President at Money Strong, LLC; Former Advisor, Federal Reserve
Early morning, December 16, 2008, with a drizzle of freezing rain
falling, few would even glance at the line of inconspicuous Mercury
Marquis sedans pulling up to Washington, DC’s Fairmont Hotel. Emerging
from the luxurious four-star establishment, their Foggy Bottom home
eight times a year, are eleven little-known bureaucrats with their
contingent of requisite subordinates.
There is no fanfare to mark the coming momentous decision they are to
take on as they comfortably settle in for the ten-minute caravan to the
neoclassical white marble edifice known as the Marriner S. Eccles
Federal Reserve Board Building, located at Twentieth Street and
Constitution Avenue NW.
Another half dozen of their peers had already left their homes in
nearby Georgetown or some other Washington suburb and they too are
making their way to the same address for the all-important 9 a.m.
meeting.
Only one of these bureaucrats—the chairman, a mild-mannered former
professor—might have been recognized in an American airport. The
rest—unelected, immune to political pressure, mostly academics, and save
one, inexperienced in the intricacies of running a major corporation,
or even a small business—were virtually invisible outside the narrow
world they inhabited despite the enormous power they wielded.
As these seventeen people arrived, they stowed their coats and
umbrellas, grabbed a cup of coffee or tea, and mingled, the low hum of
their conversation perhaps more subdued than on similar occasions. The
day before, the first of the two-day affair, had been extraordinary in
both the dire picture it painted of the American economy and the
realization that they would have to take bold and unprecedented action.
That next sleety morning, they met again, determined to take action
to prop up a faltering Wall Street, hopelessly mired in the greatest
financial crisis since the Great Depression. Even as they convened, the
wreckage of the previous three months still burned around them. Credit
markets had seized up and fears for the fate of the economy were
mounting.
With a few exceptions, virtually all of those at the meeting were PhD
economists who had earned doctorates at MIT, Yale, Harvard, Princeton,
and other top American universities. They met under the auspices of the
Federal Open Market Committee (FOMC), the decision-making body of the
Federal Reserve System. They believed a lifetime of study in economic
theory and monetary policy had given them unique insight to steer policy
for the most powerful central bank in the world, the lender of last
resort for failing Wall Street banks, and the U.S. government’s last
line of defense against utter financial chaos.
Created in 1913 after the Panic of 1907, the Federal Reserve was
founded to keep the public’s faith in the buying power of the U.S.
dollar. After failing miserably in the 1930s, the Fed aimed to be more
responsive. This led the institution to find discipline in the rising
macroeconomic models championed by top monetary theorists. During the
ensuing “Quiet Period” in American banking, deposit insurance prevented
panics, the Fed controlled interest rates and manipulated the money
supply, and though occasional disruptions flared, like the failure of
Continental Illinois National Bank and Trust Company in 1984, no
systemic risk erupted for seventy years. The Fed had tamed the volatile
U.S. economy.
Until September 2008, when all hell broke loose in a worldwide panic
that completely blindsided and, embarrassed the Federal Reserve. The Fed
had used billions of dollars in taxpayer funds to bail out Wall Street
fat cats. Everyone blamed the Fed.
Just before 9 a.m., the door to the chairman’s office opened. Federal
Reserve Chairman Ben Bernanke took his place in an armchair at the
center of a massive oval table. The members of the FOMC found their
designated places around the table; aides sat in chairs or couches
against the wall. With staff, the room contained fifty or sixty people,
far more than normal for this momentous occasion.
In front of each FOMC member was a microphone to record their words
for posterity. To a casual observer, the content of their conversation
would be obscured by economic jargon.
This day, their essential task was to vote on whether to take the
“fed funds” rate—the interest rate at which banks lent money to each
other in the overnight market—to the zero bound. The history-making low
rate would ripple throughout the economy, affecting the price to borrow
for businesses and consumers alike.
