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Fed Up: An Insider's Take on the Willful Ignorance and Elitism At the Federal Reserve
by Danielle DiMartino Booth
Never in the field of monetary policy was so much gained by so few at the expense of so many. MICHAEL HARTNETT, BANK OF AMERICA MERRILL LYNCH CHIEF INVESTMENT STRATEGIST, NOVEMBER 1, 2015
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.
Until September 2008, when all hell broke loose in a worldwide panic that completely blindsided and, embarrassed the Federal Reserve.
But the Fed’s academic models never addressed one basic question: What happens to everyone else?
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.
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. His successor, Ben Bernanke, followed suit.
His theoretical models relied on the idea of the “wealth effect,” first articulated by British economist John Maynard Keynes.
Janet Yellen, who followed Bernanke as Fed chair, maintained his radical policies with gusto. Yellen was even more married to the Keynesian model of economic growth than Bernanke.
But real people haven’t responded the way academics anticipated in their wealth-effect models.
By mid-2015, only 62.6 percent of adult workers were employed or actively looking for a job, the lowest in nearly four decades.
Since 2007, world debt has grown by about $60 trillion, enriching legions of investment bankers.
The Fed’s experiment has widened the inequality gap, angering millions of people.
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.
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.
I wrote this 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.
I witnessed the tunnel vision and arrogance of Fed academics who can’t understand that their theoretical models bear little resemblance to real life.
People are waking up. And it’s about time.
But by the autumn of 2006, my predictions were coming true. Readers’ e-mails conveyed tales of woe: people were losing their homes to foreclosure.
In hindsight, my understanding of what really went on inside the Federal Reserve was embarrassingly shallow. I knew nothing. Nada. Zip. Zero.
It’s a myth that the Federal Reserve is nonprofit. It earns billions of dollars per year through various financial functions; after expenses, most of the profits go straight to Treasury.
All those bonds pay interest. In 2015, it posted record earnings of $97.7 billion. But its expenses are borne by the taxpayer.
Didn’t Bernanke see that the era of deregulation, with the fall of the last remnants of the Glass-Steagall Act of 1933, had let Pandora out of her box? Did he not know that Pandora was now a wild alcoholic thanks to Greenspan lowering interest rates from 6.5 percent to 1 percent?
I was convinced a monetary asteroid was heading in our direction, aimed directly at the American Dream.
The Federal Reserve exists so that the American public can maintain faith in its monetary system.
This vital responsibility is carried out by an organization with an arcane, complex, and peculiar decision-making apparatus that is virtually opaque to outsiders.
Though the Fed’s “factory” functions command 83 percent of the central bank’s resources, it’s the sexy 17 percent related to monetary policy that attracts the attention of the press and financial markets.
Setting monetary policy is the job of the Federal Open Market Committee (FOMC).
The Federal Reserve has always advertised itself as being above politics, impervious to outside influence. This is, of course, nonsense.
In theory, FOMC members pledge to put partisan politics aside when they begin their terms. Few do.
The notion of some superior objectivity inside the institution is naïve at best.
The FOMC has two mandates: maintain “price stability” and maximize employment. In other words, safeguard what a greenback can buy while employing as much of the population as possible. Its tools are short-term interest rates and the money supply.
Once inside, I confronted an uncomfortable question: Why were so many of its highly-educated and well-paid economists oblivious as the worst financial crisis since the Great Depression was about to break over their heads?
Over the next nine years, as I scaled the outer walls of the Federal Reserve pyramid, always an outsider looking in, I grew more and more alarmed.
The Fed leaders we entrusted with our financial fate had in fact precipitated the crisis.
Instead of fortifying the American economy, they have repeatedly made it more vulnerable.
The Fed’s battalion of economists—from the top down—believe that their training in the world’s top universities and their unique schooling in analysis gives them wisdom and insight, when in fact their training often blinds them to reality.
The Federal Reserve is the single largest employer of PhD economists in the nation, and presumably the world.
