Good news from the financial crisis: Despite critics, QE was the emergency remedy that worked
Anyone attempting to understand the legacy of Lehman Brothers could start with two phrases that bookend the biggest bankruptcy in American history. The most famous is “too big to fail”. The most important is “quantitative easing”.
During the decade since Lehman collapsed, “TBTF” appeared in 2241 articles on the Bloomberg news terminal and became the title of a best-seller and a movie. “QE” shows up in more than twice that number of news articles. The lopsided difference helps explain lessons from Lehman’s demise.
Before September 15, 2008, when the 158-year-old firm filed for Chapter 11 and thereby precipitated the deepest economic deterioration since the Second World War, few people believed the authorities would allow a behemoth like Lehman to trigger other insolvencies and shutter much of the global financial system.
When the fourth-largest US investment bank did go under, credit evaporated and there was nothing preventing its larger peers from descending to a similar fate.
That’s when the Federal Reserve Bank of New York, acting as the agent for the US Treasury, initiated its unprecedented and controversial monetary policy.
Its quantitative easing programme involving the monthly purchase of immense piles of bonds not only reversed the largest-ever plunge in US gross domestic product, it also sowed the seeds of the ensuing 105-month expansion that has all the signs of becoming the longest in US history.
For the first time since it was founded in 1913, the Fed acquired all kinds of financial assets that were frozen after the Lehman default. It kept overnight borrowing costs at zero and allowed Goldman Sachs and Morgan Stanley to become commercial banks benefiting from such liquidity.
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. And it finally discouraged Wall St from taking ever-increasing risks with the money of shareholders and depositors.
Quantitative easing was accompanied by “stress tests” for US financial institutions in 2009.
They showed how much capital the
19 largest banks needed to survive another Lehman-style debacle.
The Fed ended QE in 2014, has increased interest rates seven times since 2015 and last year began reducing its US$4 trillion balance sheet as debt acquired during the bond-buying programme matured.
It’s doubtful that the economy’s robust health would have occurred without QE. But the academics, billionaires and politicians who denounced the policy as ruinous in a public letter with 23 signatures in
2010 still haven’t acknowledged QE’s role in the recovery and subsequent prosperity.
The group, led by Stanford University professor John Taylor, billionaire hedge fund manager Paul Singer and US House Speaker John Boehner, predicted that the monetary stimulus would provoke runaway inflation, damage the dollar’s special role as the world’s reserve currency and send bond prices plummeting. They were wrong.
The recovery from the death of Lehman proved to be the most dynamic since 1980, with the rebound making the US the only developed economy to attain record GDP by 2015, according to data compiled by Bloomberg.
The dollar rallied 20 per cent, the most of any developed economy’s currency during the past nine years.
After the crash of 1929, it took 25 years for the stock market to recover. The S&P 500, which lost 47 per cent of its value in the bear market from September 2008 to March 2009, was at a record by 2013 and is up 327 per cent from the recession low, according to data compiled by Bloomberg.
Investors who anticipated a disaster for the bond market missed a total return (income plus appreciation) of more than US$1.5 trillion from owning US government securities during the period of quantitative easing. US Treasuries produced a 24 per cent total return, or 2.6 per cent annually, since 2009. The rate of inflation, meanwhile, averaged 1.6 per cent, which means that savers who kept their money in Pimco’s Total Return Fund easily beat inflation, with a total return of 37 per cent, or 4 per cent a year, according to data compiled by Bloomberg.
Since the end of 2009, shares of US financial firms gained 173 per cent, 88 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.
The value-at-risk (VaR) of the portfolios of American banks, a measure of how speculative they had become by 2008, was significantly reduced by Fedimposed regulations.
JPMorgan’s VaR declined 90 per cent while Bank of America’s was reduced 86 per cent, Citigroup’s by 76 per cent and Wells Fargo’s by 68 per cent.
Ten years after its collapse, Lehman Brothers remains the world’s worst financial nightmare because it was too big and it failed. If it wasn’t for QE, we would still be living the bad dream. ●