Latest / The Capitalism and Freedom in the Twenty-First Century Podcast / Inside Financial Regulation: Thomas Hoenig on the Fed, FDIC, and Banking Reform | Hoover Institution

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Inside Financial Regulation: Thomas Hoenig on the Fed, FDIC, and Banking Reform | Hoover Institution · The Capitalism and Freedom in the Twenty-First Century Podcast

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[MUSIC]
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>> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast,
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an official podcast of the Hoover Institution Economic Policy Working Group,
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where we talk about economics, markets, and public policy.
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I'm Jon Hartley, your host today.
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My guest is Thomas Hoenig, who is a PhD economist, a Distinguished Senior Fellow
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at the Mercatus Center, and the former Vice Chair of the FDIC during 2010.
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And the President of the Kansas City Fed for about 20 years from 1991 to 2011.
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Welcome, Tom.
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So great to have you here.
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>> Thomas Hoenig: Well, thank you.
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It's good to be with you and I look forward to our conversation.
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>> Jon Hartley: Start by gaining your early life.
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You were born in Iowa.
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You did your undergrad at Benedictine in Kansas.
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You did your PhD at Iowa State.
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There's a close connection between Iowa State and
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Chicago that I think some people might not be aware of.
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Theodore Schultz and De Gal Johnson, agricultural economists who are both
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at Iowa State and went to Chicago won the Nobel Prize.
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I'm just curious, how did you first get into economics and
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financial regulation growing up in the Midwest?
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>> Thomas Hoenig: Well, first of all, my dad had a small business,
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so I had trips to the bank with him.
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I knew that they were around, put it that way.
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But actually I got most interested when I was in college.
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I took a course, an elective course in economics in my freshman year and
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just thoroughly enjoyed it.
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It was microeconomics, but it was very, I thought, useful and challenging.
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And so I decided that was what I was going to do.
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Although I did morph into money and banking as I graduated and
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then got into graduate school.
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So I spent a lot of time in economics thinking about economics.
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And when I left the when I graduated out of my graduate program,
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I went to the Federal Reserve bank of Kansas City.
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And I had my specialty was money and banking.
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And so when I went to the Kansas City Fed, they had
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during the period where there were a lot of mergers among banks going on.
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And so I went into the banking supervision and
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structure division of that bank rather than the monetary research division.
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And in that I learned a great deal because wasn't too long after I
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joined that we had the asset boom of the 70s and then the Paul Volcker era.
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And I was in supervision and literally watched with disappointment,
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I guess I'll use that term in the hundreds of bank failures that were going on
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just in our region and across the country.
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And that got me interested then even more in what the causes were
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monetary policy factors in that, trying to deal with inflation.
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And so I was pretty well prepared when they asked me to step
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into the role of president of the bank and join the FOMC,
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the Federal Open Market Committee, and its policy role.
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And so I had both kind of banking knowledge and the monetary knowledge.
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And I found it very, that combination very helpful to me in my career.
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>> Jon Hartley: Well, it's terrific.
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You were there during the gold financial crisis.
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You were the president of Kansas City Fed when that happened,
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when those events transpired.
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And I feel like the financial crisis was both a defining moment for
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financial regulation and for monetary policy.
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It was really then when quantitative easing was starting.
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I'm curious what went wrong in the financial crisis as you sort of see it
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in terms of underlying causes.
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What went wrong with the banks in your mind?
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Housing central to that was government subsidies important.
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There was lack of say bank capital an issue.
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Was complexity of the financial system an issue?
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I'm curious.
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You gave a speech in 2009, you gave a speech titled Too Big Has Failed which
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was pretty critical I think of the approach taken until that time.
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How do you define the events of the financial crisis and its causes?
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>> Thomas Hoenig: Well, I will tell you, first of all,
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I think most financial crisis post World War II, let's leave it.
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And I'll also kind of mark out Covid but
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most financial crisis are actually policy related,
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usually excessive monetary policy.
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And that's one thing I learned as I dealt with banks and doing the crisis and that.
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And for example in the 70s what happened was the Fed not wanting
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to have a slowdown in the economy, repeatedly lowered rates.
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And then as inflation picked up, they lowered them again, but
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they never really got an equilibrium.
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And over that time inflation, as you well know,
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went from modest 2.5% to 14% by the 1979 period.
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And what happened in that baits the banks, in other words,
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low interest rates, asset prices.
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They began to land more on collateral value and
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the expectation that the value would only increase because of inflation and
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they're willing to make higher loan to value loans, take on more risk.
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And so then when you raise interest rate and those values plummeted,
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these banks were ill prepared to deal with it and they
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didn't have enough capital given the size of the adjustment that had to take place.
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So that happened in the 80s, 70s, and 80s, and
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then we actually repeated it after the, in beginning of the decade of 2000,
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where I was a member of the FOMC then I, did object, but not enough.
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And we saw interest rates decline to as low as 1% even when
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the economy was growing in 2003.
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And what that did is it brought forward the speculative elements in the economy
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because of very low interest rates.
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You could borrow a lot of money at, say, 2%, buy a company,
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finance it with debt, strip out the equity, take the cash, move on, but
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creating increasing amounts of instability until finally inflation took off.
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They raised rates.