Despite their profession’s obvious shortcomings, academic economists have literally overrun the Fed from top to bottom.
The overwhelming dominance of academics goes a long way toward explaining why the financial crisis of 2008 blindsided the Fed.
Nobel Prize–winner Shiller nailed its cause with one simple word: “groupthink,” the tendency to agree with others’ viewpoints.
It’s worth asking: Why did Greenspan, Bernanke, and Yellen - for all of their prestige - so completely misread the American economy and fail to comprehend how extraordinarily interconnected the global financial system was until it blew up in their faces?
Hard to believe, but it all comes down to hubris and myopia. We know best. Our models say this will work. And not a thing has changed.
The transformation of my role at the bank began on February 7, 2007, when HSBC Holdings announced that its bad debts for the previous year would total more than $10.5 billion—20 percent over expectations—due to problems in its portfolio of subprime mortgage derivatives.
A few weeks later, Bernanke gave a speech that brushed aside concerns about systemic risk. “The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”
As coauthor of two Fed papers, my predictions about subprime mortgages and the potential for systemic risk had been validated. My decision to leave journalism and join the Fed was beginning to pay off.
Sitting at the epicenter of the greatest housing bubble in U.S. history, Yellen had no appreciation for what the markets were screaming.
Yellen would have been well served by actually talking to people in the trenches—the out-of-control mortgage brokers, the house flippers, the Realtors, and home builders who unwittingly would contribute to the coming disaster. Heck, all she had to do was read the newspapers.
Though precious few inside the Fed saw the crisis coming, it is patently false to suggest insiders hadn’t been fairly warned.
Transcripts from FOMC meetings in 2008 reveal that the Fed misjudged the depth and severity of the evolving crisis at almost every turn.
Bear Stearns had gotten greedy, but the underlying conditions that allowed it to grow so spectacularly and fall so hard wouldn’t have existed if Greenspan had the spine to stand up to Wall Street beginning in 1987.
The Bear rescue also marked the beginning of the unraveling of the Fed’s mystique.
Now pay attention, because shadow banking is what caused the financial crisis of 2008. Though the subprime housing market was the virus, shadow banking transmitted the virus and nearly killed the patient.
The Fed’s army of a thousand “doctors of economics” had no understanding of its enormity and significance.
It took Shadow banking, combined with the Fed’s utter lack of understanding about the true shape of the financial system, set the stage for the catastrophic meltdown of September 2008.
On June 9, Lehman reported its second-quarter earnings: a loss of $2.8 billion. The stock price tanked.
Suddenly, the financial world realized Lehman’s troubles went deep.
On September 10, Lehman reported a loss of $3.9 billion and $7.8 billion in credit-linked write-downs.
Lehman filed for bankruptcy on Monday, September 15, the largest such court action in U.S. history, valued at $639 billion.
The Fed had saved Bear Stearns. Why not Lehman Brothers?
Within hours of Lehman’s bankruptcy filing, AIG went into cardiac arrest. The largest insurance company in the world, with assets estimated at $1 trillion, 116,000 employees and offices in 130 countries.
AIG Financial Products had written about $500 billion worth of insurance on every conceivable type of derivative.
Most of AIG’s industry peers who had followed them into such markets hedged their exposure by buying their own insurance. AIGFP did not.
Lehman’s collapse triggered the largest margin call of all time. AIG faced paying billions of dollars to banks all around the world.
On September 17, the Fed invoked the “unusual and exigent” clause and agreed to bail out AIG for $85 billion.
Eventually the bailout would total $184.6 billion, with the Fed taking a 92 percent government stake.
The Fed had one set of rules for Bear, another for Lehman, yet another for AIG. And then there was Goldman Sachs.
As crowned ruler of Wall Street, Goldman was also AIG’s largest trading partner. The insurer’s collapse would blow a $20 billion hole in Goldman’s gut.
The crisis put the New York Fed on the map in a way that it had never been before.
With lines of credit open at every conceivable central bank, the New York Fed was running the world.
