October 7, 2020
Editor's Note: This is KC Conway's last WIN commentary for ACRE as he is leaving the Center to concentrate on his consulting business. ACRE appreciates all of KC's contributions over the last three years and wishes him luck in his new venture! He can be contacted at firstname.lastname@example.org. ACRE will continue our weekly insights in an exciting new format in the near future. Stay tuned!
A Fed Lesson and Warning
An important topic was overlooked during the first presidential debate on September 29, 2020, that has implications for our economy and CRE industry that arguably rivals even a Supreme Court appointment. That topic is the Federal Reserve Bank (FRB) and the fact that the next president will have the opportunity to appoint a new chairman of the Federal Reserve in Q1 2022. When one considers the Federal Reserve’s intervention in the economy during COVID-19, exploding its balance sheet nearly 100% well north of $7.5 trillion from less than $4.0 trillion at the beginning of 2020, the Federal Reserve should be an important topic of debate prior to the November 2020 elections.
Current Federal Reserve Chairman Powell was appointed by Donald Trump and confirmed by the Senate in February 2018 for a four-year term. He is the ultimate Washington D.C. and Wall Street insider having even been born in the District, educated in D.C. at Georgetown University, and practiced as a Wall Street Investment Banker from 1984 to 1990. Despite that Washington insider training, by June 2019 Trump was threatening to remove him for failing to cut rates fast enough. Had it not been for COVID-19 and the Fed rapidly cutting interest rates to near zero this past spring, Powell might not still be chairman today.
Unfortunately, many in our industry don’t know enough about the Federal Reserve, its history, and how our Central Bank functions to appreciate the double-edged sword it represents to virtually every aspect of our life. Not only does the Fed set short-term interest rates that influence consumer spending, auto purchases, housing activity, etc., it determines asset prices (by picking the winners and losers in our COVID-19 impacted economy through what it opts to buy and put on its balance sheet), and regulates the banks that influence lending activity. Believe it or not the Fed has been buying Berkshire Hathaway, Apple, Walmart, etc., corporate bonds thinking they needed support during COVID-19. Really? All this while not buying or supporting the municipal bond debt of cities with less than 500,000 in population. New York City got support for its water, transit, etc. bonds, but none to a city in Alabama. None to the first city to file for Chapter 9 bankruptcy during COVID (Fairfield, Alabama, outside Birmingham). None for our 138 college towns or states that have seen revenues decline an average of 29% March through August 2020 (Source: Tax Foundation). The Federal Reserve is a complex and powerful entity in our economy that requires more attention - and at least one debate question.
A few noteworthy items to know about the Federal Reserve include:
Its Origin: The Federal Reserve as we know it today came into existence through the Federal Reserve Act of 1913. Many are not aware that this was the third attempt at the United States having a Central Bank. The first two failed:
- The First Bank of the United States was established in 1791 chartered for a period of twenty years. The US government was the largest shareholder of the bank. Despite its shareholder status, the government was not permitted to participate in management of the bank. The bank accepted deposits, issued bank notes, and provided short-term loans to the government. It also functioned as a clearinghouse for government debt. The bank could also regulate state-chartered banks to prevent overproduction of banknotes. The bank was very successful in financing the government and stimulating the economy. In spite of its successes, hostility against the bank did not fade. Jeffersonians questioned the bank's constitutionality. In 1811, the first bank of the United States failed to be renewed by one vote in both the House and the Senate. See, the country has been deeply divided even back in its early beginnings.
- Second Bank of the United States - After the War of 1812, economic instability necessitated the creation of a second national bank. Due to expanding money supply and lack of supervision, individual bank activity sparked high inflation. In 1816, a second national bank was created with a charter of twenty years. Three years later, during the panic of 1819 the second bank of the United States was blamed for overextending credit in a land boom. The Second bank was unpopular among the western and southern state-chartered banks, and constitutionality of a national bank was questioned. President Jackson would come into office on a promise to end the current central bank during his presidency. Under the premise that the bank favored a small economic and political elite at the expense of the public majority, the Second Bank became private after its charter expired in 1836, and would undergo liquidation in 1841. For nearly eighty years, the U.S. was without a central bank after the charter for the Second Bank of the United States was allowed to expire.
The Federal Reserve System Today – Where and Why: The Federal Reserve Bank System (FRB) as we know it today was created on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law after an interesting “hunting trip” to Jeckyll Island, Georgia, without any public or congressional knowledge or participation led by the most wealthy of the day – JP Morgan, the Rockefellers, National City Bank of New York,, etc. Today, that hunting trip would be a ESG-type event led by the CEOs of Blackrock, JPM, Facebook, Tesla, Amazon and the other FAANG gang. Some things have not’ changed. The FRB system today is composed of a central and allegedly independent governmental agency with its Board of Governors headquartered in Washington, D.C. There are 12 regional Federal Reserve Banks, located in select cities throughout the U.S. that resemble nothing in terms of the influence of industry in today’s economy. How is the Federal Reserve divided up geographically? Note the following graphic from the FRB 100th anniversary website.
Federal Reserve Items/Links to track:
There are many, but the top-3 recommendations include:
1. FOMC 2020 Meeting Calendar – Note there are not 12 monthly meetings and these FOMC dates can and typically impact markets and are when interest rate decisions are made. These move markets and the CRE industry in areas like CRE finance, bank lending through tools like IOER (Interest paid to banks on Excess Reserves) which influence whether banks extend credit or hold it back and clip a coupon from the Fed versus take lending risk.
2. Federal Reserve's Monthly Release of Balance Sheet – This is a fascinating monthly release that shows what the Fed is doing with its balance sheet and how it is expanding or contracting. Remember that the Fed does not produce or sell anything. The way it attains resources to grow its balance sheet is by calling the Treasury and asking them to “print currency.” Note the Federal Reserve’s Balance Sheet has grown to over $7.1 trillion from less than $4.0 trillion pre-COVID and beyond the $4.3 trillion peak reached following the 2009-2011 Great Recession. It is important to understand that as the Money Supply (M2) expands/grows, our currency is deflated. It is how a FIAT currency like ours can be damaged/devalued to a point of no return like Germany’s was 1919-1923. FIAT currencies can and do collapse. Read John Lifflander research on this topic.
3. Federal Reserve's Beige Book: Formally known as the “Summary of Commentary on Current Economic Conditions,” this report is more commonly referred to as the Beige Book. It is published eight times per year. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its District through reports from Bank and Branch directors and interviews with key business contacts, economists, market experts, and other sources. The Beige Book summarizes this information by District and sector. An overall summary of the twelve district reports is prepared by a designated Federal Reserve Bank on a rotating basis. This report is where the rubber meets the road and you can go to get real anecdotal information on what is happening uniquely in the states/geography in each Federal District. What is happening in say the SE is reflected in the Atlanta District Bank comments. The calendar schedule for 2020 releases of the Beige Book is as follows: January 15, March 4, April 15, May 27, July 15, September 2, October 21 and December 2.
In summary, the Federal Reserve may be the most impacting entity on our economy. As a result, we need to have a continuing conversation on what the Federal Reserve is doing and who will lead it next in 2022. The FRB is arguably the most complex and least transparent entity in all of U.S. government – including the Supreme Court.
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