The big news in the US in markets over the past day is the resignation of inflation hawk Jeffrey Lacker from his position as President of the Richmond Fed. There are a lot of questions but not many answers at this point in time.
I think I have the answer to at least one question: why was the Fed talking to big money investors in the first place. My thoughts follow below.
Before I tell you why I believe the Fed leak happened, let me explain the timetable quickly.
On February 8th of 2007, Household International ushered in the financial crisis by announcing massive credit writedowns. Over the next two years, the global economy went through the wringer in the biggest financial crisis since the Great Depression. By 2010, we were back in the saddle — and the Fed had developed a closer relationship with media outlets and analysts from large investment firms. Sundry Fed officials had started to sit for interviews and meetings – it seems almost daily – to explain what the Fed was doing.
In that year, Pedro da Costa, then a reporter with Reuters, wrote a special report with two colleagues about how the Fed was giving access to big investors. The trio wrote that this access – however well-intentioned – could inadvertently reveal hints of market-moving information. Here’s how they put it:
But a Reuters investigation has found that the information flow sometimes goes both ways as Fed officials let their guard down with former colleagues and other close private sector contacts.
This selective dissemination of information gives big investors a competitive edge in the market. In the past, Fed officials themselves have privately expressed discomfort about the cozy ties between the central bank and consultants to big investors, though their concerns have largely fallen on deaf ears.
No one is accusing Meyer and his firm, Macroeconomic Advisers — or any other purveyors of Fed insights for that matter — of wrongdoing. They are not prohibited from sharing such information with their hedge fund and money manager clients.
Haag Sherman, chief investment officer of Salient Partners, a Houston-based money management firm that oversees around $8 billion in assets, says even the slightest hint of the possible direction of policy can give investors a huge leg up.
They quote former Fed governor Alice Rivlin as saying, “It’s certainly not what Fed officials should be doing. The rules when I was there were you don’t talk to anybody about anything that could be used for commercial purposes.”
The report was called “Cozying Up To Big Investors At Club Fed” and it’s still available online here in PDF.
The Fed leak didn’t happen until two years later. And all we know so far is that Jeffrey Lacker spoke to Regina Schleiger, an analyst at Medley Global Advisors, essentially confirming to her very specific information she already had regarding the September 2012 FOMC. He has now resigned as a result of this conversation. But no further legal action is expected to be taken against him.
This leak came to light in late 2014 as a result of an internal investigation at the Fed. And this revelation resulted in Da Costa, then at the Wall Street Journal, inquiring about it at a March 2015 FOMC press conference with Janet Yellen. Da Costa followed up on this story for months, with the probe eventually becoming an insider trading investigation. But eventually the story went away and seemed dead and buried…that is until Lacker resigned yesterday.
So why did this happen?
It’s simple really, and it something we talked a lot about during the days of quantitative easing; when the Fed Funds rate falls to zero, all the Fed can fall back on for policy is unconventional tools like quantitative easing and forward guidance. And that makes Fed communications critically important.
Let’s remember what QE was all about now. With fiscal policy neutered, the Fed believed that it was the only bulwark between the US economy and another severe downturn. The Fed basically decided that, because its forward guidance was so critical in the post-Financial Crisis world, it had to stay in constant communication with the market and fine-tune its understanding of Fed policy. We see this same almost-manic communication coming from the Fed today, even as it has begun to normalize policy.
What happened with the Fed leak is that, by speaking to individual analysts and investors, the Fed’s communication strategy has ended up doing exactly what critics have long claimed: it has given big money investors an inside track on government bond investing akin to the inside track they used to have in equities.
Back in the 1990s and before, big equity investors used to get special meetings with management that gave them an inside track. This access was foreclosed after the crash in technology stocks. Similarly, I believe we should see access to the Fed foreclosed for bond investors, because that access gives them too much of an unfair advantage. The Medley case makes this clear.
As for the ongoing investigation, there is almost certainly another leaker in the Fed. And now that Lacker has resigned, journalists will be reinvigorated to find out who he is. The next FOMC press conference should be good.
Going beyond the next presser though, this case is sure to have far-reaching consequences for both how the Fed conducts business and its independence in doing so.