How FedGov Destroyed the Housing Market

This podcast is published by the Mises Institute.

There is no real housing market in the US. Instead, an unholy trinity of Fannie/Freddie, the US Treasury, and the Federal Reserve Bank operate to distort the market at every turn and drive home prices up dramatically. Mises Institute Senior Fellow Alex Pollock, an economist and former mortgage banker, joins Jeff to describe the reality few Americans know.

Alex Pollock's new book Surprised Again: The Covid Crisis and the New Market Bubble : Mises.org/HAP377a

Alex Pollock on how the Fed became the world's biggest S&L: Mises.org/HAP377b

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"The Most Important Price of All"

Published in Law & Liberty:

In The Price of Time, Edward Chancellor has given us a colorful and provocative review of the history, theory, and profound effects of interest rates, the price that links the present and the future, which he argues is “the most important price of all.” 

The history runs from Hammurabi’s Code, which in 1750 BC was “largely concerned with the regulation of interest,” and from the first debt cancellation (which was proclaimed by a ruler in ancient Mesopotamia) all the way to our world of pure fiat currencies, the recent Everything Bubble (now deflating), cryptocurrencies (now crashing), and the effective cancellation of government debt by inflation and negative interest rates.

The intellectual and political debates run from the Old Testament to Aristotle to John Locke and John Law, to Friedrich Hayek and John Maynard Keynes, to Xi Jinping and Ben Bernanke, and many others.  

As for the vast effects of interest rates, a central theme of the book is that in recent years interest rates were held too low for too long, being kept “negative in real terms for years on end,” with resulting massive financial distortions for which central banks are culpable. 

The Effects of Low Interest Rates

Chancellor chronicles how over the centuries, many writers and politicians have favored low interest rates. They have in mind an image of the Scrooge-like lender, always a usurer lending at excessive interest, grinding down the impoverished and desperate borrower—not unlike contemporary discussions of payday lending. For example, Chancellor quotes A Discourse Upon Usury, written by an Elizabethan judge in 1572, which describes the usurer as “hel unsaciable, the sea raging, a cur dog, a blind moul, a venomus spider, and a bottomless sacke…most abominable in the sight of God and man.” Presumably, the members of the American Bankers Association and of the Independent Community Bankers of America would object to this description.

In fact, the roles of lender and borrower have often been and are in large measure today the opposite of the traditional image. This was already clear to John Locke, as Chancellor shows us. The great philosopher turned his mind in 1691 to “Some Considerations of the Lowering of Interest Rates” and “saw many disadvantages arising from a forced reduction in borrowing costs” and lower interest rates paid to lenders. For who are these lenders? Wrote Locke: “It will be a loss to Widows, Orphans, and all those who have their Estates in Money”—just as it was a loss in 2022 to the British pension funds when these funds got themselves in trouble by trying to cope with excessively low interest rates. Moreover, who would benefit from lower interest rates? Locke considered that low interest rates “will mightily increase the advantages of bankers and scriveners, and other such expert brokers … It will be a gain to the borrowing merchant.” Lower interest rates, Chancellor adds, would also benefit “an indebted aristocracy.”

In Chancellor’s summary, “Locke was the first writer to consider at length the potential damage produced by taking interest rates below their natural level.” Locke’s position in modern language includes these points:

• Financiers would benefit at the expense of ”widows and orphans”

• Wealth would be redistributed from savers to borrowers

• Too much borrowing would take place

• Asset price inflation would make the rich richer

Just so, over our recent years of too-low interest rates, ordinary people have had the purchasing power of their savings expropriated by central bank policy and leveraged speculators of various stripes made large profits from overly cheap borrowing, while debt boomed and asset prices inflated into the Everything Bubble.

The central bankers knew what they were doing with respect to asset prices. Chancellor quotes a remarkably candid statement in a Federal Open Market Committee meeting in 2004, in which, as a Federal Reserve Governor clearly put it:

[Our] policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of the distortion is deliberate and a desirable effect if the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand.

That boosting asset prices was “deliberate” is correct; that it was “desirable” seems mistaken to Chancellor and to me. “The records show that the Fed had used its considerable powers to boost the housing market,” he writes (I prefer the phrase, “stoke the housing bubble”). What is worse, the Fed did it twice, and we had two housing bubbles in the brief 23 years of this century. In 2021, the Fed was inexcusably buying mortgage securities and suppressing mortgage rates while the country was experiencing a runaway house price inflation (now deflating).

In general, “Wealth bubbles occur when the interest rate is held below its natural level,” Chancellor concludes.

Bad Press

On a different note, he mentions that suppression of interest rates could lead to “Keynes’ long-held ambition for the euthanasia of the rentier,” using Keynes’ own memorable, if unpleasant, phrase. The recent long period of nearly zero interest rates, however, led to huge market gains on the investments of the rentiers, and caused instead the euthanasia of the savers—or at least the robbing of the savers.

Our recent experience has shown again how borrowers may be made richer by low interest rates, as were speculators, private equity firms, and corporations that levered up with cheap debt. “It is clear that unconventional monetary policies…had a profound impact on inequality,” Chancellor writes, “the greatest beneficiaries from the Fed’s policies [of low interest rates] were the financial elite, who got to enhance their fortunes with cheap leverage at a time when asset values were driven higher by easy money.”

Historically there was a question of whether there should be interest charged at all. “Moneylenders have always received a bad press,” Chancellor reflects, “Over the centuries… the greatest minds have been aligned against them”—Aristotle, for example, thought charging interest was “of all modes of making money…the most unnatural.” The Old Testament restricted charging interest, but as Chancellor points out, the Book of Deuteronomy makes this important distinction: “You shall not lend upon interest to your brother, interest on money, interest on victuals, interest on anything,” but “To a foreigner you may lend upon interest.” This raises the question of who is my brother and who is a foreigner, but does seem to be an early acceptance of international banking. It also makes me think that anyone who has made loans from the Bank of Dad and Mom at the family interest rate of zero, will recognize the intuitive distinction expressed in Deuteronomy.

Needless to say, loans and investments bearing interest prevail around the globe in the tens of trillions of dollars, the moneylenders’ bad press notwithstanding. This is, at the most fundamental level, because interest rates reflect the reality of time, as Chancellor nicely explains. One thousand dollars ten years from now and one thousand dollars today are naturally and inescapably different, and the interest rate is the price of that difference, which gives us a precise measure of how different they are.

A perpetually intriguing part of that price is how interest compounds over long periods of time. “The problem of debt compounding at a geometrical rate has never lost its fascination,” Chancellor observes, and that is certainly true. “A penny put out to 5 percent compound interest at our Savior’s birth,” he quotes an 18th-century philosopher as calculating, “would by this time [in 1773]… have increased to more money than would be contained in 150 millions of globes, each equal to the earth in magnitude, all solid gold.”

The quip that compound interest is “the eighth wonder of the world” is often attributed to Albert Einstein, but Chancellor traces it to a more humble origin: “an advertisement for The Equity Savings and Loan Company published in the Cleveland Plain Dealer” in 1925. “Compound interest… does things to money,” the advertisement continued, “At the Equity it doubles your money every 14 years.” This meant the savings and loan’s deposits were paying 5% interest—the same interest rate used in the preceding 1773-year calculation, but that case represented 123 doublings.

The mirror image of sums remarkably increasing with compound interest is the present value calculation, which reduces the value of future sums by compound interest running backward to the present, a classic tool of finance. Just as we are fascinated, as the Equity Savings and Loan knew, by how much future sums can increase, depending on the interest rate that is compounding, so we are also fascinated by how much today’s market value of future sums can shrink, depending on the interest rate. 

