Working Capital Review
Working Capital Review
Podcast: Christopher Leonard -- The Lords of Easy Money

Podcast: Christopher Leonard -- The Lords of Easy Money

A Working Capital Conversation

We know the headlines: Inflation is the highest in 40 years, climbing 7 percent last year. Stock prices and corporate debt have been running incredibly high. Unemployment, meanwhile, is incredibly low, while the U.S. economy grew 5.7 percent in 2021, its fastest full-year clip since 1984. The wealth gap, meanwhile, continues to spread.

To fight these realities – especially inflation – the U.S. Federal Reserve Bank will soon start unwinding their two most significant policies that drove extreme amounts of available money at rates that made that money virtually free to borrow since 2008 and the Great Recession and through the Covid pandemic: They will stop the extraordinary experiment of mass buying of U.S. Treasuries known as Quantitative Easing, and they will raise interest rates at least three – perhaps 4 or more times – this year.

The American easy money party is over, and it’s time to clean up any mess.

So how did this party get started? Why did it go on so long – long after the first signs of rising inflation arose last year? Who made the decisions and, perhaps more centrally, why is the U.S. central bank, comprised of unelected governors and bank presidents, so opaque? What happened behind closed doors?

Christopher Leonard has the inside story – and he tells it masterfully. His book The Lords of Easy Money: How the Federal Reserve Broke the American Economy, is a clear telling of Fed policy and the key personalities behind it: people like Jerome Powell, Ben Bernanke, Janet Yellen, and one you may never have heard of, Thomas Hoenig.

About Leonard: He is a business reporter whose work has appeared in The New York Times, The Wall Street Journal, Fortune, and Bloomberg Businessweek. He is the New York Times bestselling author of The Meat Racket and Kochland.

Transcript: Christopher Leonard

Chris Riback: Chris, thanks for joining. Really appreciate your time.

Chris Leonard: Thanks for having me. I appreciate it.

Chris Riback: So we should start, I am so sorry you've been getting such bad press on this book. The FT named it one of the books to read in 2022, and then The New York Times review, "A fascinating page-turner made from unlikely subject, Federal Reserve policy, Leonard, in the tradition of Michael Lewis, has taken an arcane subject rife with the risk of incomprehensibility and built a riveting narrative in which the stakes couldn't be any clearer." Chris, I'll tell you what, I'll take it easy on you in this conversation so you can try to dig out of this hole that you find yourself in.

Chris Leonard: Thank you.

Chris Riback: Sound fair?

Chris Leonard: Yes, sounds fair.

Chris Riback: Why do you think it's getting that kind of reaction?

Chris Leonard: Oh, that's a great question. Well, OK, a lot of this has to do I think with what drew me to this topic. I fell into this by accident when I was reporting a different project back in 2016. And one of the great benefits and privileges of this job is I just get to meet all kinds of people from all walks of life. And I met this really brilliant guy who's a trader in financial markets, hedge fund kind of guy. And he was really, really concerned with what he was seeing in the markets. And he spent hours walking me through what he was seeing and describing how the Federal Reserve had really embarked on an unprecedented and experimental path. And so what he was saying was shocking to me. And that's what got me reporting on this. And I guess I would humbly say that maybe the reason it's getting a little bit of reaction is that this story really hasn't been told of this critical part of what happened over the last decade in our economy. I don't feel like it's been written about deeply enough.

Chris Riback: Yes, I totally agree. It hasn't been reported on deeply enough and the connection of the reporting with the storytelling, in my opinion. That's what I think hasn't been completed. Also just very brief side note, you just mentioned that source, 2016, I noticed in the acknowledgements goes by the initials ZC, I think you wrote. You're not able to name the source. I just wanted to give you the chance to break news right now, reveal your source if you want to.

Chris Leonard: Well, listen, I've got no illusions, this isn't Deep Throat or anything. But I find it very, very, very valuable to be able to have conversations with people in strict confidence. And people are very comfortable talking with me when they know that they can just be anonymous and just be honest and tell me what's going on. And so that's why I agree to talk to somebody off the record anonymously. I don't say who they are and I consider it's kind of like very discreet country club membership. There's no membership rule.

