This Thanksgiving season, as the Dow recently broke all-time highs, families waited in long lines and winding traffic at food banks all across the country. Workers at the North Texas Food bank distributed 600,000 pounds of food for about 25,000 people on the Saturday before Thanksgiving. One worker reported that forty percent of those receiving help were doing so for the first time. This year, 54 million Americans, including one in four children, may not know where their next meal is coming from. “These are record levels,” said Emily Engelhard, managing director of research at Feeding America, which has a nationwide network of food banks. “We have not seen food insecurity reach these levels for the length of time that food insecurity has been measured [1]."
Since the COVID-19 pandemic began, the US government has pumped over $2.2 trillion into the economy, in hopes of bolstering struggling businesses and providing direct assistance to the people. While 49% of the CARES act was sent to small businesses and individuals, this one-time stimulus does not account for the decade-long decline in “Main-street Lending” that has accounted for disparate growth and wealth accumulation trajectories between Wall Street and Main Street.
To clarify, I’m using Wall Street as a synecdoche for investors and institutions that have ready access to the capital markets. These would include commercial banks, private equity, corporations with outstanding debt, and even private investors with sizable equity portfolios. In other words, those for whom capital works. Main Street, on the other hand, I’m defining as businesses and individuals who rely on earned income; they work for their capital.
Since the 2008 Great Recession, the US has maintained an unprecedented period of low interest rates. The idea was to bolster borrowing, to stimulate debt-fueled activity in the economy at large. However, given the strong flow of easy money, Wall Street got to work like opportunistic beavers, building lucrative pools for themselves, siphoning off the benefits of cheap capital.
In the low-rate environment, large institutional investors like pension and endowments sought out more alternative investments to bolster their returns. Because their portfolios traditionally relied on investment-grade credit, and because such credit moved with fed rates, they were facing obligations that they couldn’t fulfill with sagging returns. In 2019, pensions allocated about 28% to alternative investments like hedge funds, private equity, and venture capital. That’s almost a third of their entire portfolio in about 6% of the investible universe[2]. Endowment investments in alternatives jumped from just under 50% to 61% in a decade[3], a historical high.
So, it follows that the stock market soared given the injections of capital from Wall Street funds, many of whom are highly levered themselves. Thomas Peterffy, the billionaire founder of Interactive Brokers, says the current environment is unlike anything he has ever seen before — but understandable. “Money is now so easy, why not borrow what you can and put it into stocks? That’s what our customers are doing, and they’re making helluva lot of money.[4]”
As the liquid market drove up valuations, the private markets followed suit, sucking in more and more capital. Low-cost money meant more leveraged buyouts, higher valuations for private equity, and more activity in acquisitions. Currently one in three companies are owned by private equity firms. Corporation levered up so much that leveraged loans, credit typically used for low-rated, heavily indebted companies, have ballooned to almost $3 trillion, doubling in the last decade. This compares to around $1.2 trillion in subprime credit in 2008.
Banks, with shored up capital, utilized low-cost funds to buy up securities and tone down lending, especially to small businesses. According to the FDIC, securities as a percentage of total assets have increased by 40% since 3Q 2008.This contrasts with small business loans as a share of total loans, which have dropped by almost 30% in the same period. The message seems to be: why bother lending to Main Street when capital works better on and for Wall Street?
The incoming Biden administration will likely push for more even distributions of any fiscal stimulus. This isn’t socialism, it is populist policy, mindful of the vast majority of Americans who are not privy to Wall Street maneuvers. Given Janet Yellen’s noted concerns for inequality, she will be inclined to damn the dams. Instead of providing “cushions” ahead of potential lending, Yellen’s fiscal policy could shift to a “use it or lose it” model. This would push more liquidity into Main Street, catalyzing small business activity in effort to revive the post-COVID 19 economy.
If liquidity is forced out of Wall Street pools, market valuations could drift lower, but there is a difference between market valuations and economic stability. Creating greater access for small businesses, which, according to the SBA, make up 49.2% of private-sector employment and 42.9% of private-sector payroll, would fortify the America’s economic foundation. This would also boost consumer ability and confidence, which will in turn feedback into the growth in market valuations based on fundamental strength. Discerning investors will find opportunities aplenty in productive assets while taking advantage of cheap credit.
It has been proven, from Reganomics to Covid-onimcs, trickle-down doesn’t work when there are incentives for dams. The federal government may not have much more room to adjust monetary policy (negative rates?), fiscal policy, especially in the new administration, ought to prioritize Main Street liquidity. It would be more stable to recover through productivity and profitability in the economy at large rather than liquidity-fueled valuation bubbles. After all, the ecosystem contains more than just beavers.