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And we had an enormous financial crisis around housing because people have been
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taking equity out of their homes and spending it.
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More leverage, more downside risk.
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And when it finally hit, we had a major problem again.
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Following Covid, the Federal Reserve, extended its loose monetary policy,
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accommodated monetary policy well past the COVID crisis.
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It held onto that $120 billion a month injection of new
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reserves into the system for over 18 months.
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And we had a breakout of inflation.
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It exceeded 9% at one point.
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And then they had to raise interest rates.
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And, of course, asset values in the banks plummeted.
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We had the Silicon Valley bank failure and then a bank run on many banks, and
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that because no one knew for sure how they were affected.
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So those are the sorts of things you have to think about in monetary policy.
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What is your policy gonna do to the institutions when you adjust it?
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And I think that was lost in each of those occasions, and
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why we had a worse crisis as a result.
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When I talk about too big to fail, the other side of that was some banks were,
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shall we say, protected, while other banks were not.
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And it created an instability and
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uncertainty in the system that I think was very harmful to the economy.
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You know, prior to the great financial recession, when Solomon failed, it failed.
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We didn't bail it out, and we didn't bail out the banks lending to it.
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But when we got to the great financial crisis and banks were under pressure,
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especially the large banks, Citibank, you name it, the, the Fed said, no, no,
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we can't have that.
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So they actually provided enough enormous amounts of liquidity into the system that
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the treasury helped provide capital, something they wouldn't do for
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a regional bank or smaller bank.
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And so we, we set up an expectation that the largest banks would be
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bailed out at whatever cost.
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And that discriminated against all the other banks and
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made our bank and our economic system less efficient.
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And so I had real objections to that as well, John, and still do to this day.
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>> Jon Hartley: Well, I guess there's this famous question about should Paulson and
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Bernanke have saved Lehman?
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And I guess there's this question of what does a run on,
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I guess the shadow banking system look like?
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And this is a traditional run where I guess you have depositors
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lined up at a commercial bank trying to get deposits out, but
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really you have investors, money market funds getting tons
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of redemptions, people are worried that there's exposure
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to Lehman commercial paper and that that triggers this,
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all these redemptions which sort of forces further selling and so forth.
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I guess the argument, I mean, it seems like, during that period, I mean,
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there were a series of these distressed firms,
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whether it's Bear Stearns eventually getting bought up by JPMorgan or
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Merrill Lynch getting bought up by Bank of America and so forth.
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You have some assistance from the Fed in some of these cases, but
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there are some people that argued that Bernanke and
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Paulson should have acted more to save Lehman.
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And there was a deal lined up with Barclays, I think, to buy Lehman, but
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I think the UK prevent it from happening.
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It's kind of the Paulson story that he tells,
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that that was, I guess, a central challenge.
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But other I think Randy Quarles, for example, might say countrywide
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was kind of, I guess the moment that things were getting really bad.
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I'm curious what your sort of diagnoses are of, of that period of time and
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all these bailouts and, and what should have been done differently, if anything.
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>> Thomas Hoenig: Well, my complaint was to begin with, when they decided for
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whatever reason to bail out Bear Stearns.
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It was not the largest institution in the world, but
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they were afraid of contagion effects or whatever the reason was.
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I thought that set the expectation.
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And when you, once you set the expectation, then you live with it.
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And the expectation was, anything that large or larger is going to be bailed out.
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It even set the expectations for Lehman itself.
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Had they let that fail, it would have required,
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it would have caused, I should say, a whole different, I think,
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set of responses in the banking industry and in the investment banking industry.
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And it would have said, wait, I better be thinking about how much capital I have.
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I better be thinking about the distribution of my assets on my balance
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sheet and the quality of my assets and whether I should build liquidity.
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This was in March of 2008, and
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then you had, basically, the GSEs.
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And you put them into conservatorship, but in fact you bailed out the creditors.
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Not that, not the investors, but the creditors big time.
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And so you set the expectation.
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So then when you give them the Lehman Brothers, you've set the expectations.
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To change direction at that time is to invite a crisis is to.
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Because now you're saying, wait a minute, those were the expectations, but they, but
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they're not living up to them.
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I better run and I better not take any chances because I don't know how other
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banks like Citi or so forth, how they prepared for it,
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because we know Lehman's didn't prepare for a further liquidity squeeze at all.
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And therefore you created this monster.
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So the mistake was starting out by bailing out.
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Once you start down a path, you can't change during that crisis.
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And they tried to do that, which was a serious error at that point.
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>> Jon Hartley: I'm curious how you think of, I guess, some of these arguments
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around Glass-Steagall and Gramm-Leach-Bliley and Glass-Steagall.
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And a large part that people talk a lot about is separating commercial banking
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from investment banking.
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And Glass-Steagall and Gramm-Leach-Bliley and other legislation around
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that time in the 90s, Glass-Steagall's something passed in the 1930s.
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Gramm-Leach-Bliley, in the sorta deregulatory period in the 90s,
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allowed for a lot of consolidation in the part of the banking system.
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Some people will say, like Elizabeth Warren will say,
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Warren will say breaking up the big banks would be a good thing at some level.
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I think it would make the financial system less
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stable in the sense that these larger banks that we now have as a result of this
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consolidation sort of benefit from being more diversified.
