In his weekly Wall Street Journal column from last week, the great Daniel Henninger commented that “For 10 years money was virtually free.” Henninger was talking about the years before Fed Chairman Jerome Powell supposedly acted like an adult, only to institute “real-world interest rates.”
Henninger’s comment about “virtually free” money didn’t read right mainly because it ran, and runs so counter to how incredibly difficult it is for all businesses of all stripes to secure funding regardless of what the Fed is doing. Think Uber. It floated its shares to the public in 2019, but it opened its doors in 2009 only to quickly evolve into one of Silicon Valley’s most talked about “unicorns." Uber was undoubtedly Silicon Valley’s most talked about company at the same time that Henninger indicates money was near costless. Apparently Uber didn’t get the memo.
When Benchmark Capital committed capital to the Valley darling, the prominent VC secured for itself a fifth of Uber for $12 million. Stop and think about that. There was no debt financing for Uber, and there realistically never is for technology companies. And they’re never able to borrow simply because somewhere north of 90% of the startups in Silicon Valley fail. Which is why lenders don’t factor where venture capitalists do. Why lend to what likely will never have earnings in the first place?
Which explains why Uber’s founders handed over 20% of the company for seemingly so little. The failure rate in Silicon Valley has shaped the investing business model there: equity finance only. And the equity is nosebleed expensive. 1,000% interest rates would be relatively cheap. That kind of expensive.
It’s something to think about in consideration of years past when the Fed was at zero. The Fed’s yearnings for “free” never reflected the market, nor does an allegedly “tight” Fed reflect the real world now. In the most dynamic sector in the world’s most dynamic economy, money is incredibly expensive. Equity finance only expensive. And it’s not just in high-risk northern California that “money” is so hard to come by.
Think investment banking, and why investment bankers are paid so well. They aren’t well-compensated because money is free, but precisely because it’s difficult to attain for 99.999% of U.S. companies.
What about those who don’t rate investment banking attention? Think subprime borrowers. This is useful to contemplate in consideration of the Predatory Loan Prevention Act, a law passed in Illinois in 2021. The latter made it illegal for non-bank lenders to charge subprime borrowers more than 36% on their loans. Economists J. Brandon Bolen, Gregory Elliehausen, and Thomas Miller conducted a detailed study of the consequences of the law, only to find what readers would expect: lending to subprime borrowers dried up in the aftermath of the law’s passage.
What’s important is the timing. Fed Chairman Powell didn’t begin raising the fed funds rate until March of 2022, but in Illinois subprime borrowers found it quite a bit more difficult to secure loans when money was still allegedly free in 2021. Not even at 36%! Price controls logically fail for states. Does anyone think they result in plenty when the Fed is the controller?
The main thing is that Henninger knows all of this. Precisely because compound interest is such a powerful concept, money is almost never dumb, which is what free implies. Which means money is never free. The Fed’s powers are theoretical, not real.
Looking back to 1980, it was then that Fed Chairman Paul Volcker was aggressively raising rates. Let’s for fun say that he, like Powell today, was working to bring “real world” to rates. Except that he didn’t. And couldn’t. Figure that in 1980 the brilliant Michael Milken was not only able to secure nearly $1 billion in funding for MCI in its quest to win long distance business from bluest of blue chip AT&T, he was able to secure the minnow that was MCI lending rates lower than the Fed rate. Ok, if MCI wasn’t paying the Fed rate what do readers think AT&T paid to borrow then?
It’s just a reminder that while the Fed searches endlessly for relevance and power, markets always and everywhere speak. That they speak is a reminder that the markets, not the Fed, set the cost and amount of credit. This truth will hopefully put to bed the notion that always nosebleed expensive credit can somehow be periodically made costless via central planning.
