Thirty-two reporters gathered in Room 538 of Capitol Hill’s Dirksen building early Tuesday morning and when they were given the five pages of testimony of Federal Reserve Chair Janet Yellen, many found it less than exciting, new or groundbreaking.
One of those reporters, however, did not stop there. Having written the obligatory headlines about Yellen’s statement to the Senate Banking Committee to be foisted on anxious trading rooms at 10:00 eastern time he then leafed through an attractively bound little booklet that was distributed to the reporters along with Yellen’s testimony.
Titled the “Monetary Policy Report,” it basically lays out at much greater length what Yellen or any Fed chair summarizes and it is the formal document the Fed gives Congress twice a year to satisfy the legal requirement, a requirement that has survived the expiration of the Humphrey-Hawkins Full Employment Act of 1978.
Since 1978 rarely has the report contained something that the Fed chief does not refer to with more clarity, and reporters soon learned to give the booklet very little attention. This particular day, however, it would have behooved the shareholders of a lot of different companies, to say nothing of holders of the IShares Nasdaq Biotech ETF – off 1.8% at midday – and the Global X Social Media Index – off 1% – to have anticipated what the little booklet could make happen.
Because the reporter leafing through it found a nugget on page 22, words that would rock the worlds of social media and biotech. The reporter was doing what reporters are supposed to do, or at least what Finley Peter Dunne – a vastly popular writer, humorist and social activist – said was his main goal back in the late 1800s, to afflict the comfortable.
He pointed out that the Federal Open Market Committee, in the third paragraph of a page 22 section titled “Developments Related to Financial Stability,” were 30 words that will live in history – or infamy – and that will be remembered from now on by reporters who will be reading every word of every future Monetary Policy Report.
No, it was not Yellen who spoke the words, although many financial blogs, commentators, financial news cable channels incorrectly assumed so at first, and some even later in the day were still saying that was the case.
The words were crafted instead by the Fed minions whose job it is to turn FOMC statements and minutes and research and speeches and a host of supporting documents into the little blue and white booklet Congress gets twice a year.
“Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms,” the words read. The relevant share prices reacted immediately, heading down almost across the board.
The observation was apparently a revelation of some sort to those who doubtless had heard the same thing before many times, but not from the FOMC. Imagine, the market reaction seemed to suggest, many biotech firms with only a promise of future success – whose potential returns are many years ahead – might be overvalued.
And Twitter, with more than 50 times its price-to-sales ratio and no profits – might be overvalued. How many times have analysts surmised Facebook or LinkedIn are overvalued?
In any event, confused shareholders might be asking, what makes the Federal Reserve the sudden authority on social media and biotech stocks? That would be because they have not been paying attention to the way the financial crisis has conferred a new responsibility on central banks in general and the Fed in particular, making them guardians of financial stability as well as the purchasing power of the currency and the robustness of the labor market.
Financial stability has many pillars and so the Federal Reserve and the Financial Stability Oversight Council of which it is a member and FSOC’s Office of Financial Research have a lot to keep track of, as if just gauging the effects of monetary policy were not enough.
Yellen herself was asked what she is looking at as she answered questions from the Senate Banking Committee.
“We’re really trying to assess the likely path of the labor market and employment, and inflation, which are the two goals Congress told us to focus on,” she said. “But in trying to make those assessments we have to look at a huge range of data. Housing, consumer spending, the strength of investment spending, what’s happening in the global economy, what we expect will happen to our exports – all of that figures into what will growth be in the economy and then in turn, matters.
“Productivity growth will affect how that translates into progress in the labor market, and with respect to inflation, of course, we’re looking at many different metrics,” she said.
Sen. Jon Tester, a Democrat from Montana, wanted more. “And of all those things you listed, which is of the most concern?”
It’s housing, she answered, “but it’s not quantitatively important enough to cause us to judge that it will hold back the recovery.”
What about biotech and social media? Like housing, it turns out they are not only growth factors but stability factors as well. Asset prices for real estate, the Monetary Policy Report told Congress, “have risen” as have those for equities and corporate bonds.” But for them “valuations have remained generally in line with historical norms.” House prices are up but “for the most part, these increases have left aggregate price-to-rent ratios.” again, “within historical norms.”
Private nonfinancial debt has increased only “at a moderate pace,” the FOMC went on in its report to Congress. The financial strength of banking “has continued to improve.”
Then, however, the good news turned to bad news for the unspecified “smaller firms” and for social media and biotech, getting the full brunt of the 30 words of FOMC negativity. Outside of stocks, the FOMC also scowled at leveraged loans, repeating that “underwriting standards have loosened.”
Of course these loans to entities that already have a lot of debt have always carried a higher risk of default and so deliver a higher yield. So for the holders of the half trillion dollars in leveraged loan paper, a Fed warning only makes them happier by highlighting the risk and raising the yield and for banks, increasing the interest charged and their profits for an already very lucrative niche.
The Fed has a direct hold on the throat of banks, as one of their key regulators, and is trying to get them to abide by the advice delivered last year, firm up lending standards. Banks being banks, a lot of energy is being expended trying to find a way around the regulatory directive.
But the Fed has no such direct influence on those who want to speculate on social media and biotech stocks. All the Fed can do is insert 30 words in its Monetary Policy Report to Congress and then hope for the best – or for some unlucky investors on this day – trigger the day’s unwelcome surprise.