Bernanke was calm but insistent. His lifetime of study of the Great
Depression indicated this was the only way. His sheer depth of knowledge
about the Fed’s mishandling of that tragic period was undoubtedly
intimidating.
By the end of the meeting, the vote was unanimous. The FOMC
officially adopted a zero-interest-rate policy in
the hopes that companies teetering on the brink of insolvency would keep
the lights on, keep employees on their payrolls, and keep
consumers spending. It would even pay banks interest on deposits.
Free cash. We’ll even pay you to take it!
As they gathered their belongings, everyone shook hands, all very
collegial despite the sometimes vigorous discussion. They journeyed back
to their nice homes in the toniest neighborhoods of America’s richest
cities: New York, Boston, Philadelphia, Chicago, Dallas, San Francisco,
Washington, DC.
They returned to their lofty perches, some at the Eccles Building,
others to the executive floors of Federal Reserve District Bank
buildings, safely cushioned from the decision they had just made. Most
of them were wealthy or had hefty defined benefit pensions. Their
investments were socked away in blind trusts. They would feel no pain in
their ivory towers.
It took a few months, but the Fed’s mouth-to-mouth resuscitation
brought gasping investment banks and hedge funds and giant corporations
back to life. Wall Street rejoiced.
But the Fed’s academic models never addressed one basic question: What happens to everyone else?
In the decade following that fateful day, everyday Americans began to
suffer the aftereffects of the Fed’s decision. By 2016, the interest
rate still sat at the zero bound and the Fed’s balance sheet had
ballooned to $4.5 trillion, thanks to the Fed’s “quantitative easing”
(QE), the label given its continuing purchases of Treasuries and
mortgage-backed securities.
To what end? All around are signs of an economy frozen in motion
thanks to the Fed’s bizarre manipulations of monetary policy, all
intended to keep the economy afloat.
The direct damage inflicted on our citizenry begins with our youngest
minds and scales up to every living generation in our country’s midst.
The journey could begin anywhere, but let’s start in Erie,
Pennsylvania, an area of the country that was struggling even before
2008. The Fed’s high interest rates in the 1980s killed its steel and
auto industries. The zero bound has dealt the region another devastating
blow. Now, in an Erie elementary school students are given stapled
copies of “Everyday Mathematics” instead of an actual textbook. After a
snowstorm, twenty-one buckets were deployed to catch leaks because there
was no money to repair the roof. In the last five years, the Erie
school district has laid off one fifth of its employees and closed three
schools to cut costs. School officials are being forced to divert
budgets earmarked for kids and facilities to cover the shortfall in its
teacher pension fund, starved for yield in a
zero-interest-rate environment where bonds return only 1 to 2 percent.
This is not limited to Erie. By mid-2016, long-term returns for U.S.
public pensions have dropped to the lowest levels ever recorded—a $1.25
trillion funding gap—forcing pension fund managers from New York to
California to resort to ever-riskier investments to meet their legal
obligations—and to cut services to make up the shortfall.
Ruining Americans’ pension systems? The professor and the FOMC had not anticipated that particular side effect.
And then there are the millennials, the 77 million young people born
between 1980 and 1995. As private equity surged into real estate,
purchasing homes to be used as rentals in search of higher yields, house
prices have soared and the market share of first-time home buyers has
dropped to its lowest level in almost thirty years. Nearly half of males
and 36 percent of females age eighteen to thirty-four live with their
parents, the highest level since the 1940s.
Delaying household formation and all the consumer spending that goes with that? Not on the FOMC’s radar.
Even with mortgage rates at record lows, stagnant wages have made it
difficult for millennials to amass down payments. Builders anxious to
maximize returns now focus on constructing expensive houses, leaving
fewer starter homes for sale in urban areas favored by today’s young
adults. It is an ominous trend for baby boomers. For many, home equity
makes up the bulk of their retirement savings.
Killing the move-up housing market? Nope, the FOMC didn’t foresee that either.