And in this case, I think this is really important, and maybe you've seen this too, but when we talk about the Fed and Fed policy, there are kind of these two spheres of people that talk about it. One is the sort of economist PhD set that frankly really runs the Fed. And then you got the folks who are actually operating in the wake of what the Fed's doing on Wall Street, the traders, the hedge fund, the private equity people. And you can get a really good view of what's happening when you talk to both groups. And again, to talk to that kind of Wall Street group, it helps to have candid, off the record conversations with people. So that's what's driving that.

Chris Riback: Well, no surprise you didn't want to reveal the source right now. And yes, you outlined that tension between the PhDs and the Wall Street types as well the business executives out in the field. I would almost add that's another leg to the stool. So we need to get into, obviously, Thomas Hoenig. I think it might help to start at the end and then let's go back to the beginning and you'll explain how we got here.

Chris, how much trouble are we in? Your book ends fairly ominously. Quoting you, "This fragile financial system was wrecked by the pandemic. And in response, the Fed created yet more new money, amplifying the earlier distortions. The long crash of 2008 had evolved into the long crash of 2020. The bills had yet to be paid." Where are we now?

Chris Leonard: Well, that's actually a great place to start. And I will break some minor news, the original title of this book was “The Long Crash.” But that takes some time to explain what “The Long Crash” is. And it really gets at what this book is about, which is that the crash of '08, in many significant ways, never ended. And what this book really focuses on is the revolution that started in November 3rd, 2010, where the book opens with our main guy, Thomas Hoenig, who's making the most consequential vote as a senior member of the Federal Reserve that he ever made at that time. And he was voting on an experimental and unprecedented program at the Fed called quantitative easing. And to just give you the headline, in the first 100 years of its existence, the Fed steadily increased the pool of base money in our economy, which is the set of high powered dollars that only the Fed can create the monetary base. The Fed gradually increased the size of that pool to about $900 billion, slowly but surely. And then in a few years, between 2009, 2014, the Fed prints $3.5 trillion.

So that's three and a half centuries worth of money printing in a few years. And that money's not a neutral force. It had tremendous effect throughout our financial system, and the biggest effect was to push more money into riskier investments to pump up asset prices like the stock market and the bond market. Those are the kind of distortions I'm talking about that you just mentioned, that the Fed has been really assiduously and patiently pumping up these asset prices for years in hopes that it would eventually create economic growth. And my conclusion in this book is that the back end of that deal, where you get actual economic growth or productivity growth for wage earners was very, very weak and disappointing. But the asset bubbles that were created, the record breaking stock prices, the record breaking level of corporate debt, leveraged loans, collateralized loan obligations, that was a super-heated market that the Fed created. And that's where we are today, is in this terrible dilemma whereby if the Fed is going to ever tighten the money supply to fight inflation, for example, these asset bubbles prices will have to correct. So, yes, we're not in a great position. We're in a fragile, volatile and worrisome position right now.

Chris Riback: And going into that vote on November 3rd, 2020, and for context -- November 2nd was the election, right?

Chris Leonard: It was the 2nd of November, 2010. And I guess if I was writing a screenplay, this is how I would've written it. It was poetic in the sense that on November 2nd, it's the first midterm election of Barack Obama's presidency, the Tea Party sweeps into power. And, as we know, the fiscal authorities, the democratically controlled institutions in our country like Congress really grinded to a halt. And so over the next decade, I think it is very fair to say whether you're conservative or a liberal, our democratically controlled institutions like Congress did not step into the breach and solve some of the very deep dysfunctional pathologies that led to the crash of '08. For example, the too big to fail banks that caused that crash are now even larger and less able to fail. That's just a tiny example. And it was in the shadow of that, the next day on November 3rd, that the Federal Reserve, which of course is insulated from democratic pressures, steps forward and says, "Okay, we're going to become the primary engine of economic growth."

And that's what's so different about that vote that happened November 3rd, 2010, is this wasn't the Fed managing a crisis. This wasn't the Fed being the lender of last resort during a panic. This was the Fed saying, "We're going to step forward to boost overall economic growth by printing money on Wall Street." Something that had never really been done before. And the character you've mentioned, Thomas Hoenig, not coincidentally, at that time on the Fed's all important policy board, the FOMC, he was the longest serving member. He'd been at the Fed for 32 years. He had seen what had happened when you let money remain too loose or easy for too long. He'd seen the inflation of the '70s, the asset crash of the dotcom bubble, the asset crash of the housing bubble, and he really tried to stop this program. And the book gets into how he tried to stop it and ultimately failed.