If the interest rate goes from 1% to 4%, about what the yield on the 10-year Treasury note did in 2021-2022, the value of $1,000 ten years from now drops from $905 to $676, or by 25%. You still expect exactly the same $1,000 at exactly the same time, but you find yourself 25% poorer in market value.

Central Bank Distortions

In old British novels, wealth is measured by annual income, as in “He has two thousand pounds a year.” One role of changing interest rates is to make the exact same investment income represent very different amounts of wealth. If interest rates are suppressed by the central banks, it makes you wealthier with the same investment income; if they are pushed up, it makes you poorer. If they change a lot in either direction, the change in wealth is a lot. The math is elementary, but it helps demonstrates why interest rates are, as Chancellor says, the most important price. 

In the 21st century, “The Federal Reserve lowered interest rates to zero and sprayed money around Wall Street.” But if the interest rate is zero, $1,000 ten years in the future is worth the same as $1,000 today, a ridiculous conclusion, and why zero interest rates are only possible in a financial world ruled by central banks.

More egregious yet is the notion of negative interest rates, which were actually experienced on trillions of dollars of debt during the last decade. “The shift to negative interest rates comprised the central bankers’ most audacious move,” Chancellor writes. “What is a negative interest rate but a tax on capital—taxation without representation.” With negative interest rates, $1,000 ten years in the future is worth more than $1,000 today, an absurd conclusion, likewise proof that negative interest rates can only exist under the rule of central banks.

“The setting of interest rates [by central banks] is just one aspect of central planning,” Chancellor observes. In his ideal world, expressed on the book’s last page, “central banks would no longer be able to pursue an active monetary policy,” and “guided by the market’s invisible hand, the rate of interest would find its natural level.” Given all the mistakes central banks have made, with the accompanying distortions, this is an attractive vision, but unlikely, needless to say.

Will The FTX Crash Kill Crypto?

Cited in Forbes:

That includes digital currencies. This the irony which Mises Institute scholar Alex Pollock points out in his new book, Surprised Again!, coauthored with Howard Adler: that crypto’s problems may well speed the digitization of national currencies and increase the power and influence of central banks—the crypto enthusiast’s No. 1 nemesis.

Jan 17 AEI Event: Should the Federal Reserve Raise Its Inflation Rate Target?

Click here to watch live.

Near-zero interest rates prevailed for more than a decade, raising concerns that the Federal Reserve lacked policy tools should stimulus be needed to counteract a recession. While some central banks experimented with negative rates, the Fed adopted quantitative easing (QE) to stimulate the economy without lower rates.

Some economists argue that the Fed should raise its inflation target so that normalized interest rates are high enough to allow interest rate cuts to stimulate the economy without resorting to QE. A recent Wall Street Journal article argues that an optimal inflation target could be as high as 4 percent—or even 6 percent.

Join AEI as a panel of experts discuss arguments for and against changing the Fed’s inflation target.

LIVE Q&A: Submit questions to Beatrice.Lee@aei.org or on Twitter with #AskAEIEcon

Agenda

10:00 a.m.
Introduction:
Paul H. Kupiec, Senior Fellow, AEI

10:15 a.m.
Panel Discussion

Panelists:
Charles Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia Business School
Gerald P. Dwyer, Professor and BB&T Scholar, Clemson University
Thomas Hoenig, Distinguished Senior Fellow, Mercatus Center
Alex J. Pollock, Senior Fellow, Mises Institute

Moderator:
Paul H. Kupiec, Senior Fellow, AEI

11:45 a.m.
Q&A

12:00 p.m.
Adjournment

Click here to watch live.

Among six proposals to regulate cryptocurrency, one is superior

Published in The Hill with Howard B. Adler:

In the wake of billions in losses suffered by investors from the failure of cryptocurrency exchange FTX and other crypto collapses, how to regulate cryptocurrencies is a hot topic the new Congress must address. Competing proposals for it to consider range from banning cryptocurrencies outright, to giving them government backing, to stifling them with regulatory bureaucracy, to letting them fail or succeed entirely on their own. 

Some urge that cryptocurrencies simply be banned. This is the approach taken by China in 2021 when it banned all private cryptocurrency transactions and imposed an official “digital yuan” to monitor its citizens even more. The Chinese approach reflects the belief that currency must be a state monopoly and the official currency must have no private competitors. After FTX, some commentators have asked whether cryptocurrency should be banned in the United States. While banning cryptocurrency may be a characteristic response by an absolutist state like China, we do not believe it is appropriate for the United States. 

A second approach, unsurprisingly advocated by Securities and Exchange Commission Chairman Gary Gensler, is to have the SEC take over cryptocurrency regulation primarily by using its existing powers to regulate securities. Gensler believes that “the vast majority” of crypto tokens are securities already within the SEC’s jurisdiction. Of course, the SEC failed to head off the FTX collapse or any of the other cryptocurrency debacles. A glaring problem with this approach is that it requires the SEC to first assert that a particular form of crypto is a security and then for this issue to be litigated — a slow, expensive and inefficient process. A former SEC chair conceded that Bitcoin, the archetypal and largest cryptocurrency by market cap, is not a security and many cryptocurrencies are structured similarly to Bitcoin. 

The Commodity Futures Trading Commission has proposed that it should be the principal cryptocurrency regulator. This is called for in the Digital Commodities Consumer Protection Act, a bill reportedly pushed by former FTX CEO Sam Bankman-Fried and other members of the cryptocurrency industry. The crypto industry is said to regard the CFTC as a less stringent regulator than the SEC. One proposal is for each cryptocurrency firm to get to choose either the SEC or the CFTC as its regulator.  

From a different perspective, a group of top U.S. financial regulators has put forward a banking-based regulatory approach. This would be applied to stablecoins, a type of cryptocurrency backed by or redeemable at par in dollars (or other government currencies), and intended to maintain a stable value with respect to the dollar. This approach, advanced by the Treasury and the President’s Working Group on Financial Markets, would require that stablecoin issuers be chartered as regulated, FDIC-insured banks. The rationale for this approach is that stablecoin issuers are functionally taking deposits, which is by definition a banking function.  

Regulation as a bank is the most invasive form of financial regulation and imposes very high compliance costs.  For the business models of many cryptocurrency issuers, this may be the functional equivalent of banning cryptocurrency.  (Perhaps this is the outcome actually intended.)  More importantly, the only good thing that can be said about FTX’s and other cryptocurrency failures is that they did not damage the wider financial system or result in taxpayer bailouts.  Requiring cryptocurrency issuers to be FDIC-insured puts them in the federal safety net and puts taxpayers on the hook for future losses.  In our view, creating taxpayer support is going in exactly the wrong direction. 

A fifth approach, in a bill introduced by Sen. Pat Toomey (R-Pa.), would authorize a new type of license from the Office of the Comptroller of the Currency for stablecoin issuers, presumably less onerous than a full banking license and not requiring FDIC insurance. Issuers would be subject to examination and required to disclose their assets and redemption policies. Most importantly, they would be required to provide quarterly “attestations” from a registered public accounting firm. 

As a further step, we believe that disclosure of full, audited financial statements is critical. Right now, most cryptocurrencies are not subject to any kind of accounting disclosure. But no one should ever invest money in an entity that does not provide audited financial statements without recognizing that their funds are at extreme risk. If a federal regulatory system for cryptocurrency is to emerge, financial statement requirements are essential. 