The revolving door between government and Goldman Sachs—or “Government Sachs,” as the joke went—was never more pronounced than during the 2008 meltdown.
But Paulson’s actions raised questions about the level of the firm’s power inside government, as if Treasury were a “de facto Goldman division,” as the New York Times put it in October 2008.
During the financial crisis, the chairman of the New York Fed’s Board of Directors was a former Goldman chairman who still sat on the firm’s board. As a Class C Fed board director, he was chosen to represent the public. Yeah, right.
By the end of 2008, American households had lost 16 percent of their household wealth.
As bad as things ever get for those on Wall Street, the damage that trickles down to Main Street is always exponentially worse.
The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost. BEN BERNANKE, NOVEMBER 21, 2002
There was no call to arms, no explanation that in early 2008, the shadow banking system, at $20 trillion, dwarfed the $12 trillion conventional banking system.
Bernanke was focused on the fed funds rate, not the risks from the shadow banking system.
Had a task force been deployed to better understand those connections, there would have been no existential crisis following Lehman’s failure. There would have been no Lehman failure.
It is doubtful the average American household comprehends how manipulative the Fed is when it comes to communication.
Though it was taboo to recognize it inside the Fed, and I didn’t dare put it in my report, Greenspan’s legacy as the Maestro had been thoroughly tarnished.
The general realization that Greenspan and the Fed had actually created the conditions that made the debacle possible was a real wake-up call.
Bernie Sanders, an avowed socialist who in 2015 launched a run for president as a Democrat, later sponsored legislation that compelled the Fed to disclose financial details of its extraordinary efforts to save Wall Street.
The single neediest day? December 5, 2008, when the Fed loaned a combined $1.2 trillion.
The Fed’s dual mandate of maximizing employment and minimizing inflation had been crumpled into a ball and thrown into the trash as it shifted from putting out the fire to rebuilding the burned-out house.
By the end of February 2009, the Fed would hold $17.5 trillion in bank debt, mortgage-backed securities, and Treasury notes.
On March 6, 2009, the S&P 500 Index hit an intraday record low of 666.
By mid-2009, unemployment had reached a twenty-five-year high of 8 percent and was still climbing.
On September 12, 2009, the Journal had this to say: “There is plenty of cash still to be put to work. In the U.S., money-market funds contained $3.54 trillion as of Wednesday [August 9].
The problem was the bulk of these trillions was in the hands of few. Those who were most insulated from the need to earn a living were driving the rally. Any middle-class recovery was an illusion.
Yellen was fixated on spending as the solution to the country’s continuing economic woes. Her staunch adherence to Keynesian theory blinded her to the reality that not every economic problem could be solved by throwing money at it.
To its credit, America had taken the financial crisis as an opportunity to clean up its banking system. But the rot in European banks lingered.
On April 23, 2010, Greece’s government asked the European monetary authorities for a bailout.
I was attending the Chicago Fed’s 46th Annual Conference on Bank Structure and Competition. “Systemic risk” was a prominent topic. Athens, anyone?
That summer, the Senate version of the proposed Dodd-Frank financial regulation overhaul bill finally lurched toward a vote.
At a staggering 2,300 pages, the running joke was the only two people who had read the legislation were Dodd and Frank.
Shadow banking had not disappeared. It had gotten bigger. The traditional banking system was dwarfed by a $16 trillion market that made up the “cash” and “synthetic” branches of the shadow banking system.
Bernanke plowed ahead. There, there, we know better than you.
By flooding the financial markets with easy money Bernanke had thrown a wrench into something investors call “price discovery.”
Instead of relying on the true pricing of assets as set by the markets, investors were “baking in” the Fed’s largesse.
In the summer of 2010 my security clearance had been upgraded to Class I. I had gone from being the complete outsider to the ultimate insider. It would take eighteen months for the bureaucracy to approve my new title: Senior Financial Analyst and Advisor.
In theory, decision makers at the Fed were united in their quest to fulfill their formal mandates. In practice, the Fed was increasingly divided, with two armies marching in different directions.
