"The Lords of Easy Money" by Christopher Leonard
Above: "Lords of Easy Money" Christopher Leonard. 305 pages.
The book is a morality tale. Though Hoenig was roundly criticized as sort of a cranky, failed Old Testament prophet for the three or four years after he resigned from the Fed in 2011, virtually all of the predictions Hoenig made about quantitative easing, and 0 percent interest rates, would come true over the next decade. Income inequality had increased, the Fed's actions had stoked dangerous asset bubbles, social instability had worsened, and the big banks became enriched while the incomes of the poor and middle class had stagnated.
I completed reading the above book today.
This book is about monetary policy actions taken by The Federal Reserve System (the FED), the US's central bank, from 2008 in the aftermath of "The Great Recession," through 2020.
Why Central Banks?
Central banks have two roles and responsibilities. The first is to regulate and manage the commercial banks and the banking sector of a particular country or state. A specific central bank does this by ensuring that these commercial banks have enough money in their reserves to avoid bank runs or in other words, by ensuring that these banks remain liquid.
The second purpose of central banks is to define and implement monetary policies with the specific goal of either increasing or decreasing the money supply to either speed up or slow down the overall economy.
The Federal Reserve System
The Federal Reserve System (FRS) is the central bank of the United States. Often simply called the Fed, it is arguably the most powerful financial institution in the world. It was founded to provide the country with a safe, flexible, and stable monetary and financial system. The Fed has a board that is comprised of seven members. There are also twelve Federal Reserve banks with their own presidents that represent a separate district.
The governing body of The Fed is The Federal Open Market Committee (FOMC). The FOMC is responsible for the direction of monetary policy. The FOMC consists of twelve members (the seven bank governors and five (rotating) of the regional bank presidents) who meet at least eight times per year to set a near term target for the federal funds rate, which is the interest rate that banks charge each other for overnight loans. The FOMC conducts policy by adjusting the level of short-term interest rates in response to the economic outlook, with the aim of achieving maximum employment and stable prices.
Global Financial Crisis 2007-2008
The 2007-2008 financial crisis or Global Financial Crisis (GFC) was the most severe worldwide economic crisis since the Great Depression of 1929. Predatory lending targeting low-income homebuyers, excessive risk-taking by global financial institutions, and the bursting the United States housing bubble culminated in a "perfect storm. Mortgage-backed securities (MBS) tied to American real estate, as well as a vast web of derivatives linked to those MBS, collapsed in value. Financial institutions worldwide suffered severe damage, reaching a climax with the bankruptcy of Lehman Brothers on 15 September 2008, and a subsequent international banking crisis.
The Lords of Easy Money
"The Lords of Easy Money" chronicles the actions taken by the Fed post GFC and considers the impact of such decisions on the US and world economies, and on sectors of the US economy to wit, asset holders and the middle class. So serious was the risk of global depression resulting from the financial crisis, that the Fed's "actions" during the period, principally orchestrated by Fed Chairman Ben Bernanke, went beyond the bounds of traditional Fed "tweaking" of short-term interest rates. Bernanke, endorsed by majority vote of the FOMC, introduced an extended zero-interest-rate-policy (ZIRP) and a massive flooding of the financial markets with cash via an unprecedented practice called quantitative easing (QE). To effect QE the Fed purchased mortgage securities from licensed dealers, crediting the dealers accounts at the Federal Reserve Bank with "manufactured" cash. This period has been termed as the "age of easy money."
Christopher Leonard's book pivots on the role of Thomas Hoenig, President of the Federal Reserve Bank of Kansas City from 1991 to 2011. Hoenig was the first president of a Fed regional bank to rise through the ranks of the organization. He became well known for his views on the "too big to fail" issue and his dissenting votes on the FOMC in 2010. The FOMC was well known for its consensus votes so Hoenig's disagreements with the FOMC votes were eyebrow raising among Fed cognoscente.
Between 2008 and 2014, the Fed printed more than $3.5 trillion in new bills. That is three times the amount of money that the Fed created in the first ninety-five years of its existence. The infusion of money into the economy during this period stoked demand for assets, driving up prices across markets. Hoenig was accused of being overly hawkish vis a vis the risk of inflation. But inflation was not Hoenig's primary concern. Hoenig worried that the Fed's easy money plan would primarily benefit big banks and financial speculators, while punishing people who saved their money for retirement. Hoenig said, "I see considerable risk in conducting policy with the consequence of transferring income from the poor, those most dependent on fixed income, and the saver to the rich." Hoenig was worried about the harmful asset allocation effects of the Fed program.