Sixth and finally, it has been proposed that cryptocurrency not be specially regulated at all. Instead, it should be treated like a “minefield,” with appropriate warnings that investors face danger and invest entirely at their own risk. Investors would be able to rely on the protections of general commercial law and existing anti-fraud and criminal laws, but if cryptocurrency ventures crash, they crash, and their debts are reorganized in bankruptcy with losses to the investors and creditors, but not to taxpayers.  

Since cryptocurrency originated as a libertarian revolt against the government monopoly on money, this approach is consistent with its founding ideas. If people want to risk their money, they ought to be allowed to do so. However, they must be able to understand what they are doing. All parties should clearly understand that Big Brother is not protecting them when they hold or speculate in cryptocurrency. 

We believe that this sixth approach is superior in philosophy, but that it needs to be combined with required full, audited financial statements and disclosures about risks and important matters such as assets and redemption policies. Such a combination is the most promising path forward for cryptocurrency regulation. 

Howard B. Adler is an attorney and a former deputy assistant secretary of the Treasury for the Financial Stability Oversight Council. Alex J. Pollock is a senior fellow of the Mises Insitute and former Principal Deputy Director of the Treasury’s Office of Financial Research. They are the coauthors of the newly released book,” Surprised Again! The COVID Crisis and the New Market Bubble.” 

The second housing bubble of the 21st Century ends

Published in the Housing Finance International Journal and re-published in RealClear Markets.

The 21st century, only 23 years old, has already had two giant, international housing bubbles. It makes one doubt that we are getting any smarter with experience.

Among the countries involved in the second bubble, both the U.S. and Canada fully participated in the newest rampant inflation of house prices. Prices this time reached levels far above those of the last boom peak. In the U.S., the S&P/Case-Shiller National House Price Index by mid-2022 had risen to 67% over its 2006 bubble peak (130% over its 2012 trough). In Canada, the Teranet-National Bank House Price Index had soared to 143% over its 2008 peak (168% over its 2009 trough). What the Federal Reserve and the Bank of Canada both wrought with their hyper-low interest rate policies, were house prices which would be unaffordable as soon as mortgage interest rates returned to more normal levels. For a number of years, one could ask: When would that ever happen? Now we know: in 2022.

Now, in late 2022, with mortgage interest rates higher, housing bubbles are deflating, and house prices are dropping on a nationwide basis in both the U.S. and Canada. Here we go again into another house price fizzle following another house price boom.

How is it that we could find ourselves caught up in the problems of another housing bubble so soon? It is only ten years since 2012, the year house prices stopped falling in the U.S., and formed the trough of the painful bust which had followed the preceding bubble of 1999- 2006. Up to the point when house prices started falling across the U.S. last time, expert voices pronounced that U.S. house prices could fall on a regional basis, as they had numerous times, but that it was not possible for house prices to fall on a national basis in an economy so large and diversified. That theory could not have been more mistaken, and national average house prices fell 27%. In 2022, the theory is again being shown to be wrong, but how big the fall will be this time is not known or knowable.

We can take as a key ironic lesson that when large numbers of people believe house prices cannot fall, especially when they are emboldened by central bank behavior, it makes it more probable, and finally makes it certain, that the prices will ultimately fall. When they do, what had been built into everybody’s financial models as “HPA,” or “House Price Appreciation,” becomes instead “HPD”— “House Price Depreciation.” It would be better all along to refer to it as “HPC,” or “House Price Change,” thus reminding ourselves that prices of any asset can go both up and down, perhaps by a lot.

Ten years, it seems, is long enough to dim the memories that prices can move dramatically in both directions, even on a nationwide basis. A bubble market when extended for years makes a great many people happy, since they are making money and seem to be growing richer, and the higher their leverage, the faster they seem to be growing richer. As the great financial observer Walter Bagehot wrote 150 years ago, “the times of too high price” mean “almost everything will be believed for a little while.”

Then the reversal comes and different beliefs come to prevail. In just four months, from June to October 2022, U.S. median house prices dropped a remarkable 8.4%, with prices declining from their peak in all 60 of the largest metropolitan areas in the country. In October, sales of existing houses declined for the ninth month in a row, and were down 28% from a year earlier. Applications for a mortgage to buy a house were down 42% from the year before. Mortgage banks reported they were on average losing money on mortgage originations and many were laying off staff. The share price of 2021’s largest mortgage bank, Rocket Companies, was down 70% from its 2021 high. The CEO of the National Association of Home Builders stated, “We’re heading into a housing recession.”

In Canada, average house prices fell 7.7% from May to October, the largest five-month drop in the history of the Teranet index, which goes back to 1997. In Toronto, the country’s financial capital and a former star of rapid house price inflation, the May to October house price drop was a vertiginous 11.9%. Successive headlines in monthly Teranet-National Bank House Price Index announcements read: “Record price drop in August”; “Another record monthly decline in September”; “Another monthly decline in October.”

In spite of these rapid percentage rates of decline, house prices in both countries are still at very high levels. How much further can they fall from here? For the U.S., the Federal Reserve carefully stated in its latest Financial Stability Report, “With valuations at high levels, house prices could be particularly sensitive to shocks.” Coming to specifics, the AEI Housing Center predicts a 10%-15% nationalaverage fall in house prices during 2023. That would wipe out a lot of housing wealth that the bubble made people think they had, a reduction of perhaps $4 or $5 trillion of perceived wealth on top of the $3 trillion lost so far this year. It would put many houses bought near the top of the market, especially under government low- down payment programs, into no or negative owner’s equity.

For Canada, the Wall Street Journal suggested that its housing market is “particularly sensitive to monetary tightening,” and reported that Oxford Analytics “estimates that home prices in Canada could fall 30%.”

Recall that a price has no substantive reality: it is an intersection of human expectations, actions, hopes and fears. I like to ask audiences, “How much can the price of an asset change?” My proposed answer: “More than you think.”

Of course, nobody, including the Federal Reserve and the Bank of Canada, knows just where house prices will go, but we can all guess. Noted economist Gary Shilling wrote in November, “Price declines are just starting,” and “recent weakness probably has far to go.” This seems to me likely.

In any case, the second great housing bubble of this still young century is over and a new phase has begun.

Letter: The Fed’s accounting ploy has echoes of S&L crisis

Published in the Financial Times:

Your article “Central banks: Rising losses risk bailouts and political pressure” (Report, December 12) points out that central banks, having bought a lot of low-yielding bonds together, are now losing a lot of money together. Do these losses matter? You quote a Danske Bank strategist saying “central banks do not aim to make profits” — a comment offered as a rationalisation. But this is contradicted by the fact that central banks are all structured precisely to make money by seigniorage from their currency monopolies. As for the Federal Reserve, whose losses are rapidly mounting, its so-called “deferred asset” accounting is not a solution, but simply a phoney accounting used to keep the losses from reducing the Fed’s publicly reported net worth, or rendering it negative. This is the same accounting ploy used by insolvent savings and loans in the 1980s during the collapse of their industry. This has some poetic justice since the Fed, with its $2.7tn of fixed rate mortgage assets, has inside it the financial equivalent of the largest savings and loan in the world by far. Alex J Pollock Lake Forest, IL, US

Profligacy in Lockstep

Published in Law & Liberty and re-published in RealClear Markets with Paul Kupiec:

The Swiss National Bank’s (SNB) financial statements for the nine months ending September 30, 2022, show a bottom-line loss of US$150 billion.* A number to get your attention!