But as long as Bernanke’s dream team of Yellen and Dudley had his back, the Fed would continue to have Congress’s back. No one wanted to exit. That would turn off the money machine.
Nothing the Fed did worked. But the people at the top were doing great.
On April 27, 2011, Bernanke gave the first scheduled press conference in the Fed’s ninety-eight-year history.
The ability of the wealth effect to trickle down to the households most suffering was virtually nil. This segment owns almost none of the country’s financial assets.
The Fed was quickly becoming more powerful than Congress.
As extensive as I thought my network was, it was about to expand beyond my wildest dreams.
“Theory is when you understand everything, but nothing works. Practice is when everything works, but nobody understands why.”
But that healthy and growing economy didn’t happen. So savers were getting hammered for no good reason for the benefit of rich people. By December 2012, the Fed was pumping $85 billion a month into the economy.
What was once extraordinary financial intervention to save the global economy had become the equivalent of an AIG bailout a month.
Bernanke’s Herculean efforts to fix the economy with Keynesian remedies stumbled even as he pulled up to the finish line.
The Fed-watch industry ramped up its speculation about who Obama would appoint as Bernanke’s successor when his second term expired in January.
Yellen was Bernanke in lipstick and a skirt.
On October 9, 2013, Yellen was nominated by President Obama to become chair of the Fed. The most liberal Fed leader since Marriner Eccles, going back to the Roosevelt and Truman administrations, she assumed the post in February 2014.
There was nothing unclear in Obama’s message: maintain the status quo.
As for me, I was determined to go down with the ship.
The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy. PAUL VOLCKER, 1994
Yellen was an intractable foe, more married to her models than Greenspan and Bernanke combined.
I began to recognize my mission: to educate the public about what goes on inside the Fed.
Driving me is the awareness of the high price of debt, psychologically and in real terms. Rather than take on hard decisions, the leadership in Washington has used debt. The Fed is their banker.
The unintended consequences of unconventional monetary policy run amok: pension systems at risk, unaffordable housing, malinvestment, rampant financial engineering by America’s top companies, stagnant wages, millions who have dropped out of the labor force. And of course, more asset price bubbles than ever before.
It could all be laid at the feet of the Fed, which has essentially become the fourth branch of the U.S. government.
How exactly is income inequality the fault of any political party when the Fed is in charge?
Through surrogates and back channels, Yellen is preparing the nation for the possibility of instituting negative interest rates, a nightmare that’s landed on Japan’s shore.
The Federal Reserve’s radical monetary policy—imposed by academics with no experience in the business world—has proved a disaster on an unprecedented scale.
Who will pay when this credit bubble bursts? The poor and middle class, not the elites.
The fundamental changes wrought by Fed policies over the last eight years will prove difficult if not impossible to unravel, especially with unexpected events like Brexit that promise to keep the global economy in turmoil.
In 2017, four out of the five District Bank presidents eligible to vote on the FOMC will be Goldman alums. And let’s not forget Bank of England governor Mark Carney and Mario Draghi, head of the ECB, just two of the many former Goldman Sachsonites now in overseas central banking posts.
Central banking around the world has become a growth industry, populated with PhD economists and a few former investment bankers. These unelected men—and a few women, most notably Yellen—control the world’s economic system.
“The Fed, not the Treasury or the White House or Congress, is now the primary economic policymaker in the United States, and therefore the world.”
But what if Yellen’s theoretical paradigm is dead wrong? The woman who “did not see and did not appreciate what the risks were with securitization, the credit rating agencies, the shadow banking system, the SIVs . . . until it happened” has led us straight into an abyss.
I could never have imagined how my near decadelong journey at the Federal Reserve would play out.
We’ve become a nation of haves and have-nots thanks to Fed policies that benefit the wealthiest investors, punish the savers and the retired, and put the nation’s balance sheet at risk.
No more excuses. The Fed’s mandate isn’t to have a perfect world. That only exists in fairy tales, dreams, and the Fed’s econometric models.