Many people have speculated whether the Federal Reserve is secretly buying equities on the stock market, but if you ever try bringing up this question, it won’t be long before you will be quickly dismissed as some kind of crazed, kooky conspiracist.
Are these people on to something, though? Does the fed actually buy equities in the open market?
If one were forced to give a simple yes or no answer to this question, the answer would actually be yes — but it’s a little more complicated than that of course. The fed doesn’t actually go out into the open market and physically buy equities, but they also don’t really need to do this either. To understand why, first it is necessary to understand how the fed is actually structured, what the fed actually does, and how they actually do it; and to your surprise, this is all very easy to understand. Anybody can learn, and this article will show you in about 5 minutes.
What is the Fed?
The fed is just an umbrella organization for a consortium of Federal Reserve “branches” that are owned by the banks and brokers; very similar to the Financial Industry Regulatory Authority and the Depository Trust & Clearing Corporation.
The largest beneficiary of credit from the Federal Reserve is the New York Fed, which is a privately owned bank that is chartered by the U.S. government with the task of micro-managing interest rates through a process known as Open Market Operations.
The “Trading Desk”
The New York Fed is the only Federal Reserve branch that is allowed to physically buy and sell treasuries in the open market. Everyday they will attempt to influence interest rates by conducting open markets operations at what they refer to as “The Trading Desk“. Included below is a rough schematic illustrating how this can work.
Short Term Lending
The fed also provides credit for “repurchase agreements”, which is just industry lingo for a short term loan. These loans can be continuous, meaning that even though they typical only last for about one or two days, they can be refinanced repeatedly.
As of today, the fed is currently issuing massive short term repo loans to investment banks at a capacity not seen since the financial crisis. These loans can be used for a variety of purposes, whether that be meeting government mandated margin requirements, or issuing new credit to proprietary traders — one can only speculate. What we do know is that this money will most certainly be lent out at a rate much higher than 1.5%.
The banks can also lend this money to institutional investors, who will then go on to buy equities from the primary brokerage houses.
The fed even holds periodic committees with several of the biggest hedge funds and asset management firms (yes, Ray Dalio even shows up) who give advice and recommendations on how the fed should conduct monetary policy. They say it’s informal, but it seems like a bit of a stretch of the imagination to think that these meetings do not influence fed policy.
Why the fed feels the need to convene regular meetings with the largest recipients of their massive credit infusions is rather puzzling, as it should be obvious to even the most passive of observers that their opinions should be considered as highly conflicted. These are the very people that will be first in line to the feds discounted credit, and remember, this is money that can be lent to consumers at rates as high as 160% per year, or used to buy equities that can be lent to investors at equally high interest rates.
Who are the Directors of these Federal Reserve Branches?
The CEO’s of the biggest financial firms in the country are the directors of the Federal Reserve branches. Currently there are nine directors at the New York Fed, but it’s important to understand that even though the big firms only account for two positions, they are each chosen to represent the interests of the banks from a particular group that is created based upon market capitalization
That term, “market capitalization” is very important to recognize in this case. Think about it for a second. What do you think will happen to the directors of the smaller firms when they refuse to play ball with the directors of the larger firms? Do you think good things are going to happen to them? Probably not.
How many people do you know that have the courage to stand up to an organization(s) with access to deposits equal in size to almost one-third of the entire GDP of the United States of America. Probably not many?
Also, don’t forget that these banks come with an implicit insurance policy against default that is sponsored by again, yours truly, the United States government; the greatest military power the world has ever seen.
This is why when Mr. Gorman says jump (or Sir Gorman, whichever title he appreciates), these small directors will be saying how high — and that is it.
“The fact that there are other directors besides the banker on the Board does not, in practice, prevent this being the result. The banker, who holds the purse-strings, becomes usually the dominant spirit”.
— Louis Brandeis, “Other Peoples Money and How Bankers Use it”, (1914)
So as to the question:
“Does the Federal Reserve buy equities on the stock market?”
They might as well. The banks that own the Federal Reserve branches buy or broker most of the equities in America, and the CEO’s of these very same banks are also the directors of these very same Federal Reserve branches, so there is very little difference; it is their bank.
What is a director
Oxford dictionary defines a director as:
“a person or thing that directs.
one of a group of persons chosen to control or govern the affairs of a company or corporation:
a board of directors.
the person responsible for the interpretive aspects of a stage, film, or television production; the person who supervises the integration of all the elements, as acting, staging, and lighting, required to realize the writer’s conception.Compare producer(def 3).
the musical conductor of an orchestra, chorus, etc.
the manager or chief executive of certain schools, institutes, government bureaus, etc.