Mike Siegel interviews economist David Malpass on the Boss Business Brief to explain QE2 and what impact the Fed's policies will have on small businesses and the overall economy.

Transcript:

Siegel: Well, folks, welcome back in. Good to have you with us. Mike Siegel with you at the BOSS Business Brief as we get back into the conversation. David Malpass is the president of Encima Global, LLC, and this organization has just released what they consider to be the proper view of what the Fed is doing with what this QE2 has been called, Quantitative Easing. QE2 is the second time they are doing this. Basically, it is about the 600 billion dollars that the Fed is going to put into treasury bonds, creating more money, and no doubt reducing the value of each dollar, which is I suppose one of the reasons that gold has been jumping recently. But the bottom line for all of us is what is it going to do about small business? What impact would this Fed's policy have on small business? We want to talk about that because according to Encima Global, in fact this so-called QE2 is not going to help small business, not going to help jobs growth, and will mostly benefit, guess who? The traders and Wall Street. Mr. Malpass, thank you for being with us. How are you today?
Malpass: Hi, Mike. Happy to be on. I'm fine. And you have got it just right there. You know, the Fed is borrowing money from banks, money that would otherwise lent to small businesses, they are borrowing that money and paying interest on it and then they are choosing to buy debt from the government. So, it just helps the government.
Siegel: Yeah, which is really…look, I am not a trained economist, but I do business programs, so I can get into studying this a little bit. I think even the first year business class at a college would make the simple point that if the Fed takes the money out of the private sector, guess what? The money isn't there for small business.
Malpass: That is right. So, you know, economists have had a lot of justifications and so on for making Washington bigger and now for making the Fed bigger. You know, they have 20,000 employees, they make 100 billion dollars a year. We are talking a giant organization. So, they have decided on their own wherewithal that they are going to buy certain kinds of government bonds that they have never bought before. Before 2008, they never bought bonds. They only bought T bills. You know, only short term stuff from the government. So, they have selected things that they want to buy and so it benefits Wall Street, it benefits traders, but it doesn't end up getting any money to small businesses and to people that are going to create jobs.
Siegel: In fact, not only does it not get money to them, but it takes money away from them because the interest that is paid on that money comes out of the available funds and those funds are no longer available to the private sector. Is that not the case?
Malpass: That is right. So, we have seen t his skewing of the economy over t he last year where big companies and the government are doing well. So, Washington is a boomtown, you know. Hiring people and going wild and yet there is not job creation at the small business level. I think part of that is because the money is getting channeled in the way that Washington is doing it and now the Fed is adding to the problem rather than fixing it.
Siegel: Well, let's talk about the impact of this, because it seems to me at least that when you talk about confidence, and that is a big part of any economy, that we reduce the confidence in the Fed around the world, I think also we weaken the dollar because there are more dollars out there, and then you add, potentially at least, the inflation of our commodities which is not good for the economy itself. So, those are negative factors that result from doing this process, is it not?
Malpass: That is right. So, if you think about the living standards of Americans – how much do people earn and how much can they buy? Can they buy a vacation? The problem is our living standards are going down relative to what is going on around the rest of the world and that is a big draw back. I think it is because the Fed has been too loose. They have not cared about the dollar, they have cared more about pumping things up. You know, big companies are able to deal with it because they borrow dollars and then they make their investments abroad, so it creates that channeling of jobs you get, creating a lot more jobs in Asia than you are in the US right now.
Siegel: By the way, one other point to be made here, Mr. Malpass, is the fact that the banks could certainly use this money if they were low on reserves, but apparently from the reports I have seen the banks do have strong reserves they just have not been making loans to small business they way perhaps they should have been. So, since they don't have any shortage of reserves, really, this will have no impact on the amount of their lending. Because they have the money, they are just choosing not to make the loans.
Malpass: That is right. Normally, there is a term for it – excess reserves. So, normally there are zero excess reserves in the US banking system. If a bank has some extra cash, they lend it out and actually lend it multiple times. That is the nature of a banking system. But right now, banks have 1 trillion dollars in excess reserves that they are not using. So, now the Fed is coming in and saying we are going to add 600 billion to that and we will hope that you might lend some of it. Well, if they didn't lend the first trillion, why are they going to lend any of this extra?
Siegel: Well, you know, I think one of the very telling points about this so-called QE2, Quantitative Easing, and the purchase of the 600 billion dollars in treasury bonds by the Fed, is that Goldman-Sachs is the biggest fan, the cheerleader, for these asset purchases, but don't firms like Goldman-Sachs make commissions on these when they do the transactions?
Malpass: That is right. So, you see kind of the community, the trading community, really enjoying going into this buying operation. It is a whole new aspect of business that people can get ahold of. It is probably not the right way to go. The Fed says, "Well, we have got to try something." Well, my view is it is up to congress now to do a better job on what they manage rather than having the Fed put in extra money. You ought to have congress spend less and that would be a better solution to this and would create more jobs.
Siegel: Well, it seems to me that that would be the case. Because if you reduce spending on the part of congress, which will hopefully happen with some of the changes in congress, then you don't need to talk about the Fed bailing out the economy. I mean, isn't there an underpinning to this that the Fed is artificially trying to hold up the American economy? Isn't that what this is all about?
Malpass: Yeah, there is some of that, or at least they want to have that perception out there. I don't think that what they are doing is actually going to be effective at propping things up, but they are playing the role of the cheerleader. Instead, I think it would be better if we just went about fixing some of the problems. This mortgage foreclosure problem with the paperwork, you know, the lawyers are on top of that and it is going to get all gummed up in the system. It would be better if Washington just decided it, and often times that is going to go against the trial lawyers, but decided it clearly that paperwork is not going to grind that system to a halt. Right now, it is a frozen mortgage system going on around the country, which hurts everybody.
Siegel: One of the Fed governors, Kevin Warsh, talked about the decision making groundwork for a wind down by the Fed of this involvement in buying these treasuries. He talked about altering the policies if they meet certain objectives; in other words, go in, do what you need to do and get out. Is the Fed planning to do that?
Malpass: We will have to see. You know, they meet every six weeks. They have got a huge amount of power. They can just do what they want. So, the fact that he was out with an article and a speech that same day, that was just Monday, a few days ago, means that there are different views on their board of directors. Some of the board members are actively against having the Fed buy more stuff. So, we will have to see how the politics evolve on the board. That is why to some extent public opinion counts and the opinion of….Bernacki will listen to people around the world. If everybody is against it, I think they will gradually wind it down, and that would be a better course for the country. That would put the spotlight back on congress and you would have everybody asking them, "what are you guys going to do?"
Siegel: In other words, in terms of cutting spending, all of the experts, the financial analysts and the reports that I have seen, indicate that your point is what is dominant. I have seen almost no one say this is a good idea. First of all, the Fed would stretch its authority. In other words, they are pushing the envelope of their authority and then create constraints on their ability to buy assets in the future. That is not a good thing, and there is no emergency here for them to do it. So, aren't they getting involved in something… they are solving a problem that doesn't need to be fixed in the way they want to fix.
Malpass: Yes, I think that is true. Now, whether the opinion is dominant against it, we will have to see. The Fed listens to its own drummer. They listen to academics, to people that are not on Main Street, and so we will have to see what the balance of opinion is on it. Don't underestimate the Fed's power, as I mentioned. They make a huge amount of profit. They are basically outside the system of checks and balances that operates in Washington. They have 14 year terms – not as long as Supreme Court justices, but one of the longest terms of office that we offer in the United States. So, they can hold to their position longer than you might think.
Siegel: Bottom line as we wrap up, we are talking with David Malpass, president of Encima Global, with respect to small business, talk to us about the difference between the favorable effect on credit availability for small business with and then without this intervention by the Fed of 600 billion of treasuries.
Malpass: What has to happen to get small business loans is banks have to be allowed to put those loans on their books. What is happening right now is that they are really adding to their lending to the government and that shows up in the data – huge increases in bank lending to government and reduction in bank lending to…. It is called C&I loans, Commercial and Industrial Loans, the normal types of neighborhood loans that banks make. Those continue to go down. So, nothing in this program from the Fed changes that climate. So, it will be noticeable if either the president or some of the regulators in Washington said, "hey, let's try something different. Let's go a different direction. Rather than having the Fed buying loans or doing anything, the Fed should just stay out of it, and let's have the banks that have excess money be allowed to start making some loans again." I think that would have a very positive impact on confidence around the country and you would see business going into their bank and saying, "hey, I hear you might make loans this month. I would like to apply for a loan. I have got a really good business idea. I am going to work my tail off." That would start the engine of job growth going again.
Siegel: Fabulous point. So, the key thing to wrap up on here, Mr. Malpass, is that the banks have the money to make the loans, correct?
Malpass: That is right, but you know, you can't make them do it if it is not in their interest. If it wouldn't be profitable after tax. Right now, the bank looks at it and says, "I would rather lend to the government."

Siegel: I understand that, but my only point is that the money is there.
Malpass: That is right. The system is floating on money. So, something is not aligned to make those loans.
Siegel: That is the huge point. That is what we need to do, harness and release those funds for good, healthy, responsible loans to small business. Your time is appreciated and I thank you. Great to have you on the program. That is David Malpass, Encima Global.


Who is David Malpass?

David Malpass is president of Encima Global, an economic research and consulting firm serving institutional investors and corporate clients. His work provides insight and analysis on global economic and political trends, with investment research spanning equities, fixed income, commodities and currencies. Formerly Bear Stearns’ chief economist, Mr. Malpass’s team ranked second in the Institutional Investor ranking of Wall Street economists in 2005, 2006 and 2007.

Mr. Malpass co-authors the Current Events column in Forbes magazine, and his opinion pieces appear regularly in the Wall Street Journal. He sits on the boards of the Economic Club of New York, the Council of the Americas and the National Committee on U.S.-China Relations.

Between February 1984 and January 1993, Mr. Malpass held economic appointments during the Reagan and Bush Administrations. He was Deputy Assistant Treasury Secretary for Developing Nations, a Deputy Assistant Secretary of State, Republican Staff Director of Congress’s Joint Economic Committee, and Senior Analyst for Taxes and Trade at the Senate Budget Committee.

In his government positions, Mr. Malpass worked on an array of economic, budget and international issues, including: the 1986 tax cut, several congressional budget resolutions, the Gramm-Rudman budget law, the savings and loan bailout, NAFTA, the Brady plan for developing country debt, and fast-track trade authority. He was a member of the government’s Senior Executive Service and testified frequently before Congress.

From 1977-83, Mr. Malpass worked in Portland, Oregon as a CPA with Arthur Andersen’s systems consulting group, the Controller at Consolidated Supply Co., and a contract administrator at Esco Corporation, a steel foundry.

Mr. Malpass received a bachelor's degree in physics from Colorado College and an MBA from the University of Denver. He studied international economics at Georgetown University's School of Foreign Service, and speaks Spanish, French, and Russian.