Under the strong financial discipline of its charter act, the SNB must mark its investments to market, and reflect any market value loss or profit in its income statement and capital account. From having capital of $221 billion at the end of 2021, the SNB’s capital has been reduced by 73% to $59 billion on September 30 due to falling market prices. Still, the SNB has a capital ratio—a bank’s equity to its total assets—over 6%.

In contrast, the Federal Reserve’s reported capital ratio, which does not reflect the Fed’s massive mark-to-market losses, is 0.5%. The Federal Reserve Bank of New York, by far the largest of the Federal Reserve Banks, has a reported capital ratio of 0.3%—again not counting its market value losses. “It helps the credibility of the central bank to be well capitalized,” said the Vice Chairman of the SNB in October 2022. Presumably, the Fed does not agree.

With Swiss candor, the Chairman of the SNB observed, also in October 2022, that many central banks “brought down longer-term interest rates by buying government and corporate bonds. This increased central banks’ balance sheets and the risks they bear.” (italics added) They certainly did run up their risk, all together, and now the big risks they assumed are turning into losses all around the central bank club.

The Reserve Bank of Australia announced in September that losses on its investments caused its capital to drop to a negative $8 billion on June 30. Its Deputy Governor admitted that “If any commercial entity had negative equity… [it] would not be a going concern,” but maintained, “there are no going concern issues with a central bank in a country like Australia.” Nonetheless, it’s pretty embarrassing to have lost more than all of your capital.

The Bank of England joined “the club of major central banks showing negative net worth” if its investments are marked-to-market, Grant’s Interest Rate Observer reported. Thus far, the Bank has lost $230 billion on its bond investments, 33 times the Bank’s capital of $7 billion as of February 2022, its fiscal year-end. Fortunately for the Bank, it has an indemnity from His Majesty’s Treasury—that is, the taxpayers—to cover the losses. “I am happy to reaffirm…that any future losses incurred by the Asset Purchase Fund will be met in full by the Government,” wrote a Chancellor of the Exchequer. In July 2022 the Financial Times summed it up: “With an indemnity provided by HM Treasury the Bank of England need not fret.” But should the taxpayers who bear the loss fret?

The Bank of Canada carries most of its investments at market value, and its financial statements reflect market value losses of $26 billion as of November 2022. These mark-to-market losses would render the bank’s capital negative were it not for a formal indemnity agreement it has with the Government of Canada. The Canadian government has contractually agreed to make up any realized losses on the Bank’s bond purchase programs. That’s a good thing for the Canadian central bank, since its capital ratio is only 0.1%.

While the Bank of Canada’s financial statements do show that its investment losses put the taxpayers at risk, you have to read the financial statement footnotes carefully to understand what the accounting means. The Bank carries an asset called “Derivatives: Indemnity agreements with the Government of Canada.” This asset is the amount that the government is on the hook for—in other words, it equals $26 billion in mark-to-market losses. Since the Bank’s total reported capital is only about $0.5 billion, the real capital of the Bank is its claim on Canadian taxpayers to reimburse its losses.

Now having created the same risks together, the world’s central banks are suffering big losses together.

The European Central Bank (ECB) has assets of over $9 trillion and a capital ratio of 1.3%. How do its mark-to-market losses compare to its $119 billion in capital? It’s hard to tell, but a German banking colleague wrote us, “ECB is not really transparent, [but] you can guess… Expect price losses in its portfolio of about $800 billion.” If his informed guess is accurate, the ECB has negative capital of about $680 billion on a mark-to-market basis. As our colleague also pointed out, many of the ECB’s investments are low-quality sovereign bonds. It will be interesting indeed to see how these ECB problems play out.

In September, the Governor of the Dutch central bank, De Nederlandsche Bank (DNB), formally wrote to the Ministry of Finance to discuss the Bank’s looming losses, and how “a situation may arise in which the DNB is faced with negative capital.” This is without considering the mark-to-market of its bond portfolio, because the DNB uses accounting conventions, like the Federal Reserve, that do not recognize mark-to-market losses on its QE investments.

“In an extreme case,” the letter continued, “a capital contribution from the shareholder may be necessary.” The sole shareholder is the Dutch government, so once again the cost would be transferred to the taxpayers.

In this unattractive situation the DNB has plenty of company: “All central banks implementing purchase programs, both in the euro area and beyond, are facing these negative consequences,” the Governor observed, adding that these included the Federal Reserve, the Swedish Riksbank, and the Bank of England.

Then, in an October television interview, the Governor brought up the old-fashioned idea of gold. The DNB’s negative capital problem could be ameliorated or avoided he said, by counting as capital the large unrealized profit on its gold. The Bank does mark its 19.7 million ounces of gold to market but keeps the appreciation in a separate $33 billion accounting “reserve,” which is not included in its capital account.

Although it is against the current rules of the Euro system, it would make perfect sense to include the market value of the gold when calculating the DNB’s capital, as the Swiss National Bank does. (This idea would not help the Federal Reserve, because it owns no gold.) It is no small irony that, to bolster their capital, modern fiat currency central banks would consider turning to the value of the “barbarous relic” of gold, against which their own currencies have over time so greatly depreciated.

Coming to the world’s leading central bank, the mark-to-market loss on the Federal Reserve’s investments, as we have previously written, is huge—estimated at a remarkable $1.3 trillion loss as of October 2022. This is 30 times the Fed’s total capital of $42 billion. More immediately pressing, the Fed is now running operating losses that it does recognize in its profit and loss statement of $1 billion or more a week, or annualized losses of $50 to $60 billion. Not counting the mark-to-market losses on its investments, the Fed’s operating losses at this rate will exceed its capital in less than a year.

Complicating the problem, the shares of the Federal Reserve Banks are owned not by the government, but by Fed member commercial banks. Under the Federal Reserve Act, the Fed’s shareholders are required to be assessed for a portion of any losses, but the Fed has thus far seemed to ignore the law and is sharing its operating losses with the taxpayers instead.

“Major central banks tend to move together,” as economist Gary Shilling pointed out recently. We believe this is because the major central banks are a coordinating elite club. They do not and cannot know the financial and economic future, and they must act based on highly unreliable forecasts. They face, and know they face, deep and fundamental uncertainty. Under these circumstances, intellectual and behavioral herding is natural and to be expected. Now having created the same risks together, they are suffering big losses together. In many cases, the accumulating losses will exceed central bank capital and be borne by the taxpayers.

*All currencies have been translated to US dollars at mid-November exchange rates.

Dec. 7: AEI: Surprised Again!―The COVID Crisis and the New Market Bubble

Hosted by the American Enterprise Institute. Also video on C-SPAN here.

Alex Pollock and Howard Adler were senior US Treasury officials during the financial markets’ bust-to-boom cycle of the COVID-19 crisis. Their new book, Surprised Again!—The COVID Crisis and the New Market Bubble (Paul Dry Books, 2022), analyzes how the government’s crisis response affected the US financial system. Their clear exposition of the financial stability risks lurking in the Federal Reserve, housing, pension funds, municipal finance, student loans, and cryptocurrencies may surprise many readers with the extent of the financial system problems hiding in plain sight.

Join AEI as Christopher DeMuth and Paul Kupiec engage Mr. Pollock and Mr. Adler in a discussion of the many important issues the authors raise in Surprised Again!

LIVE Q&A: Submit questions to Beatrice.Lee@aei.org or on Twitter with #AskAEIEcon.

