Richard Fisher retired last week after 10 years as the president and CEO of the Federal Reserve Bank of Dallas and a member of the Federal Open Market Committee.
He met with AsianInvestor on the sidelines of Credit Suisse’s Asian Investment Conference in Hong Kong to discuss interest rate policy, “lazy” asset managers and the new state of US financial markets.
You’ve described the US economy as the world’s “sweet spot”. How sustainable is that leadership position?
We don’t know because the play’s not over. The answer to your question is how well the FOMC exits what we undertook in order to restore the system. The Federal Reserve’s balance sheet went from $9 billion 10 years ago to $4.5 trillion today. I wasn’t personally in favour of the last round of QE [quantitative easing; QE3 began in 2012 with a monthly $40 billion purchase programme of asset-backed securities; Fisher was the sole dissenting vote at the FOMC] but the committee view was to pour it all in [i.e., engage in a final, massive purchasing of assets]. So now we have this huge balance sheet, of which more than $2.5 trillion represents excess reserves. So far, QE has been successful. Equity markets have tripled in value since the Fed’s balance sheet surpassed $2 trillion in 2009. The economy has been recovering.
How much of that is the Fed’s doing?
As opposed to a natural healing? I’d say the Fed was very helpful in offsetting the negative consequences of a spastic fiscal policy. It’s really been a hapless Congress. Ultimately, however, success will be determined by the great task that has been given to Janet Yellen by the Playwright in the Sky: How well do we exit QE and normalise monetary policy?
Having created this roaring market in bonds and stocks, we helped companies restore their own balance sheets. That’s the good news. But if the Fed mishandles normalisation, given all of this liquidity we created, the impact would be dangerous.
So are investors and companies totally dependent on the Fed’s decisions?
Central banks have achieved this godlike status. Markets are portraying diminutive Janet Yellen [she’s 1.6 metres tall] as though she’s Atlas, bearing the globe on her shoulders. While we are the United States’ central bank of central banks, we are not the world’s central bank. Yet everyone is looking to the Fed for direction. My concern is how we get this big camel through the eye of a needle. It’s a hard thing for the Fed to do.
Central banks made investors’ jobs easy. Analysts have become lazy. We cut interest rates to zero and squeezed down the yield curve. That changed the way analysts discount future cash flows, and we ended up with roaring bull markets. It’s not just the Fed: since the ECB [European Central Bank] announced its version of QE, the German DAX has risen by 40%.
The hurdle for investors has become too low. If and when the Fed increases the base interest rate, it will impact how investors discount things.
But lots of portfolio managers recognise that securities markets are overpriced. Nothing is cheap.
People say it, but if they try to do something about it, they get scared to death. No one’s making the first move.
Many portfolio managers at active shops argue that monetary policy has undermined fundamentals, that they can’t make a first move.
Before I joined the Fed, I ran an absolute return fund. We didn’t have to worry about relative performance. The people you’re referring to, they’re all about relative performance. They’re not responding to these conditions by reducing their long [Treasury] exposures or going net short, because they’re afraid of missing out on short-term performance. So this whole thing becomes like a giant game of chicken – that’s the trap these people have fallen into. I don’t think that should mean if there is a market correction, that the Fed should stay away from doing what’s best for the real economy of the United States.
Many pension funds and insurance companies, worldwide, are required by their regulators to buy fixed income. What about them?
Good pension fund managers have benefited from all of this [easy monetary policy]. QE came at the expense of savers and depositors, people mostly in my age group. If interest rates begin to rise, those pension fund managers will just have to position themselves accordingly. While their options are a consequence of Fed policy, the Fed can’t conduct policy in order to serve their needs.
Are big asset management companies ‘systemically important’?
It’s a hot debate. I don’t think so. If they screw up, tough luck.
The argument has been made that because the big institutional funds track the same benchmarks, the herding makes the buy side a systemic risk.