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They have both commercial banks and investment banks under one umbrella.
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And if you look at the performance of the larger banks, the JPMorgans,
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the Citis, the banks, Bank of America and Wells Fargo, I mean,
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they were generally safe during the financial crisis.
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And it was, generally speaking, those that didn't
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have diversified businesses combined that were struggling.
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This is an argument I've heard from Bernanke and others or
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others have mentioned before.
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I'm curious what your thoughts are I guess on consolidation.
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I mean, now we're also seeing a non-banking sector sort of emerge that's
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growing a lot, non-bank lending, think the Rocket Mortgages of the world.
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I'm curious how you see sort of I guess the financial system evolving and
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how consolidations played a role in that.
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>> Thomas Hoenig: Well, let me go back to the first part and that is,
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you know, Ramleach Bliley, I oppose that at the time and, and
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the reason was though not that I necessarily anything against mergers but
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the fact was the commercial banking industry was the only one that
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was heavily subsidized in the sense of deposit insurance.
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And we knew from other experiences,
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continental Illinois that they would likely be bailed out if there's a private.
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And so now you're taking this commercial banking and you're saying,
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we're gonna allow commercial banks and investment banks to merge.
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Well that sounds great except you're also then indirectly and
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sometimes very directly extending the safety net from just
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the commercial banking industry to the investment banking industry,
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especially when it's under the umbrella of a single bank holding company
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that owns both because as a policymaker that if either one of them get in trouble,
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both of them get in trouble because people, they don't distinguish,
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they can't be sure how much overlap is there.
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And I gave a speech in 1999 as this thing was being passed,
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saying, you will now have systemic risk For sure,
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you've invited systemic risk into the financial system and that
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actually entrenches to be to fail because now everything is implicitly insured.
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And that's exactly what happened.
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They say, well, J.P. morgan,
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the others were satisfactory capitalizing the great financial crisis.
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That's not actually true [COUGH] Because the US government through TARP,
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put up in place a $600 billion bailout for the industry.
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And Citibank, which was clearly on the ropes to failure,
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had equity injected preferred stock.
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They gave him enough capital and then if you look at the data,
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the Federal Reserve made enormous loans to these institutions during that period.
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They, they were, they were provided all the liquidity they need.
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And that was so called QE1, but it primarily was a liquidity vehicle.
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I did not object to that because they did have, most of them did have good assets.
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And when the treasury was done putting equity in them, they all had sufficient
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capital, but they were bailed out in every sense of the word.
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And they had to be because now you had merged banking and
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investment banking together, these, they were much larger at the time
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of the 2008 crisis than they were in 1999 or 2000 when Grammarly Spotty was passed.
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So you invited this systemic effect and you got it and we have it today.
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There's no way you could allow any of those institutions to fail today.
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And that's going to continue on into the future.
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And it gives them a huge competitive advantage.
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And it isn't, it actually is encouraging the consolidation for
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the consolidation of the industry.
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I recently was talking to a organization that merged and they said,
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Tom, we didn't have a choice.
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For example, they said when Silicon Valley hit, we had, we were well capitalized, but
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we had a run on our bank.
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And they ran to the New York banks, to the too big to fail banks or into Treasuries.
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And so we had to over and over emphasize we were very well capitalized
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with very good assets, stay with us and they survived.
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But they said we're not sure we can survive the next time that happens.
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So we've created our own future process of bailouts that are unavoidable and
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very much entrenched into our financial system today.
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Which brings me to the shadow banks or the private equity groups.
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If you think ahead and you, you think about private equity and so
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forth, they're large enough that I think the liquidity provisions
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of the Fed will flow through to them if any one of any significant size
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gets into trouble because they'll be afraid of a systemic fix.
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And one of the Primary lenders to these private equity,
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besides how they raise money are commercial banks.
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So it fall back on them, so we broaden the range of trouble.
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Also, I think there's strong likelihood we'll pass this so
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called genius act, which is a law that would, shall we say,
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put a sanction through regulation on unstable coins.
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That is basically money markets that have government securities as backup and
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they can also engage in payments.
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And when you do that, I think it's fine to have them if that's what they want and
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if that's what people want to invest.
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[COUGH] But once they become subject to government regulation and
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oversight and people then think they're protected when a crisis happens,
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the government will step in and bail them out.
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And if you don't believe me, think about the money markets.
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In the great financial crisis.
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The money markets were supposedly backed by very safe assets,
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the most liquid assets.
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And yet one of the money markets broke the buck and they were all bailed out.
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So we're moving away from a market economy.
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We're moving away from a government will bail out certain large institutions and
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certain kinds of institutions.
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And I think that makes it in the long run.
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In the short run, everyone wants to be bailed out.
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And if I had money in a bank that was there, I'd want my money.
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However, in the long run we're weakening the system overall.
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>> Jon Hartley: So I suppose in the aftermath, the golden finish,
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we adopted these Basel 3 capital standards for
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gibs globally systematically important banks.
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We've got sort of this regime of two types of capital ratios.
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We've got the, the risk neutral one, which is the supplementary leverage ratio.
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We got the risk weighted one tier one common equity.
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And we've also got, you know, a regime of bank stress tests,
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you know, CCAR dfast, these things that the Federal Reserve does.