Chris Riback: So one of the big judgements that one must make in terms of being a hawk or a dove around quantitative easing, is around unemployment, of course. Was an unemployment rate of 9.6% in 2010 too high? Was that basically an emergency or not? And you just indicated that one of the views, Hoenig's view, your view is that it might not be where we wanted it but it wasn't an emergency. It wasn't an emergency that required that level of intervention. Inflation would be another area. How high was the risk? And how problematic is a little inflation, and how do you define what is a little? Is it 2%? Is it 4%? Hoenig called it a deal with the devil, is how you describe it. Was it?

Chris Leonard: Yes. Absolutely. And we're paying the price. And the price is coming due now. And incidentally, when I wandered into this book as I described I, A, didn't really understand quantitative easy, to be totally blunt. And B, had a great deal of sympathy for the idea. There's a good case to be made that 9.3% unemployment is an emergency. I'm sympathetic with that view. But as I reported it more and had the luxury of going back and reading through the actual debates that happened inside the FOMC. As you know, those debates are transcribed and then released after a five year delay, which means they don't get read to the level they should, because thousands of pages are released at a time. But when you look at those debates, first of all, this key moment in 2010 when unemployment was high, I say it's not an emergency for a couple of key reasons.

First of all, everybody understood it was going to be a long, hard slog out of the whole of the financial crisis. Nobody expected that unemployment was going to be 5% by 2010. And secondly, the economy was starting to recover. Weak, fragile, potentially reversible? Absolutely. But as Hoenig was fervently pointing out in 2010, the economy was starting to grow again, and the Fed needed to display a little restraint and let the economy grow and adjust to what the Fed was doing. And Hoenig wasn't arguing, "Let's hike, interest rates up to 2, 3%." He was saying, "Let's keep them relatively flat, or maybe over time gradually hike them to 1%." Very mild.

But the plan that was chosen instead, of course, was pump $600 billion worth of new cash into the Wall Street banking system to push the banks toward lending or investing in whatever they could. And when he said, "It's a deal with the devil.", it's fascinating to me, the argument he was making had three parts. He said, "First, you're just going to in enrich the very rich. We all understand that this program is only going to stoke asset prices, which will benefit the rich. Secondly, you're going to create massive new levels of risky debt. We're going to pump up asset prices to levels that'll be unsustainable and dangerous, like with the housing bubble. And third, once you start printing this money, you're not going to be able to pull out. You're going to be stuck."

Chris Riback: Can't stop.

Chris Leonard: Yes.

Chris Riback: The new normal.

Chris Leonard: And he was correct on all three of those points.

Chris Riback: So the pushback, the vote in 2010 was 11-1. That's the central thesis of the tension that he feels personally and internally, and he brings it home with him and his wife sees it. And what a great quote you have, "How stressful it is to be a lone dissenting vote in a matter of such consequence." And as a reader, you feel the human emotion that he feels in these decisions, the weight of these decisions. And yet there is not unreasonable pushback. You mentioned some of it. You're not insensitive, you said, to a 9.6% unemployment.

There was some stat, I think it was the stat for that, where some intervention was going to reduce joblessness by 750,000 jobs, which wasn't going to make a complete difference, but certainly makes a massive difference to each one of those 750,000 people, as you point out. Some of the other pushback I think would be that yes, inflation is going up now, but we did have a number of years without high inflation. That yes, unemployment has remained low. The pushback that I've seen, maybe the most persuasive to me is: How do we know that Hoenig's counterfactual would have left us as good or better off? What are some of the arguments to the pushback to Hoenig and to what you argue for?

Chris Leonard: OK, great points all. And first of all, yes, I do point out in the book, you're right, when they debated this first round of quantitative easing, they thought it would only lower the unemployment rate by 0.3% or 750,000 jobs, which big picture isn't much. But I was a print reporter in St. Louis at the time and understood vividly how important a job is. We had people clinging to the middle class at the time. That really matters. So there's a case to be made. And Bernanke, the chairman of the Fed, Ben Bernanke, made this case again and again and again, there is a risk to doing nothing, and it is better to act than not. And again, as I said, I was very sympathetic to that argument going into this book.