Chances are pretty good that most boomers didn’t get the gist of the
statement released by the Fed on that December day in 2008. A
certificate of deposit (CD) now pays a hair above nothing. Those
boomers—my mom among them—have taken a long hard look at their
retirement accounts and realized with a sense of dread that a lifetime
of scrimping and risk-averse investing has left their nest eggs
vulnerable to serious erosion.
With interest rates on CDs near zero, the average boomer household
would need $10.6 million in principal to safely earn $15,930 in
interest, the annual income at the federal poverty-line level for a
family of two.
Do your folks have $10 million in savings? Mine don’t.
Of course, with $10 million, CDs might not be on the table, but
that’s the point. Several hundred thousand dollars won’t do the trick
without undue risk for aging boomers.
The members of the FOMC knew their decision would screw savers and
the risk-averse elderly. They didn’t care. They couldn’t afford to. Even
when well-intentioned smart people save the world, there are always a
few, or in this case, millions of inevitable casualties.
C’est la vie!
Sadly, there were no angry protests, no million-man marches on
Washington that sent shock waves through our country after the FOMC
issued its press release. Only the quiet, unheralded loss of some
fundamental freedoms: the freedom to save for our retirements risk free,
the freedom to sleep in peace knowing our pensions are safe, and the
freedom for U.S. companies to invest in our nation’s future.
The FOMC’s vote during its final meeting of 2008 didn’t come from
nowhere. It was part of a long tradition of economic interference by
well-meaning bureaucrats, going back to the 1930s and accelerating with
Federal Reserve Chairman Alan Greenspan in the 1980s.
Greenspan championed the era of financial deregulation that drove
Wall Street to levels of greed that surprised even the most hardened
investment banking veterans.
His pragmatic response to every crisis on Wall Street? Lower interest
rates, which Greenspan did again and again and again. Blow bubbles and
pray they don’t pop.
But they always do.
In the late 1990s, dot-com companies soared far beyond true valuations; reality pricked that balloon in 2001.
In response, Greenspan again aggressively lowered interest rates and
blew another bubble, this time in housing, with catastrophic results
that led to the worldwide meltdown in 2008.
In response, his successor, Ben Bernanke, followed suit, pushing
through a massive monetary policy experiment by lowering interest rates
to zero and using QE to flood America with easy money.
He based his policies on a lifetime of academic study. His
theoretical models relied on the idea of the “wealth effect,” first
articulated by British economist John Maynard Keynes. The concept
assumed that free money would induce businesses to borrow, invest, and
hire more employees. They in turn would buy homes, consume, and put
savings into the stock market instead of CDs, where they would earn
little to no interest. As their assets rose in value, people would spend
more.
The resulting wealth-effect tide would lift all boats. Hailed as a
genius by other academics, Bernanke had every confidence his theories
would work.
When they didn’t, when the American economy continued to stagger,
Bernanke doubled down. His models couldn’t be wrong; something else must
be holding back the economy.
Janet Yellen, who followed Bernanke as Fed chair, maintained his
radical policies with gusto, determined that households and businesses
would invest, buy, consume, damn it! Though many on the FOMC sought an
exit plan, Yellen was even more married to the Keynesian model of
economic growth than Bernanke. She continued to advocate for more QE,
and has even raised the specter of negative interest rates.
But real people haven’t responded the way academics anticipated in
their wealth-effect models. Individuals, small businesses, and
corporations alike have been flummoxed by Fed policy and made their own
rational choices unforeseen by the FOMC.
Cheap money, combined with uncertainty about the regulatory and tax
landscape, has encouraged corporations to buy back their shares rather
than invest in their future. Companies in the S&P 500 Index—the
benchmark for America’s top five hundred publicly listed
companies—dispersed more than $600 billion to buy back their stock in
2014, and more than $500 billion in 2015.
This strategy has been employed by companies as diverse as Apple,
Bank of America, and ExxonMobil, which lost its prized AAA credit rating
after one hundred years, based partially on the record amount of debt
it incurred to buy back shares. Since 2005, U.S. corporations have
disbursed an estimated $296,000 on share buybacks for every single new
employee who has been hired.