Agenda

5:00 p.m.
Introduction:
Paul H. Kupiec, Senior Fellow, AEI

5:10 p.m.
Book Preview:
Alex J. Pollock, Senior Fellow, Mises Institute
Howard B. Adler, Former Deputy Assistant Secretary of the Treasury, Financial Stability Oversight Council

5:35 p.m.
Discussion:
Christopher DeMuth, Distinguished Fellow, Hudson Institute
Paul H. Kupiec, Senior Fellow, AEI

6:00 p.m.
Q&A

7:00 p.m.
Adjournment

Dec. 15: Johns Hopkins: "Surprised Again!" Book Conversation with Howard Adler & Alex Pollock

Hosted by Johns Hopkins University:

Sponsored by Alumni in Government, Education, Law & Policy, Alumni in Real Estate, Administration & Finance, Alumni in Arts, Media, Athletics and Entertainment and the Office of Alumni Relations Lifelong Learning

Are you interested in finance or even the economy? Join former Treasury officials, Howard Adler and Alex J. Pollock as they present their book "Surprised Again!:The COVID Crisis and the New Market Bubble". Howard and Alex will present Chapter 6, “Cryptocurrencies: An Assault on central Banks or Their New Triumph?”  and Chapter 12, “Central Banking to the Max” and discuss the impact of the COVID pandemic and the economic bubbles in the economy.  Dive in for the opportunities to ask questions and get answers! 

Learn more and purchase this well reviewed book here at https://www.pauldrybooks.com/products/surprised-again-the-covid-crisis-and-the-new-market-bubble and also available through most book sellers including Amazon, Barnes & Noble, Target, Walmart, etc.

Surprised Again! Book Overview

About every ten years, we are surprised by a financial crisis. In 2020, we were Surprised Again! by the financial panic of the spring triggered by the Covid-19 pandemic. Not one of the 30 official systemic risk studies developed in 2019 had even hinted at this financial crisis as a possibility, or at the frightening economic contraction which resulted from the political responses to control the virus. In response came the unprecedented government fiscal and monetary expansions and bailouts. Later 2020 brought a second big surprise: the appearance of an amazing boom in asset prices, including stocks, houses, and cryptocurrencies.

Alex Pollock and Howard Adler lived through this historic instability while serving as senior officials of the U.S. Department of the Treasury. Their book lays out the many elements of the panic and its aftermath, from the massive elastic currency operations which rode to the rescue by financing the bust with unprecedented government debt, to the consequent asset price boom, which included a renewed bubble in house prices financed by government guarantees. It considers key leveraged sectors such as commercial real estate, student loans, pension funds, banks, and the government itself. It reflects on how to understand these events both in retrospect and prospect.

Surprised Again! The COVID Crisis and the New Market Bubble

Published in Library Journal:

by Alex J. Pollock & Howard B. Adler

Paul Dry. Nov. 2022. 222p. ISBN 9781589881655. pap. $21.95. ECONOMICS

COPY ISBN

As former senior officials of the U.S. Department of Treasury under the Trump administration, Pollock (Finance and Philosophy: Why We’re Always Surprised) and Adler are qualified to synthesize complex financial behaviors into digestible chapters; the graphs they include are excellent. This book analyzes prime money market funds, cryptocurrencies, mortgages, municipal debt, pension debt, and student loans, in regard to their pre and current pandemic behavior. Each chapter serves as a primer and an update of each category. The authors argue that all finance is political finance, and they believe that predicting financial market behavior is ineffective, since many times those forecasts are wrong or surprising. Salient points are emphasized with a “Dear Reader” salutation that is both annoying and effective, as the examples in those paragraphs are essential for understanding. The chapters on prime market funds and cryptocurrencies are especially enlightening due to their exploration of regulations, both real and theoretical, that influence their behavior. Although the book is designed to be read in sequence, readers looking to delve into these topics beyond daily media coverage will be able to start at the chapter they’re most interested in.

VERDICT A helpful and insightful analysis of current economics.

Reviewed by Tina Panik , Nov 01, 2022

William Isaac Announcements: October 28, 2022

October 28, 2022

My good friend, Alex Pollock and his colleague, Paul Kupiec, co-authored an article on the Federal Reserve, which was just published by The Hill. The legislation creating the Consumer Financial Protection Bureau required the CFPB to be headed by a single individual instead of a bipartisan board governing most independent agencies such as the FDIC, the SEC, the FTC. Moreover, the CFPB receives its funding from the Federal Reserve Board instead of being funded by Congress. A Federal Court recently ruled – I believe correctly – that these governance arrangements are unconstitutional. Alex and Paul address these issues and go on to note that the Federal Reserve is hardly in position to fund the CFPB. I highly recommend this article to you.

• The Fed is in the red: Should it still pay CFPB’s bills? By Alex J. Pollock and Paul Kupiec published by The Hill on October 26, 2022

The article can be found at williamisaac.com. Be safe and be well.

The Fed is in the red: Should it still pay CFPB’s bills?

Published in The Hill with Paul Kupiec.

The Fifth Circuit Court of Appeals just ruled that the Dodd-Frank Act’s requirement that the Federal Reserve pays the expenses of the Consumer Financial Protection Bureau is unconstitutional. This important ruling adds to another problematic aspect of the CFPB’s funding scheme — the Federal Reserve no longer has enough earnings to cover the $692 million in checks the CFBP writes each year.

The CFPB’s 2022 “Budget Overview” states that “The CFPB’s operations are funded principally by transfers … from the combined earnings of the Federal Reserve.” But in the fall of 2022, this is not true. There are no such earnings, the Fed is losing money. Making the Fed pay the CFPB’s expenses simply makes those losses larger. It also keeps the CFPB’s expenses out of the federal budget deficit where the court ruling says they rightly belong.

Former Fed Chairman Ben Bernanke has just been awarded the Nobel Prize in economics, but the policy of quantitative easing he championed has left the Fed with market value losses of monumental proportions. We estimate that the Fed’s balance sheet as of mid-October suffers from a $1.3 trillion mark-to-market loss. That is 30 times the Fed’s total capital of $42 billion. To put the size of this loss in perspective, it is nearly equal to Spain’s GDP and larger than the GDP of Indonesia.

The Fed says these mark-to-market losses are not an issue, they are “merely” unrealized losses. It does not include them in the asset valuations or the capital it reports on its financial statements. Since the Fed does not intend to sell any of its underwater investments, it says there is no danger it will experience a cash loss. While the Fed can feign indifference to a $1.3 trillion market value loss on its investment portfolio, imagine your reaction if you opened your 401(k) statement and saw a very large unrealized loss. 

As short-term interest rates increase, the Fed is experiencing both unrealized mark-to-market losses and cash operating losses. Both will continue because of the Fed’s massive interest rate mismatch. The Fed’s investment portfolio has a net position of about $5 trillion of long-term fixed-rate investments, much of them with remaining maturities of more than 10 years. These investments are funded with floating rate liabilities. The Fed is the financial equivalent of a $5 trillion 1980s-vintage savings and loan. When short-term interest rates rise, its profits naturally shrink and then turn into losses.

We estimate that, in round numbers, for each 1 percent that short-term interest rates increase, the Fed’s annual net income falls by $50 billion. Since the interest rate on the Fed’s floating rate liabilities has increased by 3 percent (so far) in 2022, the Fed is now posting substantial losses and will continue to post losses going forward.