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And they sort of have these opaque scenarios that bank balance
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sheets are supposed to be able to withstand in these simulations.
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And if they don't hold up to mustard,
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they can't issue dividends, they can't return to cash to shareholders.
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That's kind of the system that we've lived in.
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I think there's some good evidence that we're in a much safer
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place now than we were before.
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Now bank capital ratios are much higher.
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I think bank CDS spreads have generally been lower and
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bank volatility has been lower.
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And if you look too just in the recent crises periods at some level
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I think banks held up pretty well during, during COVID and
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then even during the regional banking crisis.
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I think it was largely one bank, Silicon Valley bank, that had some serious
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problems in terms of managing the duration of their balance sheet.
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And then you also had that combined with the uninsured deposits issue,
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having lots of uninsured deposits.
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I think that was a one off kind of issue.
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Sure, there were Signature bank and some credit crypto and
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Credit Suisse was sort of teetering for quite a while but
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I think by and large I think things are safer and better now.
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I mean, tell me, is that right or wrong in your mind?
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>> Thomas Hoenig: Well, it's relative.
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I don't agree with you totally, but it is relatively safer.
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But here's what I would tell you.
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First of all, the banks are not that well capitalized.
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They are when you look at the risk weighted capital and
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you look the amount of risk weighted assets to total assets is about 50%.
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So that process weights mortgages at 50% of their book value.
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It weights other assets at 20 to 30%.
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And it weights government Treasuries at almost nothing.
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And so you have these very high 13 rates.
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But when you look at the leverage ratio,
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how much capital do I have relative to my total assets available to absorb loss?
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That's the leverage ratio and it's 7%, 7 cents on a dollar.
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And in the great financial crisis we lost.
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The banks lost even the largest, about 6 cents.
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So you know, there's not that much capital.
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When you say gold plated, I think that's a word that's been
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used to convince people to believe them because it isn't true.
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They're capitalized better because at the great financial crisis because of the risk
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weighted system they were about 4%.
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But there was a time when you had capital ratios of 10 and 11%.
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And for regional banks they are, they are capitalized leverage ratio of 10%.
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So it's, it's a relative thing.
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It's better, but it's not, they're not well capitalized.
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And I would tell you, we talked about Silicon Valley and
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the banks got through it in the economy, but the Fed preemptively pumped
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hundreds of billions of dollars into the system to provide it the liquidity,
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the access to, to, to enable companies, municipal com,
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municipalities to stay solvent, not have a liquidity breakdown.
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It did preemptively because you had to run on the banks when Silicon Valley failed.
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Because when you looked at the balance sheets of the banks at that time,
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there was about $600 billion of unrealized losses on those in
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those balance sheets that were not recorded because of
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the accounting rules allowing you to not have to charge those off.
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So were we really, could we really absorb $600 billion of losses?
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Well, the idea is, well, they'll basically,
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you let them amortize until interest rates come back up.
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Well interest rates were zero for about 15 years.
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So then they shot up and you had the shock and you have the effects of that.
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There wasn't enough capital to absorb that without the Fed.
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So now the other thing that's happened, John,
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is that the banks, the Federal Reserve's balance sheet,
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which was once less than a trillion dollars, grew to $9 trillion.
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But here's the important point.
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Its footprint in the market,
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in the government securities market has become enormous.
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It calls the shots.
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And so you don't really have a market there.
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You have the Fed and one of the, you know, they, they say that the dual mandate for
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the Federal Reserve is maximum employment.
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Right.
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And.
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>> Jon Hartley: Price stability.
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>> Thomas Hoenig: Well, I was going to say interest rates or something, price
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stability but they define the Fed defines it as low inflation, not price stability.
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And I like to make that distinction there.
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But here's the main point.
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They have an unstated absolute mandate.
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Keep the, keep the securities,
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federal securities market stable and able to issue debt.
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That's, that's their mission and that is a primary mission,
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their operating procedures are around that.
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They have a standing repo facility that's around that goal.
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There didn't used to be that you had the discount window if you
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need a temporary liquidity and you have the assets to declare, but
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now just call them up, it's yours.
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So we've become,
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the Fed's become a much more important player in the securities market generally.
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And the bond vigilantes will only come into play if the Fed sticks to its
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guns on its quantitative tightening, which it is just about done with,
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I think, and then we'll see what happens from there.
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>> Jon Hartley: So I guess to speak clearly, so
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you're diagnosing the banks as not being as safe enough potentially to
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withstand another global financial crisis today.
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And, and I guess would your policy prescription be we need
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even tighter capital ratios for, for the banks.
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Would that be your.
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>> Thomas Hoenig: Well, my, here's here, I've said this for years.
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The banking industry, the largest banks included,
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the banking industry is over regulated.
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I mean that's why you have the shadow banks and everything else going on.
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It's over regulated.
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And my view was keep the capital high and the rules minimum and simple.
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Because when the industry was not, didn't have the safety net of the Fed and
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didn't have the safety net of the FDIC and didn't have the safety net of
28:44
the government putting equity in capital ratios were 20 and 30%.
28:49
Now I'm not advocating for that, but I am advocating for
28:53
10 to 15% then and I would get rid of, I mean, stress tests.