Because that’s the way the world works.
“No wonder share buybacks and corporate investment into research and
development have moved inversely in recent years,” wrote Rana Foroohar
in an op-ed in the
Financial Times on May 15, 2016. “It is
easier for chief executives with a shelf life of three years to try to
please investors by jacking up short-term share prices than to invest in
things that will grow a company over the long haul.”
Compared to the immediate post–World War II period, some American
corporations now earn about five times more revenue from purely
financial activities such as trading, hedging, tax optimization, and
selling financial services, as compared to their core businesses.
As a result, the labor market has atrophied. Though lots of so-called
eat, drink, and get sick jobs—for waiters, bartenders, and health care
workers—have been created, Fed policy effectively pulled the plug on
long-term investment and compromised high-paying job growth.
By mid-2015, only 62.6 percent of adult workers were employed or
actively looking for a job, the lowest in nearly four decades. The
so-called shadow unemployment rate is estimated to be as high as 23
percent. Many of these people will never come back into the workforce.
Paychecks reflect the stagnation. Unless you are among the top 10
percent of earners, your income has barely grown or declined since 2006.
Ultra low interest rates encouraged what economists refer to as
“malinvestment.” Yes, the shale revolution created millions of
high-paying jobs for workers with little college education. But when oil
prices plunged, many of those high-paying jobs evaporated as quickly as
they were created.
The bailed-out auto industry drove its own form of malinvestment,
pushing the subprime auto loan sector into overdrive. The last time
around, Greenspan encouraged people to buy more house than they could
afford. The result was a tsunami of foreclosures. This time, those same
budget-strapped households have been encouraged to drive more car than
their wallets can bear.
Proof: a third of all cars traded in during 2015 had loans that were
“underwater.” The owners had taken on debt for more than the value of
the vehicles. Although the market for subprime car loans is nowhere near
the size of the subprime mortgage market, it hurts the same people who
can ill afford such hardships.
Of course there are those who love zero interest rates.
In five thousand years of record keeping, debt has never been
cheaper. Stocks, bonds, real estate, yachts, planes, blue diamonds, you
name it—Fed policies have fueled skyrocketing valuations across the full
spectrum of asset classes. And bankers have happily issued debt against
them all.
Paradoxically, though returns on risky investments have been
consistently strong, fewer average Americans are comfortable with the
risk of owning the most common of the pack—stocks.
The percentage of U.S. adults invested in the stock market fell from
65 percent in 2007 to 52 percent by the spring of 2016, a twenty-year
low. Inflows into U.S. stock mutual funds—a good gauge of small-investor
sentiment—were negative in six of the seven years since 2009. In 2015
alone, mutual fund investors withdrew $170.8 billion—this despite a bull
market. Americans retrenched and retreated, especially those nearing
retirement years. Fed-blown bubbles have decimated their savings not
once, but twice.
Though they might not be able to name the Fed as the party rigging
the game, their instincts remind them about the old adage: Fool me once,
shame on you. Fool me twice, shame on me.
As for those mom-and-pop investors who remain in the market, they
have little chance of escaping Fed policy because their assets are tied
up in expensive and rigid 401(k) plans that emphasize index funds.
The Fed’s artificially low interest-rate level has distorted the
relationship between stocks and bonds. Rather than one providing cover
when the other is in distress, asset classes have increasingly moved in
concert. And though portfolio advisers make it sound safe, index
investing will prove disastrous when markets finally correct.
The one true growth industry? That would be all that high cotton
harvested in high finance. Since 2007, world debt has grown by about $60
trillion, enriching legions of investment bankers one bond deal at a
time.
The Fed’s experiment has widened the inequality gap, angering
millions of people who bought into the American dream and know it’s
being stripped away from them. The global elite get ever richer while
those who work for a living see their earnings stagnate—or worse, get
laid off.
