This federal policy enabled the fracking industry’s $280 billion loss – resilience k gas station


You can thank the Fed and ZIRP for that. One of the results of the Fed’s zero interest rate policy is that the average American saver ends up with close to zero interest on their money in the bank. This is one of the reasons that ZIRP is often described as a wealth transfer from American savers to debtors. Because the shale industry is deeply in debt, these companies directly benefit from this arrangement.

And as this next chart shows, historically that hasn’t been how it works. The graph below is the federal funds rate since 1950 (this is the interest rate that banks charge each other to lend excess cash overnight). It’s very clear that starting in 2008, the chart flatlined (due to ZIRP) and stayed that way for years — something that had not happened before.

While ZIRP has been devastating to retirees and other savers who would like to earn some interest on their money in the bank, it did manage to effectively re-inflate the housing bubble. Because even though you couldn’t earn interest on your savings over the last decade, mortgage rates have been historically low.

Bill McBride runs the economics blog Calculated Risk. He is widely acknowledged as someone who predicted the housing bubble and recovery. McBride’s track record is acknowledged in the title of this Business Insider article from 2012: The Genius Who Invented Economics Blogging Reveals How He Got Everything Right And What’s Coming Next.

The problem with trying to re-inflate one market is it tends to re-inflate all markets. It would be hard to argue that the stock market hasn’t been re-inflated as well by this policy. It has been on an epic run while the policy was in place.

There are two main ways that ZIRP has fueled the shale industry. One is that — unlike the rest of us not making money on our savings — big companies and investors have been able to borrow large amounts of money at very low rates. This is commonly referred to as “free money” during the ZIRP era because if you are paying little-to-no interest on a loan it is effectively free. This relationship was first detailed on DeSmog in 2014.

“ QE and ZIRP hugely increased the availability of credit to the energy sector. ZIRP allowed oil companies to borrow from banks at extremely low interest rates, with the worth of syndicated loans to the oil and gas sectors rising from $600 billion in 2006 to $1.6 trillion in 2014.”

The second main way that ZIRP has funded the shale “revolution” is via the junk bond market. Junk bonds are bonds issued by companies — witih help from investment banks that get their cut — that have credit ratings below “investment grade.” To be an investment grade bond requires a certain level of confidence the company will pay back both the interest and principal on the bond “through good times and bad.”

Because there is a lower chance of a junk bond issuer being able to pay back interest and principal, those bonds reward investors with the promise of higher returns. If the company does well, the investors are paid well for their gamble. If not … they lose out because they invested in “junk.”

“Time and again, despite the collapsed prices of oil and gas, the players in the shale revolution have gotten more funding from Wall Street, whose ZIRP-blinded clients kept gobbling up the newly issued junk bonds, leveraged loans, and shares, taking on huge risks and hoping to make a little extra money in a Fed-laid minefield where all decent assets are way overpriced.”

As DeSmog explained earlier in this Finances of Fracking series, Wall Street is happy to loan cash to money-losing fracking companies because banks and investment firms make their money by making loans or selling junk bonds and collecting the fees on those deals.

Because shale companies have never made a profit, they must keep doing what they have always done — that means borrowing more money to drill more wells, which have been costing more money than they make. If shale companies stopped borrowing, they would have to either drastically reduce the amount of oil being produced, or likely have to declare bankruptcy — as many shale companies have done. Fed Raising Rates: Is This the Beginning of the End for Shale Financing?

That isn’t good news for the shale industry that will now need to refinance all of its loans at higher rates. But as in all good bubbles — and despite the warning signs — the oil industry is brimming with optimism in 2018. And the Wall Street money keeps pouring in at record levels, with plenty of buyers still eager to snap up these junk bonds.

But despite the record-setting pace of junk bonds for energy companies, plenty of people are now warning of the problem (or crisis) that the Fed raising interest rates will create for the junk bond market and the shale industry. The problem was summed up quite well by the sub-title of this Seeking Alpha article: “Fed tightening affects junk bond prices negatively.”

How negatively? Financial data company Pitchbook recently highlighted some of the risks based on information from the U.S. Treasury’s Office of Financial Research ( OFR), which says that the financial risk of interest rate increases is at an all-time high. “Just a 1 percent rise in interest rates would result in $1.2 trillion in losses from the Barclays U.S. Aggregate Bond Index — with even larger losses when one includes ‘junk’ high-yield bonds,” reported Pitchbook.

A return to even the historically low federal fund rates in the 5 percent range — where they were just before the financial crisis of 2008 — would be devastating to the junk bond market and the shale industry — as well as all of the asset managers who currently own this junk.

It’s important to keep in perspective that even major shale oil companies like Continental Resources haven’t been able to pay the interest on the money they already owe at these historically low rates, a point that holds true throughout the industry. Companies have been borrowing money to pay interest on the money they have already borrowed. Full Speed Ahead … Towards a Wall of Debt and Higher Rates

The movie (and book) The Big Short features several investors who all saw the housing bubble for what it was and then bet against Wall Street and the bad debt that was fueling the housing bubble. They were right and eventually made billions. However, they spent years knowing they were right but watching the housing bubble continue.

Ivy Zelman, a housing-market analyst at Credit Suisse, was one of the people who identified the housing bubble early on, and she notes that while it was clear there was a problem, it wasn’t clear when the reckless financial behavior would end.

Much like the housing bubble, the shale bubble has gone on much longer than expected (by some). Of course, that just means that the industry is in a lot more debt than in 2014 when people first started warning about this issue. If things go bad now, they will go much worse than in 2014.

Sounds like an accurate description of the last nine years of the shale industry. But that wasn’t all White had to say: “All the market indicators right now look very similar to what we saw before the Lehman crisis, but the lesson has somehow been forgotten.”