The Damage Done by the Federal Reserve

A recent interview on CNBC with former Dallas Federal Reserve President, Richard Fisher, now Senior Advisor at Barclays, gives us an insider's viewpoint on the monetary mess that has been created by the Federal Reserve's extremely lengthy experiment with near-zero interest rates.  If you would rather watch the interview with Mr. Fisher than read my transcript, you can find it here. 

In his interview, Mr. Fisher addressed the sectors of the economy that he is most concerned about in the current low interest rate environment, whether the Fed should follow the lead of other central banks to lowering interest rates further and whether the Fed will boost rates in June.  Here's what he had to say about the impact of ultra-low rates on two key sectors of the economy:

"A lot of damage is being done.  I'll tell you the industry I'm most concerned about - insurance.  Insurance companies, particularly life companies, are like noble oxen.  They pull that cart forward steadily forever and ever.  They're living in a 1 percent world in this country, but they're pulling a 3-to-6 percent liability cart. It doesn't square.  Banks' interest margins are being hammered.  Money-market funds are trying to squeeze out a return.  This is the kind of stuff, to be honest, sitting at the table, we did not foresee at the FOMC, and if you're in Germany, you're in worse shape because 85 percent of the Germans save through life insurance and their pension funds in a negative interest rate world.  How do you provide for insurance company returns in that kind of...   That's where I would be looking for real concern."

If you want a sense of the importance of yield to life insurance companies, a 2013 essay from the Federal Reserve Bank of Chicago stated that U.S. life insurance companies owned 6 percent of all outstanding credit market instruments in the United States which included $1.5 trillion worth of corporate bonds at the end of 2011.   Here is a table showing their aggregate holdings in 2011:

Here is a graphic showing the life insurance holdings by industry and the percentage of the bonds issued for each sector in 2012:

As you can see from this data, yield is extremely important to life insurance companies; as yields drop, they are forced to invest their accumulated premiums in riskier assets to ensure that they have sufficient funds to meet their insurance obligations.  

When asked whether the Federal Reserve should lead on higher interest rates or follow the lead of other central banks that already have negative interest rates, Mr. Fisher commented that:

"I'm an American.  I believe in leading not in following and we have to do what's right for our country.  I don't want to sound too "Trumpian" here, but not "America First", but the point is do what's right for the long-term health of our economy and for those institutions that underpin our economy like the insurance companies, like the banks, like others."

When asked whether the Fed will move on rates in June, he stated that:

"This is a guessing game. Come on.  I have no idea but they've got the Brexit and all this kind of stuff.  I think there's a little bit of buyer's remorse.  They should have moved earlier, everybody agrees to that.   Now it's easy to say that in hindsight....  I would like to see them move in July or June and again in September...  Remember, Janet Yellen talked about the asymmetry of risk when she spoke here in New York.  What does that mean?  There's very little to give back in case we have backwards slippage.  I'd like to have something to give back.   The Bank of Israel did it three times under Stan Fisher who's now Vice Chairman of the Fed and he had to give it back.  What she was saying during that speech was that there's nothing to give back.  And the punchline of that speech was that, the penultimate paragraph, which said the only thing that we can do is go further out the yield curve and the reinvestment of the $1.1 trillion maturing between now and 2019.  Flatten the curve even further.  That would be the only tool left in the Fed's toolbox." (my bold) 

Here's the quote from Janet Yellen's  March 29, 2016 speech to the Economic Club of New York that Mr. Fisher is referring to when he mentions the asymmetry of risk:

"Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric. If economic conditions were to strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy. By contrast, if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.

One must be careful, however, not to overstate the asymmetries affecting monetary policy at the moment. Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed." (my bold)

It's interesting to note that, according to Mr. Fisher, the "only tool left in the Fed's toolbox" is a tool that would further punish the already penalized life insurance companies and banks that are, like all individual investors who are risk adverse, suffering in this prolonged low interest rate environment.  God help us all if the Federal Reserve ever lowers interest rates into negative territory like Japan and Europe.