The acclaimed Noam Chomsky documentary
Requiem for the American Dream chronicles
how the “concentration of wealth and power among a small elite has
polarized American society and brought about the decline of the middle
class.”
Chomsky’s intent is to crucify conservatives. But had the
predominantly liberal Fed leadership not facilitated the bad behavior of
the elite by encouraging them to borrow at virtually no cost, their
wealth and power would never have become as concentrated as it is today.
The ostentatiousness with which the so-called one percent has
flaunted its wealth has fueled the rise of anger and extremism, leading
to the presidential campaigns of Bernie Sanders on the left and Donald
Trump on the right.
And politicians wonder about the genesis of a deeply divided and dispirited populace.
Central bankers have invited politicians to abdicate their leadership
authority to an inbred society of PhD academics who are infected to
their core with groupthink, or as I prefer to think of it: “groupstink.”
Annual borrowing costs for the United States since 2008 have hovered
around 1.8 percent, thanks to an overly accommodating Fed, which allowed
a dysfunctional Congress and the administration of former President
Barack Obama to kick the responsibility down the road. Massive spending
programs, however ill conceived, got funded with little opposition.
Obamacare, anyone?
According to the Congressional Budget Office (CBO), since 2008
federal debt held by the public has nearly doubled and now stands at 75
percent of gross domestic product (GDP). If this lunacy doesn’t end,
debt will be 110 percent of GDP by 2036, exceeding the post–World War II
peak of 106 percent.
And yet feckless politicians get to brag that they’ve cut the
deficit, a distinction lost on too many of us. Yes, it has cost less to
run the government and fund the safety net. But it’s done nothing to
staunch the run-up in our nation’s crippling debt load, which has
tripled in just twenty years’ time.
Were there voices of dissent to be heard in that conference room on
that December day in 2008? Did anyone argue for the little guy, the
cautious investor? Did someone in the room speak on behalf of pension
fund managers now forced to take undue risks? What about the leadership
of firms and big banks whose incentives are perverted to the extent that
they no longer invest in our country’s future?
The short answer is yes. I worked for one of those who pushed back
against the majority. He was the lone member of the FOMC who voted
against the professor’s theories at that fateful meeting.
He fought the good but lonely fight, and I, in my capacity as trusted
adviser, waged many a battle with him. But the sad truth is we lost the
people’s war. In a world rendered unsafe by banks that were too big to
fail, we came to understand the Fed was simply too big to fight.
I wrote a book to tell from the inside the story of how the Fed went
from being lender of last resort to savior—and then destroyer—of
America’s economic system.
During my nine-year tenure at the Federal Reserve Eleventh District
Bank of Dallas, where I served as adviser to President Richard Fisher, I
witnessed the tunnel vision and arrogance of Fed academics who can’t
understand that their theoretical models bear little resemblance to real
life.
To tell this story, I relied on firsthand experience, interviews with
dozens of high-powered market players, reams of financial data, and
publicly available documents from the Federal Reserve, including FOMC
transcripts and other historical materials.
People are waking up. And it’s about time. Although I do not believe
it is right to end the Fed, it’s high time it was upended. Every
American must understand this extraordinarily powerful institution and
how it affects his or her everyday life and fight back.
This is a special preview excerpt from
FED UP: An Insider’s Take on Why The Federal Reserve is Bad for America By Danielle DiMartino Booth
To be published by Portfolio, an imprint of Penguin Random House, on February 14, 2017. For more information please visit
www.DiMartinoBooth.com
Copyright © Danielle DiMartino Booth, 2017. All rights reserved.
Danielle DiMartino Booth is the founder of Money Strong, LLC, an
economic consulting firm. She began her career in New York at Donaldson,
Lufkin & Jenrette, and Credit Suisse, where she worked fixed income
and the public and private equity markets. After working as a financial
columnist at the Dallas Morning News, Booth spent nine years as an
advisor to Richard W. Fisher at the Federal Reserve Bank of Dallas.
