Quantitative Easing in the New Economy

August 23, 2010

The Federal Reserve needs to be creative with a new quantitative easing program that will support our
country’s evolving new economy rather than one that continues traditional policies that try to prop up the
dying old economy. The S&P 500 dropped 3.8% following the Fed’s FOMC meeting and is now down 4.2% for
the year. The Fed admitted that the economy was slowing from a level where underemployment approaches
20%. Their announcement of new limited, quantitative easing programs left the stock market underwhelmed
as these policies have had limited success. Rather than wasting ineffective bullets, the Fed should analyze
new options that can restart sustainable job creation and economic growth in an asset-light, Internet-based
world.

In the new economy, strip malls anchored by book superstores are out, ereaders and ebooks are in.
Blockbuster is out, Netflix is in. Sears/Kmart are out, Amazon is in. Unfinished malls (such as New Jersey’s
Xanadu, Atlanta’s Streets of Buckhead, and Syracuse’s Destiny USA – a total investment of $5 billion) are out,
on-line shopping is in. Paper storage is out, iPads and $30 USB flash drives storing the equivalent of 40 file
cabinets are in. In the new economy, baby boomers owning McMansions is out, baby boomers renting and
retiring in-town is in. Jumbo mortgages and more debt are out, savings is in. Banks with 50% of their assets
in real estate are out, venture capital investing is in. Mark to market artificial wealth is out, productivity
generated wealth is in. Greed is out, philanthropy is in. Economic decision making based on old-economy
regression analysis is out, creative thinking is in.

he Fed’s quantitative easing and other policies to date have tried to keep the old economy propped up.
TALF and PPIP, $1 trillion commitments each, tried to cushion the commercial real estate market’s drop of
over 40%. The Fed’s purchase of $1.5 trillion of mortgages and the $8,000 home-buyers credit tried to keep
the housing market up, but housing prices are continuing to decline. The Fed’s zero percent interest policy
is enabling the banks to “extend and pretend” within the old economy. These Fed actions give investment
bankers and the stock market short-term highs, but it’s a losing game. The Fed’s future quantitative easing
plans must account for the massive unstoppable trends caused by internet shopping, Americans downsizing
their lifestyles and increasing their savings rate, and technology eliminating the needs for capital intensive,
asset-oriented investments.

lternative ideas have languished, maybe because entrenched special interest groups are lobbying for more
of the same, maybe because many new ideas have yet to be proposed, or maybe because new strategies
are hard to comprehend. Any Fed strategy should be focused on one thing: getting capital out of the old
economy so that it can be invested in the new and existing businesses focused on an Internet-based economy.
Specifically, we need to get capital out of the $30 trillion residential and commercial real estate market, so
that money is available for the $20 billion a year venture capital industry and the $14 trillion stock market, the
growth drivers of the new economy. One could argue that the Fed’s support of bad real estate investments is
discouraging good investments, like the stock market at the current valuation.

Let’s try a new approach. Let’s get rid of the excess construction, especially in commercial real estate. We
can learn from the U.S. railroad industry: more assets don’t increase wealth. It’s the utilization of assets that
increases wealth. This country has eliminated 55% of railroad track in the last 60 years, 200,000 miles worth,
enough for 30 cross-country double track lines. Yet, rail tonnage handled is up 5.3x, resulting in a 12 fold
increase in rail productivity. Railroads have never been more profitable and efficient than they are today.
We’ve converted 19,000 miles of the excess tracks to Rail-for-Trails, linear parks.

We’ve had the PPIP and TALF programs that tried to backstop commercial real estate with limited success.
How about a PPIP or TALF –like fund that gets rid of excess developed real estate by converting underutilized
commercial real estate to parks and adjacent land “banked” for future development? A $200 billion+, 0%
interest, PPIP- and TALF-like fund provided by the banking system backed by the Federal Reserve could be
established to help finance the acquisition of underutilized developed urban real estate to be held as green
space. Additional $20-30 billion for property demolition, construction, and ongoing park maintenance,
could be raised from a combination of public, private and non-profit sources. Instead of the Fed just buying

Mortgage Backed Securities (MBS), they can buy Land Backed Securities (LBS) as well – assets that once were
unproductive commercial real estate to be held as urban green space.
Under the plan, hundreds of thousands of new construction jobs would be created immediately for demolition
and green space conversion. The plan would also stabilize local property values and remove bad loans
from bank balance sheets. Banks could then apply their capital to new loans to support economic growth.
Philanthropic entrepreneurship would be stimulated. Remaining property owners would show more
confidence in the economy knowing their property values have stabilized.
Besides the railroad model, there are other examples of substantial land bank and green space returns.
Pittsburgh, PA converted excess steel mills to parks and green space in the 1980’s and is now considered the
most livable city in the U.S. Flint, MI has invested $4 million in a land bank, holding excess property as raw
green space, and has increased the remaining property value in the city by $100 million.

Don Rissmiller, Chief Economist of Strategas notes that bank reserves have skyrocketed, but are not being
used to support the economy: “There are already $1 trillion of excess reserves in the system, so right now
it’s like we’ve dropped money out of helicopters and it has all fallen into bank vaults. Excess reserves get into
the economy through bank lending – what “reserves” do is reserve against bank lending (which has not been
growing). Freeing up the banks (which are behaving like “zombies” now in part because of the potential for
additional asset impairment) to return to normal would open the door to this liquidity.”

Rissmiller estimates the multiplier effects of a land bank fund: the program captures both the infrastructure
spending multiplier of 1.5x and the banking reserve multiplier that can approach 10x.

Over 150 years ago, Frederick Law Olmsted started the construction of Central Park in Manhattan. During the
following 60 years until 1920, America embraced a green wave, where every major city used green space to
make their cities more livable. A green wave today would solve the real estate mess, and restart the economy
in the new asset-light Internet world.

 

Michael G. Messner
Partner, Seminole Capital
Trustee, Speedwell Foundation
212-838-6055