In May, we estimated that the Fed would begin losing money when short-term rates exceed 2.7 percent. With the last FOMC rate increase, the Fed is now paying about 3.1 percent on bank reserve balances so the Fed’s operating profits should already be in the red. A comparison of the Fed’s Oct. 19, H.4.1 Report with its report from mid-September shows that, over the past month, the Fed has accumulated an operating loss of about $5 billion. The loss appears in Table 6 in the account, “Earnings remittances due to the U.S. Treasury.” On Oct. 19, the account is negative, which means the Fed is now losing money.

A loss of $5 billion in a month annualizes to a loss of $60 billion. At current short-term interest rates, not only are there no Fed profits to cover the checks CFPB will be writing, but the Fed’s annual operating loss is on a path that will soon exceed the Fed’s total capital. If these operating losses were booked into retained earnings, as required by Generally Accepted Accounting Principles, within a year, the Fed would report negative capital. In other words, using normal accounting standards, the Fed will soon be technically insolvent.

But unlike the banks it regulates, the Fed will not report negative capital and it won’t go out of business as its losses continue to accumulate. In its accounting statements, the Fed will offset operating losses dollar-for-dollar by debiting an intangible (better said, an imaginary) asset account called a “deferred asset.” As long as the Fed has a deferred asset balance, which may be for years, it will make no payments to the Treasury. In the meantime, the Fed will print money to pay its bills, further contributing to inflation.

If interest rates continue to increase, as nearly everyone expects, Fed losses will grow. The Fed’s total cash losses could easily grow to $100 billion or more over time — maybe a lot more — before rates decline. Ironically, the more the Fed fights inflation by increasing short-term interest rates, the bigger its own loss becomes.

From its inception in 1913, the Fed has been structured to make profits from its money printing monopoly and required to send most of its profits to the Treasury to reduce the federal deficit. But today the Fed’s short-funded quantitative easing investments have resulted in losses that exceed its seigniorage profits.

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Accounted for properly, Fed losses increase the federal deficit that ultimately must be paid by future taxes — but Fed losses are currently not counted in federal deficit estimates. As the next Congress considers Fed reforms, it should also require that Fed operating losses also be included in the federal budget deficit.

While the CFPB’s expenses are clearly federal government expenditures, they are currently not counted in the federal budget and have hitherto been set by an unelected CFPB director and evaded congressional appropriations by making the Fed pay the CFPB’s bills. If the Fifth Circuit’s ruling prevails, these expenditures could be put into a normal democratic process, set by the elected representatives of the people in a constitutional fashion, and no longer be increasing the Federal Reserve’s already embarrassingly large losses.

Alex J. Pollock is the co-author of the newly published “Surprised Again!—The Covid Crisis and the New Market Bubble,” and a senior fellow at the Mises Institute.  Paul Kupiec is a senior fellow at the American Enterprise Institute.

Role of the General Manager

By Alex J. Pollock, 8/1989 

Broad Tasks   |  What Works Well 

1. Build the system of communication | Consistent display of integrity - insight into strengths and weaknesses 

2. Put the right people in the right places | Never be threatened by subordinates - appreciate the best - think long and carefully about managerial change 

3. Give an emotional meaning to the enterprise | Repetition of themes - consistency of words and actions 

4. Imagine and form robust approaches to the future | Time to think - study the long past - flexible ideas 

5. Create openness to the outside | Broad interests - not taking self too seriously - customer focus 

6. Insure the development and maintenance of key competences | Always have little experiments running - build as they succeed - honor the old and new key skills and knowledge 

7. Create psychological security, the ground for common action, out of uncertainty and risks  | Self confidence - be an emotional exporter 

8. Balance between the uncaring outside world demanding change, and the emotional inside organization longing for stability. | Perspective - guiding and teaching - getting others to want to do what is needed - patience

Ten Commandments of Leadership

By Alex J. Pollock, 12/24/87 

1. Drama - Giving emotional meaning to the organization and to the efforts and sacrifices of the individual. Appearing a leader so others will believe they should follow. Providing an element of mystery.

2. Physical presence - Being seen and felt by the ranks as at the head. 

3. Empathy with the ranks - Their problems, sacrifices, risks, fears, hopes. 

4. Detachment - Necessary to think above and beyond the traditions, commitments and beliefs of the organization and to make decisions causing suffering (and in the military, death). 

5. Courage - Sharing the risk. Going on in spite of fear and uncertainty. 

6. Imposing sanctions - Required for coordination of large groups. 

7. Knowledge – Both general knowledge and detailed information on the problems at hand. Historical perspective required. 

8. Decision - Setting the right course at the right time with the appropriate level of abstraction or detail. Taking on the burden of turning actual uncertainty into psychological certainty, the ground of common action. 

9. The right inner circle - Those who will tell the truth, are not awed by your drama, and fill in your gaps and mistakes. 

10. Creation of a personal role - A necessary part of drama. The role must both separate the leader and link him to the ranks through its appeal. Possible components: flamboyance, calm, brilliance, drive, speed, good cheer, human touch, wisdom, determination, idiosyncrasies, heroics, visions. 

Adapted from John Keegan, The Mask of Command.

The Political History of Money

Published in Law and Liberty:

Those who fail to study the intellectual debates of the past are condemned to repeat them,” is a variation on Santayana’s famous dictum particularly applicable to economics and monetary theory, where ideas cycle along with events. In The Currency of Politics, Stefan Eich has written a valuable and very interesting review of specific monetary debates in their historical settings during centuries of thought about the nature of money as it is entwined with politics. The author’s own recommendations, however, are sketchy and betray a naïve faith in governments. The historical survey does inexplicably leave out the intense debate of “the money question” at the end of the 19th century in the U.S., starring William Jennings Bryan, which we will fill in at the end of this review.

The Currency of Politics was published in 2022, well timed to be greeted by the Great Inflation in this country, and runaway inflation in other countries as well, which has given rise to a new global debate about central banking, money, and inflation, with the global club of money-printing central banks on the defensive—at least for now. The current arguments and monetary stresses must become a new chapter in any future second edition.

Eich’s principal overall theme is that “money is always already political.” This does seem obviously true. I often point out that the old title, “Political Economy,” was a more accurate term than the current “Economics.” We find economics without politics only in theory, never in reality. Likewise, there is no “Finance,” only “Political Finance.”

One reason this is true is the recurring cycles of financial crises, which inevitably trigger powerful political reactions.

A second reason is that the control of money is extremely convenient to governments, especially to have their own central bank to buy their debt when they are out of money. This was the reason for creating the archetypical Bank of England in 1694. It is an arrangement so advantageous to politicians that virtually every national government has its own central bank now. This is particularly useful in times of war, but also handy in general while running budget deficits.

As George Selgin observed in his 2017 study of the nature of money:

Governments have come to supply currency, and to restrict the private supply of currency and deposits, not to remedy market failures, but to provide themselves with seigniorage and loans on favorable terms. Government currency monopolies…can thus be understood as part of the tax system [and reflect] the preference of the fiscal authorities.

This ability of the government to use its control of money for fiscal purposes is precisely what appeals to practicing politicians when they want to spend more, and to a statist academic like Eich, who wants “more precisely political control over money” and “to reconceive of money as a malleable political institution,” in order to have “more democratic visions,” although the “visions” are fuzzy.

In support of his true, but hardly surprising, theme that money is political, Eich goes back to Aristotle. He says Aristotle thought that “money could be an institution that would contribute to the cohesiveness of the polis—but one that was insufficient, imperfect and laden with potentially tragic consequences.” Indeed, such tragic consequences have been experienced by every victim of the hyperinflations that numerous governments have visited on their populations, and as are being experienced today, for example, with Argentina’s reported 71% inflation rate in July 2022.