Let me tell you where I really hit a hinge moment, when the subtitle of my book changed from How Quantitative Easing Changed the World to How the Fed Broke the American Economy. And to me, the moment was when I read the debates later in 2012, when they do the third round of quantitative easing, QE infinity, the largest round yet. At that time, the debate within the Fed was even more intense than when Hoenig voted no on that first round of its kind of quantitative easing in 2010. And first of all, I got to point out then, the vote was 11-1, but there was intense dissent inside the FOMC. It was just that a lot of the people against it were not voting members. But in 2012, you see people like current Fed chairman, Jay Powell, Dallas president Richard Fisher, Betsy Duke, Fed governor from Wells Fargo Bank, Jeremy Stein, a professor at Harvard, all of them making this argument that we are only going to get very small, short-term gains from this policy if we do another round of quantitative easing. But we're at the same time going to be piling up long-term risks.

Jay Powell spoke about this more starkly than anybody. He said we are elevating asset prices. If we continue to do this, we are going to have, quote, "a large and dynamic event." Which is sort of polite speak for a crash. "And we're not going to be able to handle it." And you also had people like Richard Fisher pointing out categorically this program will benefit the richest of the rich, the private equity firms, the hedge funds, the stock speculators. Those are the people who are going to benefit. People who earn wages are going to benefit far, far less.

And so there was a knowing push into this territory to inflate these asset bubbles on Wall Street, to build up the systemic risk for very small short-term gains. And I think that that is unwise policy. In fact, I'll go so far as to say it was hubristic. That it was an ability that we see time and time and again in different institutions to look like you're doing something in the short-term and taking action, when you're really delaying the inevitable or piling up risks that won't eventuate until down the road.

Chris Riback: And that hubris, you're really speaking largely of Bernanke.

Chris Leonard: Yes.

Chris Riback: And the characterization that you give, the reporting that you've done about the politicization of the internal workings of the Fed. Particularly, the way that he politicked and helped maneuver the Fed governors.

We all know that there are presidents of the Fed banks around the country, but they don't all sit on the FOMC committee, they don't all vote. But all seven of the Fed governors do vote. And you point out how Bernanke really would lobby and work those Fed governors to make sure that he had the votes. He did not want dissent.

Chris Leonard: That's exactly right. And it was an amazing story to me. So the policies we're talking about are set by the Federal Open Market Committee, or the FOMC. It's the most powerful policy board within the Fed. It's run by the Fed chairman. So that group is comprised of 12 voting members. Very importantly, seven of them are always the Board of Governors at the Fed, who are the sort of political appointees that all work in one office in Washington, DC. So you've got seven governors who vote, and then you've got five regional bank presidents who fly in every six weeks to vote. The governors always have the majority. And you can see it that the outliers and the dissenters always tend to be, or always are, the regional bank presidents who fly in, and then one or two might vote no. If two vote no, that's a big deal.

And it really hit home to me why this is when I interviewed that former governor, Betsy Duke. And she just explained to me how Bernanke will lobby the governor's on a one-on-one basis between meetings. So they're not having an actual meeting of the governors, but it can happen one-on-one, that's what gives the chairman so much power. And Betsy Duke told me on the record how they basically, as governors, all come to agreement on how they're going to vote before the meeting even happens. So that's why the regional bank presidents are left out in the cold and you can allow one or two of them to dissent without changing anything. And then you feed into that this culture that really prizes consensus. There's this key idea that you've got to have near unanimous votes inside the Fed so Wall Street will have full confidence-

Chris Riback: Full confidence in the institution, otherwise it'll demonstrate institutional weakness.

Chris Leonard: That's exactly right. But it disguises the fact that this committee is still made up of human beings and they are making policy decisions. They are not just PhD economists solving math equations. They are making policy decisions. And I'll tell you what, they operate on hunches. Ben Bernanke in 2012, this is one way he would politic, he'd go out in public to this big symposium in Jackson Hole, Wyoming in August and announce something. And he did this in 2012.

He gives this speech saying, "Hey, quantitative easing's been working like a charm." I am paraphrasing, the speech is public, it's in the book. But he says, "QE is working great. I think we're going to do more." And then in private, in the FOMC just weeks later he says another round of quantitative easing will be, quote, "a proverbial shot in the dark. And that we don't understand what's holding the economy back. We don't understand how our tools work or what this is going to do, but we need to try it anyway." So the idea that there's just this consensus all the time really disguises the fact that it's a policy making body.

