This week the Federal Reserve embarked on a new policy intended to drive down long-term interest rates. Known colloquially as “Operation Twist,” the Federal Reserve will sell off short-dated Treasury securities to purchase long-term Treasury Bonds.
The result is a fundamental change in the Fed’s balance sheet. Previously, the Fed maintained an average maturity date of 6 years on its balance sheet. By dumping short-dated securities and buying on the long-end, the price for money will fall further. The balance sheet’s average maturity date will rise.
30-year Treasury securities now yield less than 3%, closing with a yield of 2.83% on Thursday. Naturally, borrowing costs for any creditworthy borrower will follow. Corporations, which typically earn a 2% risk premium to the risk-free rate, will now be able to borrow (theoretically) at 4.83% for 30 years.
Obviously such a low cost of borrowing at a time of lowly business valuations offers the ability for companies to leverage up, improve their return on equity and purchase competitors as well as vertically integrate suppliers. Lest we not make the same error as Dave Ramsey in his book Entreleadership; there are plenty tax benefits to debt.
The S&P500, which has an average ROE of over 27% and a P/B ratio of 1.82, is on firesale. I mentioned that stocks are cheap—they are—and the next wave of LBO activity is soon to come.
Timing is of the Essence
The Federal Reserve obviously has its own detractors and critics. Operation Twist was timed perfectly, given the political and economic reality. Fears in the Eurozone brought investors back to safety, driving yields down and T-bill prices up. The Fed can now sell its T-bills to scared investors, and buy on the longer end of the curve.
Also, the Fed avoids inflation hawks, who are increasingly concerned that monetary policy measures will stoke inflation. Food and oil, which are included in broad measures of CPI, have dropped in recent weeks, as have the “core” inflation measure components. Given outlook for the world economy, what better time to interject more liquidity into the markets and monetize more debt obligations?
For my generation, this is a boon. For seniors, savers, and those nearing retirement, well, they’re “Royally F***ed.” Welcome to a world where money has no time value—where a dollar in the future is on equal basis with a dollar in hand today. If you aren’t leveraging to the hilt, then the Fed’s operation twist will absolutely burn you in the worst way. If, however, you take the recent action to mean that the Fed will do anything to make the time value of money zero, then you’re going long ANYTHING with Other People’s Money.
This time is never different, but your response should be. Leverage to the hilt—money is free.
Stuff Around the Web
- LaTisha has another post on Google Wallet. I’ll be interested how this plays out, especially with Google execs on the hill to contest monopoly charges.
- 20sFinances reminds everyone that compound interest takes time. My goal is to outlive everyone by 100 years–that’s guaranteed inclusion in the Forbes 400!
- Darwin suggests an interesting policy change to unemployment. Should Unemployment benefits become UI loans?
- Maximizing social returns over investment returns? Hmm, this is a great read from FinanciallyConsumed.
- I really digg this billionaire profile series at MoneyedUp. Learn about how Harold Hamm made his billions.
- Sam posts an email from Wall Street, which rails on Main Street’s complaints about high finance. Absolutely a must read.
- Andrea talks about love–PF blogger love–in a post about why personal finance bloggers shouldn’t date. Cute.
- DollarVersity asks if you have what it takes to be a successful entrepreneur. “Got balls?”
Photo by: I love Butter