28:58
Come on, I mean they haven't failed a stress test in 10 years.
29:03
That's process, expensive process.
29:06
The risk weighted capital measure which the banks favor and the government favors
29:10
is costs hundreds of millions of dollars, billions of dollars wasted when a simple
29:15
leverage ratio does the same thing in a much more effective way because it tells
29:20
you transparently how much can this bank lose before it's insolvent.
29:24
It puts discipline out there.
29:26
So I would have the capital ratios high, give people confidence and
29:30
get those rules minimized.
29:31
And I think you would see more business come into the banking industry than
29:35
leaving.
29:36
And you'd have a, you still have a, you can always have a crisis.
29:42
But right now the largest banks under the risk weighted system are homogenized and
29:46
into a single bank there's no differences because the risk weights
29:50
on the assets define where you put your money.
29:54
>> Jon Hartley: Right? Well, I guess,
29:55
wouldn't that be a criticism of the simple leverage ratio,
29:58
supplementary leverage ratio too in the sense that.
30:01
Well, you could do to respond to that is just by you could still
30:06
keep the same overall level of risk for your equity by just
30:12
investing the assets in much riskier securities or investments.
30:17
Think buying 3X levered ETFs or
30:21
whatever have you to compensate for that.
30:26
>> Thomas Hoenig: Yes, I know the argument.
30:28
But here's what I tell people.
30:29
If you didn't have too big to fail and capital was as it's supposed to be.
30:34
So I want to have a bank, I gather capital now I have to, I'm the management.
30:39
I'm not the government.
30:40
I'm the management.
30:41
And I have to decide how much do I have in riskier loan assets for return.
30:48
How much do I have in governments to get a return but provide some liquidity.
30:52
How much do I have in consumer.
30:54
Okay, so I know there's risk there, but there's a good return.
30:57
I have to make those decisions and I have to make them for
31:00
the long run benefit of my stockholders and my survivability.
31:04
But now I know I'm too big to fail.
31:08
Or creditors know that banks are going to be,
31:11
they're going to get bailed out even though they invested my lose.
31:14
So they don't mind putting money into high risk organization because they may get,
31:17
they're, they're sure they're going to get their money back.
31:20
You've distorted the market process and, and, and you're proud of it.
31:26
And I'm saying no, I'm not proud of it,
31:28
the market gives us in the long run the most effective outcomes.
31:32
Look at us today.
31:34
The leverage, excuse me,
31:36
the risk weighted capital measure is tilted to encourage banks to invest in
31:40
government debt because you have a ton of government debt to issue.
31:46
Well, that's not a reason to have a risk weighted system.
31:49
And now there's a proposal.
31:50
The Secretary of the Treasury and
31:53
each of the agencies have under consideration a proposal to
31:58
exempt government securities from any capital standard.
32:03
That's, that's saying, okay, no cost of capital, go ahead and
32:06
invest in all the government that you,
32:08
that you want because it's not going to cost you anything.
32:13
It's just gravy, isn't it?
32:15
>> Jon Hartley: Just for Treasuries, though, excluding.
32:17
>> Thomas Hoenig: Just for Treasuries.
32:21
But, that's what I mean.
32:23
So the government, so the government has a Treasury auction.
32:27
I'm the bank I lend the government the money.
32:33
I take the government's securities, the government takes the cash,
32:37
it spins that money, it circulates back to the bank, so it has the Treasuries.
32:42
But now it's circulated back because the government spent.
32:44
It goes back into the banking system, much of it, not all of it.
32:48
And I buy another tranche of new government debt.
32:51
As long as the government has to issue new debt, I'm there to do it and
32:54
there's no cost to capital.
32:56
Well, now you've taken any discipline from the government away to print money.
33:01
Even the Fed is out of the picture there.
33:04
I mean, we're going down a road that I'm not sure
33:09
you ever get back from without a major crisis.
33:13
>> Jon Hartley: Just speaking of, I guess, recent crises.
33:15
So we did have this Silicon Valley bank regional banking crisis, 2023.
33:21
And I'm curious what you think about deposit insurance,
33:23
because I think we're in an interesting place there.
33:25
So, we had, again, you had a few banks, a lot of uninsured deposits,
33:29
forgot how to manage interest rate risk.
33:32
FDIC came in, resolved the banks, but
33:35
there's still this weird kind of thing which is well,
33:40
we kind of have this implicit unlimited de facto deposit insurance now.
33:46
And of course, before you had $250,000 for every bank account.
33:50
And in theory you could go to every bank in the United States and
33:53
that would give you hundreds of millions of dollars of deposit insurance.
33:56
I mean, I don't think in practice anyone's done that.
33:59
Maybe, I don't know, but you could in principle.
34:01
And now we sort of have unlimited de facto deposit insurance.
34:06
I'm curious, do you think that's, I mean,
34:09
there's lots of, I guess more hazard issues that some people raise.
34:13
Do you think that this is a problem where we're at with deposit insurance and
34:17
what do you think things should be?
34:19
>> Thomas Hoenig: I think we're past that point.
34:20
I mean, the moral hazard issue, if you take into account the too big to fail
34:25
banks and you take into account the reasonably sized regional banks, you may
34:31
let the investors in the regional banks fail, but you will not let the creditors.
