The Federal Reserve's zero-interest-rate policy is going to hamper the recovery because it discourages bank lending. When lending is held back, it will prevent a more aggressive economic recovery and particularly in the housing market.
Published: Wednesday, 1 Feb 2012
By: Jeff Cox
The Federal Reserve's zero-interest-rate policy is hampering economic recovery by discouraging bank lending, Pimco bond titan Bill Gross said in an analysis.
For banks, a healthy lending environment exists where they can borrow at low rates in the short term and lend at significantly higher rates over the long term, a situation that creates a profit through a positively sloped yield curve.
When the slope is tighter, banks still can make money if they can count on the principal value, rather than the yield, of their bonds rising. Bond prices rise when yields fall.
In the current environment, though, near-zero rates mean less room for appreciation either way — from a steepening yield curve or in price gains that would accompany lower yields. Gross said that's holding back lending and thus preventing a more aggressive economic recovery, particularly in housing.
"Zero-bound money may kill as opposed to create credit. Developed economies where these low yields reside may suffer accordingly," Gross wrote on the Pimco Web site. "It may as well, induce inflationary distortions that give a rise to commodities and gold as store of value alternatives when there is little value left in paper.
Banks were near the bottom of stock market performers in 2011 as the industry suffered under the weights of intensified regulation, a lackluster economy and worries over contagion from the European sovereign debt crisis.
Yet the group has enjoyed a relief rally thus far in 2012 even as earnings have remained mediocre.
Roughly as many banks beat earnings estimates as missed in the previous quarter — 44 percent to 43 percent, with 13 percent meeting Wall Street expectations — though financials have underperformed the market since earnings season began, according to Keefe, Bruyette & Woods, a New-York based financial services specialist.
Banks actually reported 1 percent loan growth for the quarter, with large regionals especially aggressive. But net interest margins remain under pressure — flat for the same period last year and actually down from the previous quarter, KBW reported.
Gross said the retrenchment of banks is a troubling sign that he expects to persist well into the future as financial markets swing from one extreme to the other in terms of risk-taking.
"A 30- to 50-year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets — bonds, stocks, real estate and commodities alike — is now delevering because of excessive 'risk' and the 'price' of money at the zero-bound," he wrote. "We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time."
The most recent Fed Senior Loan Officers Survey provided mixed signals about the state of lending.
Demand, particularly from small businesses, rose — in fact, more so than the "willingness to lend" category, which grew at its slowest level in two years.
"While lending standards continue to ease, the pace of progress has been set back some," Citigroup economist Steven C. Wieting said. "Such readings don’t suggest restrictions in credit supplies will weigh on economic activity outright, but that broad conditions and bank lending are not highly accommodative despite a near zero Fed funds rate."
Gross said the Fed has disincentivized lending by allowing banks to earn as much by parking their money in overnight reserves as they would in a two-year Treasury.
Fed Chairman Ben Bernanke, according to Gross, is making "it up as he goes along in order to softly delever a credit-based financial system which became egregiously overlevered and assumed far too much risk long before his watch began."
Gross added that investors need to be alert "to the significant costs that may be ahead for a global economy and financial marketplace still functioning under the assumption that cheap and abundant central bank credit is always a positive dynamic."
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