From Aristotle, the book leaps two thousand years ahead to another great philosopher, John Locke, and in my view, becomes more interesting. The setting is the debate about the great British recoinage of 1696, two years after the founding of the Bank of England, in which Locke was an original shareholder. Famous for his influential political philosophy and theory of knowledge, Locke, as Eich recounts, was also a key monetary thinker. (That was left out of my philosophy courses, and I’ll bet is equally news to many others. As Eich comments, “today political theorists rarely engage with his monetary writings”—bravo to Eich for doing so.) At the same time, the towering scientific genius, Isaac Newton, was also involved in monetary affairs, as he became Warden of the Royal Mint in 1696. He was made Master of the Royal Mint in 1699, a post he held until his death in 1727.

Locke becomes a principal intellectual antagonist in the book for proposing “that the government call in all the circulating currency [that is to say, coinage] and recoin it to affirm its official silver content as originally set in Elizabethan times,” a century before. Eich writes, “For Locke, a pound sterling was and had to remain neither more nor less than three ounces, seventeen pennyweights, and ten grains of sterling silver.” This was in order “to restore trust in the monetary and political system.” The historical outcome was that “to the surprise of many, Locke’s novel insistence on the unalterability of the [monetary] standard carried the day… Parliament passed the act in January 1696…clipped and worn coins were removed from circulation and replaced by newly minted coins with milled edges…[accompanied by] the new emphasis on coins’ inviolable intrinsic value.”

Eich considers this an attempt to “depoliticize” money, but fairly points out that “Locke’s intervention was itself political.” Indeed, sound money, like inflationary money, is itself a position in Political Economy about what monetary system is best.

After Locke, Eich moves on to the German Idealist and nationalist philosopher, Johann Gottlieb Fichte, a theorist more to his taste. Fichte “set out the most incisive plea for…the political and philosophical implications of the new possibilities of fiat money,” which he believed would require a “closed commercial state” which cuts itself off from all foreign trade “with external commerce banned,” and “commercial autarchy.” Further, it would be “a state that enjoyed the full trust of its citizens had at its disposal the full powers of modern money,” and—an expansive claim by Fichte—“it would ensure for all time the value of the money distributed by it.” Needless to say, in a world of monetary politics, the probability of that is zero. A permanent related question is whether it is ever wise to trust the government in monetary affairs.

Eich is well aware that others doubt (as I do) that the state can or should be so trusted. But could fiat currency work anyway? That it could, at least for a while, was shown by a key historical event: the suspension of the convertibility of its notes by the Bank of England in 1797, in order to help finance England’s war against Napoleon. (A hundred years before, the Bank of England had been set up to finance England’s wars against Louis XIV, and one hundred years later, the Federal Reserve first made its mark financing American participation in the First World War.)

Eich’s discussion of this period is extremely interesting to us denizens of the current pure fiat currency world. Like President Nixon on August 15, 1971, the British government on February 26, 1797 “issued a breathtaking proclamation…The Bank of England had suspended…The pound sterling, still in name referring to the weight measure of silver, had become a piece of paper backed only by the word of the state.” This was “a dramatic opening of a now largely forgotten episode in global monetary affairs…from 1797 until 1821, Britain experimented with the most advanced monetary practice in the world—pure fiat money,” Eich says, “and with it the politics of modern central banking. [This] challenged and transformed not only reigning conceptions of money, but also the nature and role of the modern nation state.”

Like the United States in 1971, Britain in 1797 had little choice about this dramatic move—they were both running out of the gold they had promised to pay on demand to their creditors. Here was the British situation:

“The latter part of 1796 had brought a new wave of failures of mercantile and banking houses all over the country. The apprehension of a French invasion heightened the alarm, and when in February 1797 a single French frigate actually landed 1,200 men in Fishguard in Wales, a run on the Bank of England started.” Think of that. According to Hayek, “[Prime Minister] Pitt, being informed of the state of affairs by a deputation from the Bank…forbade the directors, by an Order in Council [from] issuing any cash payments.” The prohibition lasted more than two decades.

Eich emphasizes that “for the first three years prices stayed almost completely stable.” But they didn’t stay that way after that. You have to go to footnote 85 of his Chapter 3 to find that “Over the next two decades…prices rose overall by about 80%.” Eich comforts himself with the thought that this was only “an annualized rate of less than 4 %.” He apparently did not do the math of compound growth rates. At an inflation rate of 4%, prices will multiply by 16 times in a lifetime of 72 years.

Eich hopes that his history will help “by providing a better language to capture the politics of money, including its promises and limitations.”

Likewise, in our own fiat currency days, after a period of central bank self-congratulation for “price stability,” prices have also not stayed stable, to say the least.

In the historic British case, “a lively debate ensued,” famous to students of monetary history. If we get to footnote 86 of Chapter 3, we find that “The most important English contribution to the debate… was that of Henry Thornton’s An Enquiry into the Nature and Effects of the Paper Credit of Great Britain.” Unfortunately, Thornton does not make it into the book’s main text or appear in its index. We may remedy this lack with two of Thornton’s essential conclusions:

That the quantity of circulating paper must be limited, in order to the due maintenance of its value, is a principle on which it is of especial importance to insist.

To suffer…the wishes of the government to determine the measure of the bank issues, is unquestionably to adopt a very false principle.

At the end of the classic monetary debate in which Thornton played an important part, and with Napoleon well and truly defeated, Britain went back to gold convertibility in 1821.

As the book proceeds, Eich devotes a chapter to his real hero, John Maynard Keynes, and one to the other principal intellectual antagonist of the book, Friedrich Hayek. These chapters have much history of interest—for example, how in 1925 Keynes rightly advised Chancellor of the Exchequer Winston Churchill not to go back on gold at the old, pre-War parity, because the War had destroyed the parities of the old gold standard for good. How Keynes proposed at the Bretton Woods Conference in 1944 the impractical creation of a global central bank and an international fiat currency, “Bancor,” but was representing Britain, which was by then a broke debtor nation and a loser in the argument. The world moved on to the Bretton Woods system based on the U.S. dollar with inter-government gold convertibility, which collapsed in 1971. And on the other side, how Hayek intellectually led “the devastatingly effective politics of the 1970s, which not only paved the way to disinflationary discipline, but also effectively buried Keynes, at least until…2008,” and how Hayek suggested “depriving governments of their monopolistic control of money.” Eich views that as the renewed heresy of “depoliticization” of money.

Eich likes Keynes’ 1930s proposal for zero interest rates which would bring “the euthanasia of the rentier.” However, when in our day central banks imposed zero interest rates, they brought instead the “euthanasia of the saver” and for the rentiers created giant profits by asset price inflation in their bond and stock portfolios.

In the Epilogue to the book, Eich explains, “Following past thinkers…is not meant to produce a catalogue of answers.” Still, he mentions a few suggestions, none spelled out and none, in my view, of much interest, like bringing back postal banking or making the Federal Reserve into a government lending bank. He wants “the greater democratization of money power,” but suggests the anti-democratic need to shield monetary decisions from “the whims of public opinion.”

As a summary thought, he hopes that his history will help “by providing a better language to capture the politics of money, including its promises and limitations.”

The most surprising thing about The Currency of Politics is that the great American monetary debate in which “the money question” dominated national politics, and particularly the presidential election of 1896 with the stirring oratory of William Jennings Bryan, gets not a single mention. Yet its focus was precisely the politics of money in a clear, dramatic, and historic fashion.