34:36
We know that from Silicon valley.
34:39
So, about 70% or more of deposits are directly or implicitly insured now.
34:45
So we're only talking about a small percentage,
34:48
which are primarily the community banks,
34:50
as we learned that their depositors are not 100% insured, they're the only ones.
34:55
So I think you have an argument for just 100% deposit insurance because the moral
35:00
hazard issue off that is going to be that much larger and
35:03
it's more fair because you've gone down that road and you say fair.
35:07
What's fair?
35:08
Well, if you're going to have a banking industry under the same rules,
35:11
you better have a banking industry under the same rules.
35:15
Otherwise you bifurcated it and you've treated some differently and
35:19
it actually accelerates the consolidation process as you go down the road.
35:24
So I think it was a very bad mistake.
35:27
I also wonder to myself in the Silicon Valley situation I
35:32
cannot understand as a former vice chair of the FDIC,
35:37
to how you made, you couldn't have made
35:41
the least cost test for bailing out depositors.
35:47
It was a systemic crisis test only because a lot of depositors,
35:51
very large, influential depositors,
35:54
would have lost money, maybe 20% of their deposit in the end.
35:59
And so, you've changed the game.
36:01
You once again changed the game, and I think that's unfortunate.
36:04
So, yeah, we have the moral hazard problem, and adding another 20% or
36:08
30% to it isn't going to be that much more expensive, given where we are today.
36:13
Now you have to worry about who's entering it.
36:16
But look what you have going on at the moment.
36:19
You have a whole new system of stablecoin emerging.
36:23
We have many, many issues ahead of us that will focus
36:28
the debate about moral hazard going forward.
36:34
>> Jon Hartley: Well, I'm curious, so let's talk about monetary policy for
36:39
a minute here, because this is, I think,
36:42
a somewhat related topic coming out of the global financial crisis.
36:48
The Fed did its first sort of quantitative easing rounds where they were buying up
36:54
a lot of these toxic assets and they were helping to resolve bank balance sheets.
37:00
And so that was, I guess, the sort of initial foray, maybe QE1, I think,
37:05
is what people call it.
37:07
But then if you've asked for it a couple years later,
37:11
start getting this new process, starting with, I think, QE2,
37:16
which is the Fed going out, buying treasury bonds and issuing reserves,
37:21
paying interest on those reserves, and also buying not just treasury bonds,
37:27
but mortgage bonds too, GSE backed mortgage bonds,
37:31
buying those, expanding the size of the balance sheet.
37:35
And this goes on for quite a period of time.
37:38
And then in more recent years, the Fed's tried to unwind some of
37:42
this Quantitative tightening is what some people call it.
37:48
And we've had some hiccups along the way.
37:52
For example, the repo crisis of 2019.
37:56
The banking system has sort of adapted to this new world.
38:00
And I'm curious, you've been a long time critic of quantitative easing.
38:05
What are your criticisms of quantitative easing in this system?
38:10
Well, first of all, QE1, which was in the crisis itself.
38:14
>> Thomas Hoenig: I voted for it, but it wasn't even called QE.
38:18
It was a liquidity facility given the circumstances of the moment and
38:23
the size of the freeze up in the market.
38:26
>> Jon Hartley: Okay, Judicial lender of last resort, lender.
38:29
>> Thomas Hoenig: Of last resort, liquidity provider of last resort.
38:33
And the idea was that's kind of the theory of central banking for banks that
38:37
are sound and I won't get into the ones that weren't sound and were bailed out.
38:41
That we've already talked about but that was fine.
38:44
But what I found objectionable was QE2, 3 and
38:49
4 all the way through post Covid, because there
38:54
was this view that unemployment was still high.
38:59
But in the third quarter of 2009,
39:02
even before QE2 started, the US economy was in recovery.
39:09
Industrial production was picking up, employment was picking up.
39:12
But there was a view among some that, well, employment was still close to
39:17
10% too high and we might be able to bring it down faster if we do QE2.
39:23
And I said, it doesn't work that way.
39:26
I mean, bringing people back in takes time.
39:28
We have a recovery underway.
39:29
Let's look at the recovery.
39:31
Let's be patient because if we go down that road, I said,
39:35
you won't be able to get out of it.
39:39
I said in QE1, the whole idea was we're going to do it and then we'll pull back.
39:44
And instead we're not pulling back, we're going forward with even more,
39:49
hundreds of billions of dollars more.
39:51
And I said, what you're going to do is you're going to set a new
39:56
equilibrium around zero interest rates and high reserve balances.
40:01
And they say, well, we're not printing money.
40:04
Yes, you are printing money, you're printing high powered money and
40:07
you're keeping interest rates from going negative by having reverse repos.
40:11
So you're putting it in over here and you're pulling it over there.
40:14
I said, why would you do that?
40:18
Because it provides enormous liquidity into the market to take care of things.
40:22
But what were the other effects?
40:24
Because you had this cheap borrowing capacity.
40:27
You went in and you encouraged speculation.
40:30
You encourage hedge funds to go in and buy companies,
40:34
borrow the money to buy them, strip out the equity and then move them offshore.
40:42
That's number one.
40:43
Number two, they said, well yeah, but they'll take, the investors will take that
40:48
money and they'll invest it in other things like the stock market.