Chris Riback: And as you pointed out around that Jackson Hole speech, and I think there's another one that he gives later, maybe it was one that Powell gave later, that by making the announcements in advance in a public forum like that, it gives a signal to the markets that this is going to happen. It prices that activity into the activity and into the market already, at which point, if X number of months later the FOMC were to vote against it, they would be in a sense almost unofficially changing policy that was already baked into the market.

Chris Leonard: That's exactly right. And they call it the announcement effect. And that's one way Ben Bernanke boxed in the numerous critics of these policies.

Chris Riback: Chris, as we conclude, I want to go back to your summation of Hoenig's November 3rd, 2010 dissent, where he said in short, "Once the Fed..." And we've talked about at this a bit, "Once the Fed started this program, it would create so many distortions and side effects that it would almost certainly not be able to end the program without causing massive instability or even a crash." That's kind of the center of Hoenig's dissent and his concern.

The last time the Fed tried to end quantitative easing, it didn't go so well. That was late 2018, early 2019. And you talk about the “Powell Pivot.” They backed off. As you know, as we're talking today, the Fed, Jerome Powell, they've signaled that quantitative easing is coming to an end again, interest rates are set to rise. This is all being done, of course, with the hope of a soft landing, controlled unemployment, reduced consumer price inflation and no bubble burst of asset prices. As we think about trying to do this soft landing with controlled unemployment, reduced consumer price inflation and no bubble burst of asset prices, Chris, how likely is a smooth landing?

Chris Leonard: Oh boy. OK. First of all, I did not come to this book as some kind of monetary hawk. Let me please make that point. I don't take joy in talking about this and I'm not some hike interest rates for the sake of it kind of guy. To me as a reporter, having been looking at this, the chances that we will have a soft landing is inconceivable. And it's really hard to lay it out so quickly. But as you talked about, they tried to, quote, "normalize" for years. And that culminated in 2018, 2019. But they are facing a tremendous problem if they ever try to raise interest rates or tighten the money supply. And this is how I would characterize it. The entire goal of 0% interest rates and quantitative easing, which were unprecedented in scale, just to put this again in context, interest rates had brushed up against zero a couple times in the past, we kept them pinned at zero for seven years during the 2010s, an entire ecosystem built itself oriented around a zero rate. And that has consequences.

I describe it as squeezing toothpaste out of the back of the tube. The Fed by intentionally drawing down yields on long-term bonds was squeezing investment in what we call a search for yield. It was squeezing loans out anywhere they could find yield, risky corporate debt, risky leverage loans, Tesla stock, which can grow more in a month than there's a total value of Ford and GM combined. When the Fed does what it did with these easy money policies, it pushes money out into these risk assets. This is not controversial. They knew what they were doing. The flip side of that coin is when you raise rates and when long-term yields rise, the mathematical equation changes and investors can withdraw from those risk assets. I describe it as like a seesaw. And so the money will start flowing out of the risk assets and back into safe havens as the Fed raises rates and yields rise on long-term bonds. There's no way to tighten the money supply without a downward correction in asset prices.

And it follows logically, the Fed knew it is pumping up asset prices for years. This is in the transcripts. They knew that's how the program would work. And we could have had a soft landing if the Fed had the luxury of maybe seven years to unwind this insanely gigantic balance sheet. Again, I sound hyperbolic describing this. The Fed's balance sheet was $1 trillion in '09, it's north of $8 trillion now. And $3 trillion of that came during the COVID crash, which by the way is when bills were coming due on the previous years of asset inflation. But yes, the Fed's hand, unfortunately for all of us, the Fed's hand is being forced and it's going to have to unwind this stuff much more quickly than it would want to.

Chris Riback: Yes. What did Thomas Hoenig tell you about the book?

Chris Leonard: Well, he is such an interesting guy and he's a big part of why I wrote this book. He's got this sense of probity, is how I would describe it. With all of my sources, I gave them a chance to fact check the material about them in the book. And his response was to correct mistakes he found. His dad leased a shop, he didn't own the shop kind of thing. I think he likes the book, because really my goal was to shine a light on how principled I believe he is and what a principled stand he made. But I don't know, it's been very official. I still call him Dr. Hoenig. And I know that since the articles and the book has come out, he's gotten a lot of calls from central bankers around the world, which I think is a great thing. I think he has a lot of wisdom that he can share with people.

Chris Riback: Chris, thank you. Thank you for the conversation, and thank you for the book, which is beyond a great read. It's a really important read. Thank you.

Chris Leonard: Thank you. Thanks for the time.