“I understand that you do address issues of valuations through macroprudential policies in the first instance. But there’s a range of assets, and I know you do watch a range of assets. But from Bitcoin to corporate bonds to the stock market in general, to some of these more
Federal Reserve press conference, Steve Liesman, CNBC, January 27, 2021
specific meteoric rises in stocks like GameStop. How do you address the concern that super easy monetary policy, asset purchases and zero interest rates are potentially fueling a bubble that could cause economic fallout should it burst?”
Financial markets understand all too well the positive impact that easy monetary policy has on asset prices. Yet, when anyone tries to take the Federal Reserve to task over distortions, from these supports to asset prices, the Federal Reserve artfully dodges responsibility. For example, former Chair Ben Bernanke absolved monetary policy from contributing to the housing bubble. Federal Reserve Chair Jerome Powell was particularly artful in this latest attempt to deflect critique or question (emphasis mine):
“If you look at what’s really been driving asset prices really in the last couple of months. It’s not monetary policy. It’s been expectations about vaccines…and also fiscal policy. Those are the news items that have been driving asset values in recent months. So I know monetary policy does play a role there. But that’s how we look at it. I think that the connection between low interest rates and asset values is probably something that is not as tight as people think, a lot of different factors are driving asset prices at any given time.”
In the same breath, Powell transitioned from completely disconnecting monetary policy from fueling a bubble to acknowledging “a role” in asset price inflation. The pandemic delivered a particularly powerful mix of interconnected factors: monetary policy, fiscal policy, a global effort to develop a coronavirus (COVID-19) vaccine, and coordinated efforts from the globe’s major central banks. As a result, it is near impossible to untangle the impacts of any one driver acting against the pandemic and the resulting recession. Still, I cringe at the suggestion that the Federal Reserve is mainly a spectator on the sidelines when asset prices spiral higher and higher. At the same time, I appreciate that the Fed loses credibility and constrains its policy options if it ever admits to making a direct contribution to asset price bubbles.
The Fed Lacks Good Options to Prevent Fueling A Bubble
Unsurprisingly, Liesman was not quite satisfied with Powell’s answer. He strategically inserted GameStop (GME) and Bitcoin (BTC/USD) in his question, but Powell refused to take the bait. Liesman followed up with a related question: “Do you see as one of your tools in the toolkit the idea of adjusting monetary policy to address asset values?” Liesman implicitly insisted that the Fed maintains responsibility for soaring asset prices. Powell responded as follows:
“As you know that’s one of the very difficult questions in all of monetary policy. We don’t rule it out as a theoretical matter. But we clearly look to macro-prudential rules, regulatory rules, supervisory tools, other kinds of tools rather than monetary policy in addressing financial stability issues….
Monetary policy we know strengthens economic activity and job creation through fairly well-understood channels. And a strong economy is a great supporter of financial stability. That will mean strong well-capitalized institutions and households will be working and so we know that. But we don’t understand the trade-off between…the sense of it is would you raise interest rates and thereby tighten financial conditions, reduce economic activity, in order to address asset bubbles and things like that…will that even help? Will it actually cause more damage? I think that’s unresolved….it’s not something we plan to do. We’d rely on macroprudential and other tools to deal with financial stability issues.”
Essentially, Powell deferred to the concept that asset bubbles are a necessary evil as a side effect of efforts to support the economy. The Fed has limited control over where money flows, but it wants to make sure that money and credit ARE flowing. On the other side of the same coin, the Fed is reluctant to act against bubbles with tighter monetary policies because such actions risk undermining other parts of the economy. Instead, macroprudential policies provide targeted tools by controlling loan requirements to specific sectors of the economy. However, to my knowledge, these policies have not yet targeted bubbles in the stock market.In the stock market portfolio allocation and trade decisions, not loans, can be a much bigger factor.
A Role for Other Regulatory Bodies
Today’s micro-bubbles in stocks like GameStop (GME) compound the Fed’s challenge of avoiding fueling a bubble. The Fed has no legal authority to stop or even limit the trading in specific stocks. Moreover, micro-bubbles by definition act only in a small part of the market. Their collapse is unlikely to create broad damage to financial markets. If the Fed finds systemic (broad-based and intrinsic) drivers of financial instability, it might push on the regulatory machinery to rein in wild speculation. Before THAT point, other regulatory bodies have their own tools. For example, yesterday, the U.S. Securities Exchange and Commission (SEC) issued this warning about recent stock market volatility:
“The Commission is closely monitoring and evaluating the extreme price volatility of certain stocks’ trading prices over the past several days…Nevertheless, extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence…
…we will act to protect retail investors when the facts demonstrate abusive or manipulative trading activity that is prohibited by the federal securities laws. Market participants should be careful to avoid such activity.
In other words, “buyer and sellers beware” is the operative rule.
A GameStop Sidebar
I feel a bit of irony in the whole GameStop (GME) saga. Over two years ago, I wrote about Robinhood’s offer to award free stock to new accounts. I finally took the plunge in March, 2020. I practically laughed when I got a single share of GME worth $3.94. It looked like a lottery ticket on an outdated retailer headed for imminent bankruptcy. I sold the stock 6 months later after GME doubled. The stock was still barely pocket change, but I marveled at the prospects of repeating this experience. Before I could get myself into trouble, GME entered the stratosphere of micro-bubbles. At one point last week, GME traded for 100x the price of my original award! Now THAT is real money!
My lesson now? Do not under-estimate the power and force of collective action underpinned by market liquidity. Even the technicals cannot “explain” this kind of extreme trading action.
Planet Money broadcast a great backgrounder on the history of the GameStop trade. Apparently, I sold my one share just as buzz was starting to build on GME as a value play and a short squeeze. I had NO idea…
Be careful out there!
Full disclosure: long BTC/USD