40:52
Well, the only thing you did with the stock market, that's not new investment,
40:56
that's not plant and equipment, that's raising the price to earnings ratio.
41:02
And that's what they did.
41:04
So how much more productive did we become?
41:06
Well, that decade was a low productive decade and a low real increase in wages.
41:14
So you accomplish nothing but to distort the allocation of resources,
41:19
find yourself unable to pull back without having a crisis.
41:24
You know, the paper tantrum and
41:26
all that stuff that followed and we're still suffering from it today.
41:31
And we go, we go past the COVID period and we're bailing, we're,
41:35
I understand we put the money in and I would have been for it from March of 2020
41:40
to August of 2020, but they continued quantitative easing for another 18 months.
41:48
And what they did is they increase asset value.
41:51
So we had further just redistribution of wealth, relatively speaking, because if
41:56
you held assets, you were richer, if you didn't, you didn't gain much.
42:01
And, and what do you, what, what else did you sow?
42:05
Societal unrest because people were saying, wait a minute,
42:10
this isn't fair, I want mine, I want mine.
42:14
And so now we have a government spending $6 trillion a year,
42:19
issuing new debt of $2 trillion because everyone wants theirs and
42:24
it's not going to end well.
42:28
>> Jon Hartley: Well, I'm curious about like I've heard those same
42:33
arguments from QE critics in the past.
42:37
And I’m curious, what about this for a different argument that
42:42
QE largely awash, in the sense that, sure, the Fed goes out,
42:48
buys some 10-year longer-dated Treasuries,
42:52
maybe they decrease the yields on those by 20 basis points,
42:58
30, 40 basis points, I've done event studies myself.
43:03
Other people have done event Studies that find some small but
43:07
meaningful effects to that extent.
43:10
They issue some reserves and just paint bearing reserves.
43:14
At some level they're taking in treasuries and long term maturities,
43:20
issuing essentially very short term maturities or reserves.
43:26
And it's kind of just swapping one hand for the other.
43:30
I'm curious what you think about that at some level too.
43:34
I think that there is some conflation in my mind.
43:36
I don't buy the argument that quantitative easing is responsible for
43:41
the run up in US equities in the past decade and a half or so.
43:45
Because I think you look at the US compared to say Europe,
43:49
Canada, Japan, a lot of these, Europe, UK, Japan,
43:54
they've had just as much quantitative easing as a fraction of GDP.
44:01
And those places have had stock markets that are essentially flat for
44:05
the past 15 years or so that haven't seen almost any return.
44:10
Their GDP per capita has been extremely flat as well.
44:14
I think the difference between the US and those places are largely the US has this
44:18
massive tech sector that's very vibrant and we can debate why it has that, but
44:22
it has it and these other countries and regions don't.
44:25
And if you were to strep out the earnings and the productivity from
44:30
the tech companies in the US, you probably would see something.
44:34
You see a US economy that looks pretty similar to Europe,
44:39
UK, Japan and maybe Canada.
44:42
I'm just curious what your thoughts are on that.
44:44
That like the inequality thing might not necessarily be what's going on.
44:48
I buy the whole, once we're in this thing, it's very hard to get out.
44:51
And if you were to get out of it, you'd need a Fed chair and
44:56
an FOMC that is extremely laser focused on doing it.
45:00
Even if it did upset investors,
45:01
they'd have to communicate extremely transparently.
45:05
But yeah, the whole inequality thing, QE I've never really bought.
45:10
>> Thomas Hoenig: Well, first of all, we'll have to see how the, how,
45:13
how it all plays out in the end.
45:14
But number one, I would say, you know, frankly, Europe, Japan, Canada,
45:19
they all did quantitative easing, you're right.
45:23
And a good part of that was strengthened the dollar as they invested in our tech.
45:30
So the money did move, it moved in it.
45:33
But the other part of it is okay, so you want to argue about it didn't,
45:38
it didn't matter relative to equities, housing, other assets, both here and
45:44
in Europe and Canada, inflation, they all have experienced that.
45:50
And that didn't happen because we reduce the amount of money in the economy,
45:56
the nominal GDP numbers are all up nominal-wise,
46:00
even though sometimes productivity isn't as high and so forth.
46:05
So I mean your market signals have been distorted,
46:09
the relative cost of capital has been distorted and
46:14
the effects have been, I think for the most part damaging.
46:19
And if you didn't have the QE and you still had the technology,
46:25
yes, they may not carry the values price to 200 to 1,
46:30
price to earnings or price to book, whichever, but
46:36
they would still be very successful companies.
46:41
You didn't need the money printing the QE to make them successful.
46:46
That's not why they were successful.
46:49
And therefore that doesn't excuse the fact that we've expanded the wealth difference
46:55
in this country across the board, not just in stocks but in every asset held.
47:04
I don't see any good outcome from that.
47:07
>> Jon Hartley: I guess on the inflation point, I've always associated the 2020s,
47:13
early 2020s inflation more so with, I guess, the fiscal policy and
47:18
transfers that hit all these people's bank accounts,
47:22
whether it's the economic impact payments in the US or PPP loans and so forth.