Hoenig distilled his objection to the Fed's easy money policy to three points:
1. The Fed would find it extremely difficult to end a quantitative easing program once it began. When would it stop?
2. The Fed might compromise its independence because it would be purchasing so much government debt. This could put the Fed in a bind. If the Fed pulled back on the quantitative easing, it might cause interest rates to rise. That, in turn, would put more pressure on the Fed to keep buying to keep the price of government borrowing artificially low.
3. The program could "unanchor" inflation expectations. This was different than saying it would cause inflation. Hoenig was warning that companies and financial speculators would start anticipating higher inflation in the future thanks to the inflow of new money, and they would start to invest accordingly.
Hoenig had quasi allies on the FOMC. Richard Fisher, President of the Dallas Federal Reserve Bank noted: "Quantitative easing is like kudzu for market operators. It grows and grows, and it may be impossible to trim off once it takes root." Still, Fisher and one or two squeamish FOMC members, voted for Bernanke's Fed program in the end. Hoenig was the only hold out.
The book is a morality tale. Though Hoenig was roundly criticized as sort of a cranky, failed Old Testament prophet for the three or four years after he resigned from the Fed in 2011, virtually all of the predictions Hoenig made about quantitative easing, and 0 percent interest rates, would come true over the next decade. Income inequality had increased, the Fed's actions had stoked dangerous asset bubbles, social instability had worsened, and the big banks became enriched while the incomes of the poor and middle class had stagnated.
Years later Hoenig didn't say that he voted the way he voted because he was smart. He said he voted that way because of what he'd learned over more than thirty years of working inside the Fed. Over his thirty years of working at the Fed he had seen firsthand how much devastation the Fed could cause when it got things wrong.
The book chronicles the early life of Thomas Hoenig. He was a rule follower in his early career. He was a young bank examiner at the Kansas City Federal Reserve Bank, the institution where he would later become president. He had seen the pitfalls of the Fed's easy money policy in the 1970's where the Fed had kept rates so low during the 1960's that they were negative when accounting for inflation by the late 1970's. This kind of environment fuels inflation because all of the easy money is looking for a place to go. E.g. "too many dollars chasing too few goods." Moreover, Hoenig learned early in his career that easy money policies don't just drive up the price of consumer goods. Low rates fuel demand for assets, which eventually inflate asset bubbles. Hoenig learned that when the asset bubbles burst, farmers go bankrupt, and banks fail.
Most of the Fed governors and regional bank heads are economists. A central point of the book, even if it is somewhat implicit, is that Hoenig's school of hard knocks background gave him a totally different perspective than that had by economists about how the Fed should operate.
The author shows us examples of how "easy money" affected the world beyond Washington, D.C. In 2013 John Feltner landed a unionized job at Rexnord, a manufacturer of heavy-industry equipment. Two years later, Rexnord moved his Indianapolis plant to Mexico. Starting in the 1980's, a string of private equity firms saddled Rexnord with so much debt that the company's reason for being became the servicing of that debt.
One of the private equity firms that acquired Rexnord in the early 200s was the Carlyle Group, and one of the partners of the Carlyle Group at the time was Jerome Powell, currently the chair of the Fed. The Rexnord example shows how extreme financialization has transformed the economy and US politics.
Powell is depicted by Leonard as the personification of the financial system... an astute operator compared to Hoenig's principled but doomed prophet crying in the wilderness. Still, the author respect's Hoenig's hawkishness. Leonard credits Hoenig as being a steward of "prudence and integrity."
Hoenig was not a false prophet. There is no doubt that since the financial crisis of 2007/2008, America's middle class has been weakened and that big business and big banking has been strengthened in relative terms and that central banking policies of low interest rates and seemingly endless money printing have contributed to that outcome. The implications of the central bank's actions will continue to play out over the coming decades. Read this book and decide for yourself whether we should have paid more attention to the Hoenig's of the world than we have so far.
Thrift Advisory Board to the Federal Reserve Bank - 1993 to 1995.
Reading this book caused me to reflect on my own experiences at the Fed. From 1993 to 1995 I was on the Thrift Advisory Board to the Federal Reserve Bank. While I was CEO of American Savings of Florida, I made eight quarterly visits to the Eccles Building, Fed Headquarters, in Washington D.C. At those meetings, seated around that famous, oval, shiny wood conference table, I and several other heads of S and L's around the US, would give a business update for our respective markets to the Fed board of governors. I left the advisory board in early 1995 after American Savings of Florida was sold to First Union Corporation. At the time of the sale, I was Vice President of the advisory board and slated to be its president for the 1995 term. It (the presidency of the advisory board) was not meant to be. Still, my time at the Eccles Building was well spent... a fascinating education for me.
Above: Image of Thrift Advisory Board to the Federal Reserve Bank and Fed Board of Governors. 16 December 1994.