In his traditionally impressive manner, Warren Buffett shared, for over four hours on Saturday, his insights on the economy, investing, and American capitalism, as well as on individual companies and sectors. His remarks at the virtual annual meeting of Berkshire Hathaway, livestreamed by Yahoo Finance, ignited a flurry of reactions: From the sale at a loss of the entirety of his holdings in U.S. airlines and the importance of a fortress balance sheet in such an uncertain economy to what’s ahead for the economy and why he never bets against America long-term.
Buffett also framed well an important debate that could easily pit the current well-being of stock investors versus their long-term prosperity, as well as amplify worries about persistent inequalities in our system (those favoring companies over people, the connected over the marginalized, the rich over the poor, and the establishment over the rest).
What’s better for the economy and markets over time: The large-scale intervention of the Federal Reserve in this crisis or the bigger window for private rescue financing that accompanied the 2008 crisis?
There are compelling arguments on both sides, as indeed acknowledged by Buffett.
The Fed’s exceptional market interventions in March and April — which were significantly greater than what it did in 2008-09, both in scale and in scope — quickly normalized market segment after market segment.
In terms of input, you need only compare and contrast two things to appreciate the material difference between this crisis and 2008: the near-doubling in the central bank’s balance sheet to over $6 trillion in just a few weeks, and the precedent-creating announcement to buy certain segments of the market for junk bonds.
In terms of output, the Fed pushed markets to open wide for corporate funding, resulting in record levels of bond issuance. It avoided financial market failures and severe credit rationing that would have risked financial dislocations aggravating what is already a historic collapse in employment, production, consumption, and company investment.
(With that, and as acknowledged by both Buffett and Charlie Munger, his long-standing partner, Berkshire didn’t receive many calls for rescue financing — another stark difference from the 2008 crisis.)
But these interventions come with potential costs and risks.
They lack the incentive alignment and outside influence that come with the well-structured financing that Buffett is famous for. They encourage both deserving and less deserving companies to increase debt and systemic risks. They weaken the markets’ ability to differentiate, signal, and discipline. All of which increases not just the risk of zombie companies that eat at the long-standing dynamism and entrepreneurship of the U.S. economy, but also zombie markets that fail to properly price and allocate capital in an efficient manner.
Like many debates in life, rather than being an either/or, it’s about balance.
Buffett refrained from stating where he would have preferred this balance to be struck. For my part, I feel that certain aspects of the massive emergency relief efforts, such as the Fed venturing into high yield so early on in its reaction function, may have gone too far/too quickly in that the timing of the benefits involved could well be more than offset by the costs and risks.
We may get a better feel over time for both desirability and feasibility. But don’t hold your breath. Even then, the counterfactual will be hard to establish with sufficient conviction and foundation.
This is a debate that will linger for a while, and in a non-deterministic fashion.
Dr. Mohamed A. El-Erian is the Chief Economic Advisor of Allianz and President-Elect of Queens’ College Cambridge. The author of two New York Times bestsellers, he is a senior advisor to Gramercy, professor of practice at the Wharton School (University of Pennsylvania) and senior global fellow of the Lauder Institute.