by Wolf Richter, Wolf Street:

What’s so insidious about the Fed’s bailouts of investors in hedge funds, mortgage-REITS, stocks, bonds, leveraged loans, and other often risky assets? The destruction of capitalism.

By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT. You can listen to it on YouTube, and you can find it on iTunes, Spotify, Stitcher, Google Podcasts, and others.

We’re in an economic meltdown like I’ve never seen before. Tens of millions of people have lost their jobs – and so suddenly, that the government data to track them has fallen into chaos, with different agencies reporting data that is all over the place and contradicting each other. None of these systems were designed to track this type of sudden collapse of the labor market during a pandemic.

Then there are the many small businesses that have had to shut down or lost most of their customers and revenues. And these entrepreneurs have no idea if they can make it through this period.

Over the past three months, about 110,000 people in the United States have died from the coronavirus. That number is still growing every day at a rate of about 1,000 deaths. But the efforts to slow the spread of the virus and save lives have caused enormous economic damage.

And people’s frustration and anger with racial injustice has boiled over, and they’re frustrated and angry over a host of systemic issues, including the inequality of economic prospects, and there have been big protests every day around the country for well over a week.

Just now, there was a protest march going by our place here in San Francisco. They had police escorts on motorcycles and cars. They were chanting “black lives matter” and other phrases, and clapping and waving, and holding up cardboard signs with various messages written on them. They were of all races – and I would say that the majority was young and white. These people woke up.

And there has been widespread looting earlier in this phase – in my neighborhood, all the drugstores were systematically looted a week ago at night by a convoy of cars that drove from store to store, and there were no protests anywhere near.

The looters came for the money and reacted to the horrendous economic inequality in this country, to the mind-boggling wealth disparity, and to the whole bizarre system that encourages a private equity firm to raid a company and loot it, and burn its creditors, and destroy its jobs, and then walk away a capitalist hero as the company collapses as nothing but a shell, which is what private equity firms have done repeatedly all over the place, including with Toys ‘R’ Us.

In a Wall Street Journal/NBC poll out today, 80% of the respondents said they feel that the country is spiraling out of control.

So there are some huge multi-faceted problems that need to be grappled with, and that need to be resolved, and people are hurting, and they’re frustrated, and they’re angry, and many are unemployed, and others have jobs that don’t pay enough to meet the rising living expenses, and small businesses are on the ropes, and there’s going to be a lot of pain.

And what does the Federal Reserve do?

It printed $2.9 trillion since early March to bail out investors in highly leveraged hedge funds that were imploding, and to bail out investors in highly leveraged mortgage REITs that were imploding, and to bail out asset holders whose stocks were plunging, and speculators in the riskiest concoctions, and investors of all kinds, and to bail out asset holders of any kind – and the wealthier they were, the more they got – to make sure they don’t feel any of the pain.

That’s what the Fed is doing.

So the Fed printed $2.9 trillion since early March. That’s about $22,000 per household. For the bottom half of households, $22,000 would have helped a lot to get through the crisis.

But this money wasn’t spread to them. It was helicopter money for Wall Street. And it went on to multiply. And most of it ended up with a relatively small number of households. And their wealth increased by the trillions of dollars.

The Fed’s huge purchases of Treasury securities in March was a hedge-fund bailout. As the Treasury market went haywire with the 10-year yield first plunging then spiking, hedge funds that had huge and highly leveraged bets on Treasuries began to blow up.

That the Fed’s massive Treasury purchases were a backdoor bailout of highly leveraged hedge funds was confirmed in an editorial by William Dudley, former president of the New York Fed. These hedge funds, he wrote, “were caught in an untenable trade of being long cash Treasuries and short Treasury futures.”

He explained: “When volatility was low, these positions could be leveraged up to generate attractive returns. But when the pandemic hit and volatility soared and those trades lost value, margin lenders who financed the positions asked for more equity.”

These were the margin calls that hedge funds couldn’t meet. And hedge funds were forced to sell their positions.

Dudley added, “This led to fire sales, with many sellers and few buyers. The result was a climb in Treasury yields, a widening in bid-offer spreads and a sharp drop in liquidity in what is normally the most liquid market in the world.”

And so the Fed bailed them out through the “backdoor” by buying vast amounts of Treasuries that pushed up their prices and pushed down their yields. And this action made sure that the people whose money was tied up in these hedge funds didn’t have to pay the price for the risk they took. They were made whole entirely, even as tens of millions of Americans lost their jobs.

The Fed’s huge purchases of mortgage-backed securities in March came when prices were plunging, as mortgage forbearance and huge job losses were putting mortgage payments at risk. And that was a bailout of highly leveraged mortgage-REITs, Dudley said.

“As volatility soared, real-estate investment trusts that invest in mortgage-backed securities were forced sellers as they struggled to meet margin calls,” Dudley said. “Again, the Fed purchases helped limit their losses.”

And then there is the bailout of “heavily indebted corporations,” as Dudley put it.

“This is significant because many corporations took on lots of debt by choice,” he said. So the Fed set up these special purpose vehicles, or SPVs, to purchase corporate bonds and leveraged loans, which pushed up their prices, pushed down the yield, and allowed these over-indebted companies to borrow in the market that was suddenly chasing yield as yield was evaporating.

“These actions also protected investors in high-yield mutual-bond funds,” Dudley said. “Had the funds been forced to sell amid plunging prices to meet large redemptions, this could have set off a chain reaction in which falling prices begat more sales. Both the asset managers and the retail investors who bought shares in these junk-bond funds escaped bearing the cost of their actions,” he said.

In central-bank lingo, this is called “moral hazard”: Bailing out the wealthy and asset holders, hedge funds, mortgage REITs, private equity firms, and huge risk takers, and it’s called “moral hazard” because it encourages this risky behavior because they know that they’re going to get a bailout when it hits the fan next time, and so they do the same thing again and take even greater risks, and it blows up again with even bigger consequences, and they get bailed out again with even more trillions.

Tens of millions of people are out of a job, and many people protest in the streets, seething with anger and frustration. And many of those that didn’t lose their jobs are living from paycheck-to-paycheck, while the fruits of their labor continually get eaten up by rising prices and rents and healthcare costs – the lucky ones that even have healthcare.

But the Fed bails out that concentration of wealth and power so they never have to feel the economic pain, so that they don’t have any skin in any crisis, and so that the wealth disparity continues to surge.

There is an elephantine long-term problem with these bailouts. People took these risks because they wanted the returns. Bailing them out and making them whole destroys the discipline of capitalism – and it destroys capitalism itself.

What you’ve got left is a messed-up situation where asset holders reap all the gains and rewards and returns, and when these bets hit the fan, the Fed shuffles the losses and risks into the other direction, which in the end crushes the fruits of labor of those who have to work for a living as they end up having to pay higher prices for everything, from healthcare to housing.

With these bailouts, the Fed confirms that there is no level playing field. And it purposefully and with premeditation increases a wealth disparity that is just out of this world.

Read More @ WolfStreet.com