I urge your readers to read Charles Mackay’s “Extraordinary Popular Delusions and the Madness of Crowds”, which was published in 1841. “Men think in herds,” he wrote. This has been a repetitive issue, there’s nothing new there and we can’t do much about it, whether you’re talking about the Mississippi Bubble or CLOs and CDOs. The Fed can’t overreact if there’s a market correction, or get involved in the business of asset allocation or social engineering.
Central bank policies have created a gigantic herd, like wildebeests in Africa, by making interest rates zero and sparking massive bull runs. The question is, where are the lions that are going to bring some of these wildebeests down?
And when will the predators emerge?
We won’t know the success of QE until we reach the end of the normalisation process, and that could take years. If it’s successful, Ben Bernanke and Janet Yellen will go down as great heroes. If it’s not, central banks will be pounded by the politicians.
Current futures on federal funds rates suggest the market expects rate rises to be low and drawn out. Is that good, because it shows the Fed is managing expectations, or is it bad, because it suggests investors are worried about the economy?
The surveys don’t suggest people are pessimistic. I think it just reflects an expectation that the Fed will stretch out the pace of any change to the federal funds rate. And you know markets; they can change their drift pretty quickly.
Does the FOMC discuss problems of liquidity in bond secondary markets?
There’s not much to discuss. Those regulatory issues around bank capital are based on Dodd-Frank, and we must implement the law as it is written. There’s a history that we are correcting for. Alan Greenspan took his hand off the regulatory wheel because of his belief that financial institutions could monitor themselves, so we had extremely lax standards. I like to tease Alan that he was an Ayn Rand regulator, and the world doesn’t work that way.
Today we have created a strong central authority represented by Daniel Tarullo, a member of the Fed board of governors and also vice chairman of the Federal Financial Institutions Examination Council, who carries out stress tests and higher supervisory standards. Although I notice some banks like Citi are developing large derivatives books again.
Is complexity in financial markets getting easier or harder to measure and identify?
The exuberance that the Fed has engineered has led to a new generation of CLO and CDS derivative transactions, to excesses, to a reach for yield. I like to quote Charles Dickens’ Little Dorrit, in which one character defines ‘insurance’ as one person who can’t pay getting another person who can’t pay to say he can pay.
What happened was that, thanks to the innovations of Sandy Weill, Wall Street took depository institutions – commercial banks – and added income-statement operations – that is, investment banking – and merged the two cultures. I’d argue these two cultures don’t mix too well. Now we’re forcing out some of the income-statement mentality to ensure the deposit base remains strong. To what degree is liquidity needed to operate a sophisticated financial system, and who guarantees that risk? Before, government backing was just for depository institutions, but then banks starting using low-cost depositor money to back high-risk operations.
Are you satisfied that post-crisis regulation has defused the socialisation of investment bankers’ risk appetite?
We’re further away from that because of Dodd-Frank, but we have also greater concentration. The top five financial institutions now capture more deposits. But I don’t think there would be popular will to another bailout. The big banks are not well liked in the halls of Congress – although plenty of Congressmen and Senators seem happy to accept bank campaign donations.
China was a bulwark of stability during the 1997 Asian financial crisis. During the 2008 crisis it was both a source of stability and economic growth. But today its economy is growing less quickly and it has its own credit problems. If there is a market crash, can China remain a source of stability?
They are working hard to clean up their banking system. They have a significant problem with shadow banking and there are questions about the credit quality of their financial institutions. So I’d say the situation is less stable than before. But the Chinese have also gotten an awful lot done. They are moving in the right direction and their capital account is not open. Their authorities are trying to ensure their banking system is not vulnerable.
When you became president at the Dallas Fed, you changed the office’s hold music from country to classical. Will that legacy endure?
My predecessor had been from Georgia, not Texas, but he loved the cowboy culture. But Dallas is an arts centre. The Fed’s office building is across the street from the opera house. I love country music, but that is not in keeping with what North Texas is all about. We’ve gone from cow chips to computer chips, cowboy boots to loafers. Texas accounts for 37% of oil wells in the US but those make up only 2.6% of the state’s workforce: it’s a highly technological business in what has become a highly diversified economy.