year, according to data compiled by Bloomberg.
Since the end of 2009, shares of U.S. financial firms gained 161 percent, 73 percentage points more than their global peers, as the second-best-performing industry among 10 groups led by consumer discretionary companies, including Amazon and Netflix. American banks' so-called value at risk, which made them so speculative in 2008, was significantly reduced by Fed-imposed regulations. JPMorgan's VAR declined 90 percent while Bank of America's was reduced 86 percent; Citigroup by 76 percent; and Wells Fargo by 68 percent.
Last year, for the first time, every bank passed the stress test. Economists surveyed by Bloomberg predict GDP will grow 2.8 percent this year, 2.5 percent in 2019 and 2.1 percent in 2020. That would be the longest expansion in modern times. Huge credit for that must go to the federal government, specifically the Federal Reserve — and most of all, the New York Fed. — With assistance from Shin Pei
To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net.
©2018 Bloomberg L.P.