by John Hussman, Hussman Funds
To the members of the FOMC,
You’ve emphasized the tremendous burden placed on the Fed in recent years, and your dedication to collectively doing right by the country. It’s important to start with that recognition, because as concerned as I’ve been about the impact and economic assumptions behind the Fed’s actions, I don’t question your motives or integrity. What follows is simply information that may be helpful in realistically assessing the outcomes and risks of the present policy course, and perhaps to help prevent a bad situation from becoming worse.
Some brief background
As the head of an investment company, it’s natural to conclude that what follows is simply “talking my book,” but for what it’s worth, the majority of my income is directed to the Hussman Foundation. Academically, I earned my doctorate in economics from Stanford, studying with Tom Sargent, John Taylor, Ron McKinnon, Robert Hall, and Joe Stiglitz, and spent several years as a professor at the University of Michigan and Michigan Business School before focusing on finance.
We’ve done well in prior complete market cycles (combining both bull and bear markets), and were among the few who warned of the market collapses and recessions of 2000-2002 and 2007-2009. In contrast, the half-cycle of the past 5 years has been challenging because of the awkward transition it provoked, following a credit crisis that we fully anticipated. Economic policy failures, departures from Section 13(3) of the Federal Reserve Act (which Congress subsequently spelled out like a children’s book), avoidance of needed debt-restructuring (except in the auto industry), and extortionate cries of “global meltdown” from the financial industry all contributed to a collapse in economic confidence beyond anything witnessed in post-war data. That forced us to stress-test every aspect of our approach against Depression-era outcomes. We missed returns from the market’s low in the interim of that stress-testing, and have foregone the more recent speculative advance because identical features have resulted in spectacular market losses throughout history.
In hindsight, the crisis ended - precisely - on March 16, 2009, when the Financial Accounting Standards Board abandoned FAS 157 “mark-to-market” accounting, in response to Congressional pressure from the House Committee on Financial Services on March 12, 2009. That change immediately removed the threat of widespread insolvency by making insolvency opaque. My impression is that much of the market’s confidence and oversensitivity to quantitative easing stems from misattribution of the initial recovery to QE. This has created a nearly self-fulfilling superstition that links the level of stock prices directly to the size of the Fed's balance sheet, despite the absence of any reliable or historically demonstrable transmission mechanism that relates the two with any precision at all.
The FOMC certainly had a part in creating a low-interest rate environment that provoked a reach-for-yield and a gush of demand for securities backed by mortgage lending of increasingly poor credit quality (I’ll note in passing that new issuance of “covenant lite” debt has now eclipsed the pre-crisis peak largely due to the same yield-seeking). Still, it may ease the burden of power to consider the likelihood that the actions of the Federal Reserve – though clearly supportive of the mortgage market – were not responsible for the recovery. One can thank the FASB for that, provided we’re all comfortable with the reduced transparency that results from mark-to-model and mark-to-unicorn accounting.