47:28
I guess, looking at how the Fed performed during that period of time,
47:33
do you think that the Fed made a critical mistake by not raising rates
47:38
early enough when it was very apparent, say by October 2021,
47:43
that the inflation story wasn’t purely about used car prices jumping,
47:48
and that it was very broad-based and involved housing rents?
47:53
I'm curious what you think about how the Powell Fed has performed in recent years,
47:58
how they responded not only to the great inflation, but also to COVID.
48:03
I mean, how would you rate them in that sense?
48:08
>> Thomas Hoenig: Well, in terms of the response to Covid,
48:10
they did more than they needed to do, but I wouldn't criticize them.
48:15
I mean, in a crisis like that, you do what you have to do.
48:19
I'm not going to criticize them.
48:20
I think after August, when we knew that recovery was underway,
48:25
then it was clear that they should been they didn't have to,
48:30
they didn't have to shock the economy.
48:33
They just, instead of 120 billion of new reserves a month,
48:37
weaned the economy off that gradually.
48:40
Rates didn't have to be zero after a while.
48:42
I mean, they didn't have to be five and a quarter percent either, but
48:46
they could have been higher and you would have had a transition that I think would
48:49
have been more successful rather than a shock that we had to take.
48:53
Now I think they also made a mistake using the word transitory as long as they did.
48:58
And, everyone tends to agree with that, even them.
49:02
So I think had they made their moves more modestly sooner,
49:06
we could have had a smoother transition than we had.
49:10
But at least they moved this time as opposed to after the great
49:14
financial crisis, and I give them credit for that.
49:20
>> Jon Hartley: Yeah, no, it's amazing and
49:22
interesting to see just how much has changed just in the past few years.
49:27
I mean, do you think that the Fed maybe under the next Fed chair,
49:33
whether it's Chair Kevin Warsh or a Chair Scott Besant or someone else?
49:38
I mean, do you think that we will ever in our
49:42
lives get back to a reserve neutral system or
49:46
a world where we don't have a QE balance sheet any longer?
49:52
Do you think that that will ever happen or
49:54
do you think that the political economy problems are just too big?
49:58
I mean, there is this problem which is when you're at the Fed and
50:01
you're tightening sometimes that when you cause disruptions in financial markets,
50:07
my sense is that there's always this temptation to ease and turn around,
50:11
just like the Fed did in 2019 in response to the repo crisis.
50:15
I'm curious what you think in, through the long run, whether we'll ever get there or
50:19
whether we'll be able to solve our too big to fail issues as well.
50:23
>> Thomas Hoenig: I think we're on a path that it will take enormous leadership,
50:29
not just at the Fed, but enormous leadership in this country
50:34
to bring us back to a more neutral kind of policy era.
50:38
For example, I do agree in 2019 that was a bailout for
50:46
certain groups, if you will.
50:51
I think it's very hard not to Bail out when you're under that pressure.
50:55
And let's, let's think about the Future.
50:58
So the US government has to fund $2 trillion of debt every year or
51:03
more going forward.
51:06
So where is the money going to come from to fund that debt?
51:09
Well, because of our tariffs, war potential war or
51:14
war, whichever way you think of it, foreign entities
51:19
aren't going to be as for the least, for what I can see,
51:24
as anxious to fund that debt to have those government securities.
51:32
I hear Europe talking about portfolio of reserve currencies and so forth,
51:36
I have other.
51:37
So there's less demand there.
51:40
The bank industry is loading up on them now.
51:43
Who's going to buy it?
51:46
Who can print money to buy it?
51:49
Only one institution that I know of, maybe two,
51:52
given that there's no capital requirements and no reserve requirements.
51:56
And that would be the banking industry and the Fed.
51:59
The Fed can print the money or by buying and
52:02
recycling the treasury money, it, it can be the shadow central,
52:07
what I call the shadow central bank and print the money as it multiplies up.
52:15
That's the future.
52:16
And what follows that?
52:19
Well, either a crisis that brings it under control or inflation which has another
52:24
form of crisis that brings it eventually forces it under control.
52:29
That's not an outlook I really want at all, but I don't see it any other way
52:34
unless the leadership says, yes, we're going to, we're going to scale this back.
52:42
Yes, we're not going to print money for a while.
52:46
We're going to go through that transition.
52:49
But in the long run, I think we'll have higher productivity and we can maybe,
52:53
maybe bring our debt under control.
52:55
It's pretty hard to bring under control now because the amount of interest
53:00
we're paying on the debt and so forth.
53:03
So it's going to take a lot of willpower and a lot of leadership.
53:07
Or we'll wait and have a crisis.
53:09
Tell us what to do.
53:10
That's my, that's my thinking.
53:13
>> Jon Hartley: Fascinating.
53:14
Tom, I really want to thank you for coming on.
53:16
It's been a really amazing conversation.
53:18
>> Thomas Hoenig: Well, I enjoyed it, and great questions.
53:21
I wish I had perfect answers for all of them, but it was a great conversation.
53:25
Thank you.
53:26
>> Jon Hartley: This is the Capitalism and Freedom in the 21st century podcast,
53:29
an official podcast of the Hoover Institution Economic Policy Working Group,
53:32
where we talk about economics, markets, and public policy.
53:35
I'm John Hartley, your host.
53:36
Thanks so much for joining us.
53:37
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