Who Needs the Fed?. John Tamny

1988, at which time “junk bonds” had a much better reputation, these high-yielding instruments were but 1 percent of savings and loan assets.¹⁶ More than 95 percent of corporate debt for companies with earnings greater than $35 million (and a 100 percent of debt for companies with earnings less than $35 million) is rated “junk.” Milken’s innovation was securing more credit for them to grow.¹⁷ A banking system that the Fed interacts with, and that is naively seen as the source of economy-wide credit, hasn’t historically tangled with this aspect of the credit market, which suggests that banks are increasingly irrelevant to our economic health.

      Importantly, Milken was not done. Thanks largely to financing from traditional banks and investment banks, U.S. corporations had purchased all manner of companies unrelated to their core mission. Others had become top heavy in terms of unaccountable executives enjoying excessive executive perks and had consequently grown somewhat flabby by the 1970s. Milken’s innovation involved backing upstarts largely shunned by the blue-chip banks (think Carl Icahn, T. Boone Pickens, Reginald Lewis—the first black CEO of Fortune 500 company Beatrice Foods) eager to restructure corporations that were operating at a fraction of their potential. This included “breaking up” large-for-large’s-sake corporations by selling pieces to investors with a stated objective of running the business lines purchased more effectively. These “hostile” takeovers performed by Icahn, Pickens, and other outsiders were similarly shunned by establishment banks, mainly because the blue-chip firms these “corporate raiders” eyed for necessary restructuring were often the banks’ clients. Milken had created yet another market, and he was a magnet for credit.

      Milken was so successful at discovering companies worthy of both finance and take over that investors lined up to participate in his deals. Fischel writes:

      Drexel became known as a firm that could, if necessary, finance a takeover bid by raising billions of dollars within a matter of hours. Its reputation was so formidable that a Drexel-backed deal for billions of dollars could go forward even if no money had been raised. All that was necessary was a letter from Drexel announcing that it was “highly confident” the funds would be available when needed.¹⁸

      Although Milken frequently backed companies and individuals who lacked a track record, his own track record of financing the companies of tomorrow and the fixers of the companies of today made him a brilliant credit risk. So confident with Milken were the sources of credit that they would back his deals based on his word alone.

      With Milken, reputation coalesced beautifully with talent such that he was the ultimate credit risk. Milken rates discussion not only for how willing sources of credit were to entrust him with billions worth of access to the economy’s resources but also because he was raising money for the breed of business entities for which traditional bank credit was either always “tight” or not available at all.

      The Fed lives in an unreal world in which it believes it can render access to resources cheap almost literally by waving a magic wand. But as we know from the first chapter, when those in government, projecting power that is not their own, decree the prices of anything artificially cheap, scarcity is the inevitable result. Thankfully, the Fed’s power over credit is not remotely absolute. If it were, geniuses like Milken who financed those for whom credit was never going to be easy wouldn’t have been able to access it at all.

       CHAPTER SIX

       Ben Bernanke’s Crony Credit

       In my career, the Fed has a 100 percent error rate in predicting and reacting to important economic turns.

      —John Allison, retired Chairman & CEO of BB&T Bank

      IN 2015, Chicago-based hedge fund Citadel hired former Federal Reserve Chairman Ben Bernanke as an outside advisor. What’s interesting about the hire is that the founder of Citadel, Ken Griffin, is said to have a net worth of $7 billion.¹ What Griffin’s financial worth clearly reveals is that he’s a rather brilliant investor.

      In that case, why hire Bernanke? Griffin’s immense wealth signals that he has been right when it comes to predicting the future more often than he’s been wrong. And as John Allison has observed, the Fed is always wrong.

      One guess is that Griffin hired the former Fed Chair with an eye on betting against his economic predictions. Stranger things have happened. While at Goldman Sachs, in a previous career, this writer was made aware of clients who would ask what Goldman’s economists were forecasting, only to build investment positions contradicting those forecasts.

      More realistically, Griffin was likely buying access to Bernanke’s connections at the Fed. Although he is no longer in the Fed’s employ, it’s no major reach to say Bernanke can easily get anyone there on the phone at any time.

      This matters, because what the Fed does can profoundly affect market prices. The Fed, in seeking to influence the federal funds rate that banks charge one another for overnight loans, is frequently a “size buyer” of Treasury bonds held by banks.

      To use but one example, on August 19, 2015, the Fed released its “minutes” to various news organizations, including Bloomberg. The minutes reveal the thinking of the Fed officials whose decisions affect the buying of U.S. Treasuries. Knowledge of what those inside the Fed feel about the economy is valuable to asset managers and hedge funds that trade Treasuries based on this information.

      There was nothing abnormal about what the Fed did. News organizations regularly receive the central bank’s minutes ahead of their release to the general public so that reporters can have a story ready once the Fed officially makes them public. Until then, reporters abide by the embargo rule: They don’t publish any information about the minutes until the Fed has released them.