4 ms·

Can you explain how VCs are a pipe for Fed money?

by Mefis 9y ago

SmellTheGlove 9y ago
That statement is a little hyperbolic, but at a very simplistic level, here's kind of, sort of, how - Fed keeps the interest rate low. That means low borrowing costs for those that can borrow, but also lower yields on debt instruments. Doing so keeps money in equity markets where VCs obviously play, because the risk-adjusted returns are favorable to investing in debt. At the same time, it's doubtful that the sorts of businesses that VCs back could raise debt funding at reasonable rates (they're not borrowing at the Fed overnight rate, nor do they have any real assets to collateralize the debt), so VCs come in and buy equity instead. If there's some path to which the Fed is printing money and directly washing it through VCs, I'd love to hear how that works. To me it's just more of a market dynamic with low interest rates (which the Fed drives).
gigatexal 9y ago
if the VC has access to a bank which has access to funds at the fed funds rate of < 1% then they can lend or borrow and invest at 10x returns thereby making them a funnel for fed money
aluminussoma 9y ago
I am not the original poster, but I share some similar sentiments. I will try to explain why I agree with that comment: The Federal Reserve has kept interest rates artificially low through its programs, in order to nudge economic growth. In turn, companies have used these low interest rates to borrow vast sums of money. Most have spent it on share repurchases but others have used it to fund acquisitions to chase higher growth. It is in this environment that VC money has thrived, funding candidates for future acquisitions or providing money to large companies (like Uber) to continue growing their business. I am by no means a professional economist. I am just trying to interpret the current situation with the little bit of knowledge I have. I welcome other opinions telling me I am wrong and why.
Afforess 9y ago
The federal reserve is keeping the federal funds rate low to try and run the economy "hot", and grow inflation. This is in the hopes that a "hot" economy will also grow wages and decrease unemployment further. Inflation is seen as less of a problem in recent years, as its been too low* for a long time. The low federal funds rate (federal reserve interest rate) results in new Treasury bills being issued at very low interest rates. Large banking institutions must maintain certain capital reserves, which they hold in these TBills, and the low interest rates mean the banks earn tiny returns on the capital. Banks, being commercial ventures, are expected to return a certain profit. The low interest rates from the TBills are too low of a rate, and won't cover inflation or operating expenses. So banks must chase riskier investments (in general, risky investments return higher interest rates) with their remaining capital to return high enough profits. The riskiest investments are startups. Very high returns, if a startup succeeds and exits in an IPO, but failure is more common. Banks don't invest in startups though, they are too risky, but banks end up investing in all the less risky assets available. This demand for "medium" risky assets (sovereign debt, corporate or municipal bonds) drives other investors out of the market, they can't compete with the volume banks can purchase at, and are forced to chase the even riskier assets banks won't touch. So low rates -> low interest tbills -> banks chasing risky assets -> investors chasing startups
- bogomipz 9y ago
  Except that the Fed is not keeping the federal funds rate low. The Fed has raised the rate twice already this year as well as once at the end of 2016. They have also signaled that another increase is coming in December. See: http://thehill.com/policy/finance/337790-fed-raises-rates-for-second-time-in-2017 http://thehill.com/policy/finance/337790-fed-raises-rates-fo... and https://www.nytimes.com/2017/09/20/business/economy/fed-bond-buying.html https://www.nytimes.com/2017/09/20/business/economy/fed-bond...
  - xtacy 9y ago
    It's still low by historical standards: https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS

Can you explain how VCs are a pipe for Fed money?

by Mefis 9y ago

Can you explain how VCs are a pipe for Fed money?

That statement is a little hyperbolic, but at a very simplistic level, here's kind of, sort of, how - Fed keeps the interest rate low. That means low borrowing costs for those that can borrow, but also lower yields on debt instruments. Doing so keeps money in equity markets where VCs obviously play, because the risk-adjusted returns are favorable to investing in debt. At the same time, it's doubtful that the sorts of businesses that VCs back could raise debt funding at reasonable rates (they're not borrowing at the Fed overnight rate, nor do they have any real assets to collateralize the debt), so VCs come in and buy equity instead. If there's some path to which the Fed is printing money and directly washing it through VCs, I'd love to hear how that works. To me it's just more of a market dynamic with low interest rates (which the Fed drives).

gigatexal 9y ago

if the VC has access to a bank which has access to funds at the fed funds rate of < 1% then they can lend or borrow and invest at 10x returns thereby making them a funnel for fed money

aluminussoma 9y ago

I am not the original poster, but I share some similar sentiments. I will try to explain why I agree with that comment: The Federal Reserve has kept interest rates artificially low through its programs, in order to nudge economic growth. In turn, companies have used these low interest rates to borrow vast sums of money. Most have spent it on share repurchases but others have used it to fund acquisitions to chase higher growth. It is in this environment that VC money has thrived, funding candidates for future acquisitions or providing money to large companies (like Uber) to continue growing their business. I am by no means a professional economist. I am just trying to interpret the current situation with the little bit of knowledge I have. I welcome other opinions telling me I am wrong and why.

Afforess 9y ago

The federal reserve is keeping the federal funds rate low to try and run the economy "hot", and grow inflation. This is in the hopes that a "hot" economy will also grow wages and decrease unemployment further. Inflation is seen as less of a problem in recent years, as its been too low* for a long time. The low federal funds rate (federal reserve interest rate) results in new Treasury bills being issued at very low interest rates. Large banking institutions must maintain certain capital reserves, which they hold in these TBills, and the low interest rates mean the banks earn tiny returns on the capital. Banks, being commercial ventures, are expected to return a certain profit. The low interest rates from the TBills are too low of a rate, and won't cover inflation or operating expenses. So banks must chase riskier investments (in general, risky investments return higher interest rates) with their remaining capital to return high enough profits. The riskiest investments are startups. Very high returns, if a startup succeeds and exits in an IPO, but failure is more common. Banks don't invest in startups though, they are too risky, but banks end up investing in all the less risky assets available. This demand for "medium" risky assets (sovereign debt, corporate or municipal bonds) drives other investors out of the market, they can't compete with the volume banks can purchase at, and are forced to chase the even riskier assets banks won't touch. So low rates -> low interest tbills -> banks chasing risky assets -> investors chasing startups

bogomipz 9y ago
Except that the Fed is not keeping the federal funds rate low. The Fed has raised the rate twice already this year as well as once at the end of 2016. They have also signaled that another increase is coming in December. See: http://thehill.com/policy/finance/337790-fed-raises-rates-for-second-time-in-2017 http://thehill.com/policy/finance/337790-fed-raises-rates-fo... and https://www.nytimes.com/2017/09/20/business/economy/fed-bond-buying.html https://www.nytimes.com/2017/09/20/business/economy/fed-bond...
- xtacy 9y ago
  It's still low by historical standards: https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS