Streetwise for Friday, September 22, 2017

Readers: Please note that due to Hurricane Irma and a resulting loss of power, this is another favorite column from a year ago. Next week we should be back to normal.

Maybe I am getting too old and soft to deal with Wall Street. I admit that the Street has never been a walk in the park and that greed and one-upmanship are part and parcel of the investment world. However, the recent and often dramatic volatility has stripped the markets of any reality.

Meanwhile, October is almost upon us once again, that time of the year when trees display their fall colors and pumpkins debut as pumpkin pie. It is also the most dreaded month in the annals of investing, the month of black Mondays.

Does October really deserve its rotten reputation? There is some justification for the bad rap when you consider the debacle of October 1929.

More recent, but still only history book material for most of those on Wall Street today, is the decline on October 19, 1987 that sent the Dow down 23 percent and resulted in the initiation of this column. Moreover, we cannot forget the relatively minor “October massacres” in years such as 1978, 1979, 1989, 1997 and 2008.

One question that keeps nagging at the markets is how and when the Federal Reserve will undertake a more proactive stance on raising interest rates. Federal Reserve Chair Janet Yellen has indicated that there is a possibility of the Fed raise rates and possible begin reducing its bond portfolio. Yet, traditionally, the Fed does not change policy during the holiday season that begins with the Thanksgiving.

The more interesting aspect of all this is not when but rather how will the Fed accomplish their goals. The immense stimulus campaign that the Fed began in response to the 2008 financial crisis changed its relationship with the financial markets.

The Fed has increased liquidity to the extent that it cannot easily drain enough money to discourage lending, its traditional approach. The Fed has also concluded that working through the banks is no longer sufficient to influence the broader economy. Instead, it plans to strengthen its hold by working directly with an expanded range of lenders.

It became clear that banks needing funds, including overnight loans, could borrow more cheaply elsewhere than from the Fed. The average rate has been about half of the Fed’s benchmark rate of 25 to 50 basis points.

The financial system, awash with both cash and lenders such as money market mutual funds, has put considerable downward pressure on interest rates. So, this is where things become less orthodox.

The Fed lacks the legal authority to pay these non-bank lenders a minimum interest rate on deposits, as it does to the banks. However, the Fed could achieve the same goal by borrowing from these companies with what is known as overnight reverse repurchase agreements.

This is a significant break from the Fed’s history of working exclusively through the banking industry. (A reverse repo is a secured cash loan where treasury securities are the collateral and the excess amount paid to redeem the collateral represents the interest paid.)

When it begins to again raise rates the Fed will likely utilize the familiar language of the old system, announcing that it is raising the federal funds rate, the Fed is unlikely to emphasize that it plans to do this outside the limelight utilizing its new tools.

In testing the system, potential lenders have in the past had 30 minutes to offer the Fed up to $30 billion each.

During its experimental testing, the Fed has adjusted the rates it pays, the amounts it accepts, and the time when it enters the market, among other variables.

To everyone, Jewish or not, L’Shanah Tovah! May this New Year grant all your wishes for love in family and in self.

Note to Readers: I will again be teaching two courses for Ringling College’s Lifelong Learning Academy – Introductory Investment Analysis and Portfolio Management. Classes begin on September 25 and run every Monday for 8 weeks. Call 941-309-5111 or go to www.RCLLA.org.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.