Not so free markets

It hardly seems contrarian or in any way original, these days to engage in a bout of “Fed-bashing”. And yet the appeal is almost irresistible, even some 3 and a half years after the onslaught of the “global recession”. In spite of my natural inclination to question the predominant opinion of market pundits and armchair economists (are here any other types out there?), I will merrily join them just this once as they continue to aim their metaphorical darts at Mr. Bernanke.

So, what prompted this sudden round of Anti-Fed sentiment?. To be perfectly honest, there’s little sudden about it. Ever since the crisis meetings held by our friend Ben in late 2008, in conjunction with the EU’s ECB, the UK’s BOE and Japan’s Central Bank, I have followed the actions of the Federal Reserve with a critical eye.

Sure, at the time as Lehman’s last hours reverberated across financial markets world-wide, I, like most sane people, felt that the coordinated actions of central banks across the world were not only warranted but in fact essential to hold our fragile confidence-based system together to survive and see another day. However, not long after that fateful second week of September 2008, the actions of both the Fed and indeed the US Treasury took a rather random turn. On the one hand, backstopping (ruined) financial giants like AIG whilst at the same time blatantly interfering with free functioning markets via the temporary ban on short-selling activities.

Remarkably enough, this sort of behavior simply has not abated even as we enter 2011. But how could it? After all, the main man behind the wheel, Mr. Bernanke, has willingly admitted that he simply did not see the crisis coming and more importantly “it could not be predicted”!. In short, ordinary citizens, sorry I meant tax-payers, are asked to trust a man who is unwilling and unable to see the obvious bubble-formation on the way up and hence proclaims to be powerless to act. You’d think this weakness would work both ways right?. Wrong.

Consistent, repetitive and clearly excessive use of the tools at Mr. Bernake’s disposal (direct control of the money supply and indirectly of interest rates) has been the hallmark of his actions for the last 36 months. The Governor’s ability to make errors doing all phases of the bubble-to-bust cycle, firstly of omission and ultimately of commission defies the most basic logic. As I write these lines, the second round of money printing is well under way in the US and interest rates remain dangerously close to zero, providing an enormous distortion in the fundamental functioning of a market economy.

Ultimately, as the first signs appear to point that the worst is over and indeed this too “shall pass”, what remains in place is the foundation for a much larger disaster in the future, aided and abetted by a reckless, short-sighted approach. Tax-payers the world over can thank Mr. Bernanke for transferring what was essentially private-market risk onto the wider public ,i.e. us.

On a more micro-level, the damage done to, would-be shrewd asset allocators or to the more mundane community of individual stock pickers out there, has been and continues to be very substantial. The Fed’s actions have made the distinction between weak and strong, well-managed companies very blurry indeed. In the words of Barclay’s strategist Matthew Rothman:

“… After all, a company that is generating lots of free cash flow and has a strong balance sheet …will not be particularly helped by a cheap money regime. Free money doesn’t help them. Instead, it is a company with low cash flow and no cash reserves… that will be disproportionately helped by what is effectively free money. In these situations, true fundamental investors who focus on such banalities as valuations, free cash flow generation, the repeatability of earnings and the return on shareholder equity find themselves struggling to generate returns”.

It is against this backdrop of market tampering that investors must operate in. I just hope that the trend of free money is soon reversed and we all learn to live with the consequences and proven virtues of true free markets.