Howard Marks: The Federal Reserve Cannot Prevent Market Cycles

And why it shouldn't anyway

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Oct 16, 2020
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The ups and downs of the market are a constant source of anxiety for many investors. Most of us would probably like it if the market went up all day, every day. Unfortunately, history has shown that whenever the investing public gets complacent and begins to take on more risk, they are dealt a tough lesson by the market.

Nonetheless, in every bull market there is always a belief that this time it will be different. In an interview with Bloomberg, value investor Howard Marks (Trades, Portfolio) was asked whether central banks like the Federal Reserve might be able to "iron out" the market cycle and eliminate those pesky downturns. Here's what he said.

Too big to be useful

Marks has said that investors today are in danger of becoming complacent by assuming that the Fed will always be able to lift the market whenever it begins to wobble. He is skeptical of the idea that any institution, even one as powerful as the Fed, can eliminate the market cycle, as human psychology will always drive trends to excess.

Of course, Fed action is not all about supporting asset prices - it is also about keeping businesses afloat through the purchase of corporate bonds. In the interview, Marks was asked to comment on the state of the U.S. airline industry, which has been among the hardest hit by the sharp decrease in travel:

"I believe there's a case to be made that the airlines need to be smaller, that fewer people will fly over the next five years than flew over the last five, and that the best way for a business to contract is to go through a reorganization through bankruptcy, to discharge onerous contracts, and reduce their overheads. All the airlines would be facing financial difficulties now if it weren't for, 1) the specific bailouts they received, and 2) the general help to the economy. Obviously, the Fed and the Treasury have targeted the airlines specifically to preclude bankruptcies."

Marks went on to point out that the Obama administration allowed Chrysler and General Motors (GM, Financial) to go bankrupt, which was a painful, but ultimately helpful thing, as it allowed those businesses to reorganize themselves. If the economy is a mechanism to allocate society's resources, then there is a strong case to be made that there is no point in having airlines that are too big for the future demand for air travel.

Proponents of bailouts (via both fiscal and monetary means) often point to the fact that jobs will be lost if businesses are allowed to fail, but there is an opportunity cost of throwing money at these companies too. A properly functioning capitalist system should allow the freedom for companies to fail and restructure themselves in the face of changing market conditions, and having the Federal Reserve and U.S. Treasury ride to the rescue every time there is a problem curtails that freedom and creates inefficiencies.

Disclosure: The author owns no stocks mentioned.

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