Bryan—“that Heaven born Bryan, that Homer Bryan, who sang from the West,” according to the poet Vachel Lindsay—thrilled the Democratic National Convention of 1896 with his “Cross of Gold” speech, the high-flying rhetoric of which was an attack on the gold standard and the promotion of an explicitly inflationist monetary program by the free coinage of silver. One commentator, with some exaggeration, calls it “the most famous speech in American political history.” It is surely the most famous American speech on monetary policy.

Says one history, Bryan “leaped to the speaker’s stand two steps at a time,” and “appeared like a Democratic Apollo.” He proclaimed “that the issue of money is a function of the government, and that the banks should go out of the governing business”—a proposition to which Eich would subscribe. After much more, which I wish we had space to quote, Bryan reached his unforgettable conclusion:

We shall answer their demands for a gold standard by saying to them, “You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold!”

Bryan got three runs for the U.S. presidency and lost three times. Whatever your views on the substance of his ideas, he certainly gave us notable rhetoric. Eich might add it to his study while he searches for “a better language to capture the politics of money.”

Letter: On this measure, the Fed is already in negative equity

Published in the Financial Times:

“Are central banks going bankrupt?” Robin Wigglesworth asks (FT Alphaville, FT.com, October 10).

He points out that the Federal Reserve has disclosed a $720bn unrealised loss on its investments as of June 30 of this year. By now, this loss is much bigger.

Paul Kupiec and I have estimated it at about $1tn — an especially remarkable number when compared to the Fed’s total capital of $42bn.

Moreover, the mark-to-market loss presages cash operating losses on the way, as the Fed will be funding low-yielding fixed rate investments with expensive floating rate liabilities, generating negative net interest income — just like a 1980s savings and loan.

Depending on the path of interest rates, these operating losses could go on for some years. “Central bank negative equity,” Wigglesworth writes, “coming to a Fed or BoE or ECB near you soon?”

On a mark-to-market basis, Federal Reserve negative equity in size is already here. Alex J Pollock Senior Fellow, Mises Institute Auburn, AL, US

Economic Truths, Perennially Forgotten

A review of Surprised Again! The Covid Crisis and the New Market Bubble, written by William M. Briggs and published in Law & Liberty.

In 2021, Treasury Secretary Janet Yellen assured Americans that recent inflation was “transitory.” Back in 2017, Yellen, then Chairman of the Federal Reserve Board, hinted there would not be another financial crisis “in our lifetimes.”

Maybe she got that idea from Morgan Stanley boss James Gorman, who in 2013 put the chance of a crisis “in our lifetime” as “close to zero” as he could imagine. Well, imagination, as the song says, is crazy. “Your whole perspective gets hazy.”

These two experts, as Alex J. Pollock and Howard B. Adler tell us in Surprised Again! The Covid Crisis and the New Market Bubble, are far from alone. Economic experts, they confirm, have a collective accuracy that would embarrass a busload of blind golfers. Not one expert, they remind us, saw the Great Depression coming. And none foresaw the Calamitous Coronadoom Panic of 2020. Which lasted until now.

What is fascinating is that being wrong in no way dents the awesome armor of assurance donned by our experts. Whatever they do when given power, they do it boldly and without doubt. Whether this lack of humility is caused by amnesia or hubris can be debated. But no one can doubt  the astonishing effects of the economic “solutions” foisted upon us by a string of experts during the panic, each trying to correct the ill effects of the other “solutions.”

Read the rest here.

The historical waning of the U.S. Savings & Loans

Published in Housing Finance International Journal.

At its founding in 1914, the original name of the association which publishes Housing Finance International was the “International Union of Building Societies and Savings & Loan Associations.” This narrow focus fit the times; the name got the unattractive acronym of “IUBSSA.” When it was 75 years old, and after the disastrous number of failures in the U.S. savings & loan industry during the 1980s, a broader perspective was reflected in a new name for the association in 1989: the “International Union of Housing Finance Institutions” (“IUHFI”). Fundamental change in housing finance markets continued, notably the great expansion of mortgage securitization, and showed this was still too narrow an idea. So 1997 brought a yet broader and still current name: the “International Union for Housing Finance.”

I had the honor of co-chairing the committee which proposed the by-law revisions of 1997 that included changing the name, symbolizing that the IUHF is interested in and welcomes participation from all forms of the essential, worldwide activity of housing finance, one of the largest credit markets in the world, as well as one of the most politically and socially most important. Financial evolution, as it has continued in the 25 years since then, shows that wider perspective to be the correct approach.

A fundamental idea governing the shape of housing finance in its historical form of building societies and savings and loans was what was called the “special circuit” of funding for housing finance. As Michael Lea, a former Director of Research for the IUHF, and Douglas Diamond, Jr. wrote in 1992:

“Housing finance traditionally has been an area of intervention by governments, especially through the creation of special circuits for [mortgage] funding flows. … In many countries, governments intervened in the market to set up special circuits, characterized by a significant degree of regulation, segmentation from the rest of the financial markets, and often substantial government subsidy.”1

American savings & loan associations were a large and perfect example of such a special circuit, with savings accounts, which received regulatory advantages, directly linked to mortgage loans, both of which got a lot of favorable political attention. In the U.S. case, the savings & loans were required by law and regulation to make principally very long mortgage loans, with the interest rate fixed for 20 or 30 years. A special circuit was also represented by building societies in the United Kingdom and other countries, thus making up the two parts of the original name and membership of the International Union of Building Societies and Savings & Loans. As Lea also wrote:

“Specialist-deposit funded institutions… traditionally dominated the provision of housing finance in Anglo-Saxon countries (for example, Australia, Canada, South Africa and the United States) as well as Commonwealth countries… Through most of the 20th century, the building societies/savings & loan model dominated housing finance in the English-speaking world.”2 In the U.S., the specialist institutions included, in addition to the savings & loans, their close cousins, the mutual savings banks, known together as “thrift institutions.” In 1980, there were 5,073 thrift institutions in the United States.

As Lea observes, “Starting in the 1980s, this model began to lose influence and market share to commercial banks.” In the U.S., they also lost massive market share to the government-sponsored enterprises, Fannie Mae and Freddie Mac, as that duopoly’s government-guaranteed securitization replaced the balance sheets of thrifts for mortgage funding. By the late 1980s, one housing finance expert could write, “Mortgage-backed securities have forever blown apart thrift balance-sheet compartmentalization.”3

The decline of the special circuit was especially marked in the United States by the collapse of much of the thrift industry. There were failures by the hundreds. Between 1982 and 1992, 1,332 U.S. thrift institutions failed. That is on average 121 housing finance institution failures per year continuing over eleven years, or a rate of more than two failures per week for a decade.

The savings & loan industry as a whole became insolvent on a mark-to-market basis. The government’s deposit insurance fund for the savings & loans, the Federal Savings & Loan Insurance Corporation (FSLIC), itself became completely broke. In 1989, the same year IUBSSA was renamed IUHFI, all these failures resulted in a $150 billion U.S. taxpayer bailout under the emergency Financial Institutions Reform, Recovery and Enforcement Act. Expressed in inflation-adjusted 2022 dollars, that is a bailout of $350 billion.

This was a crisis indeed: the collapse of an entire housing finance structure of a special circuit promoted and guaranteed by the U.S. government. The thrifts had total assets of $796 billion in 1980, or $2.8 trillion in 2022 dollars.

Since the savings & loans had unwisely been required by the government to make primarily long-term fixed rate mortgage loans with their short term, variable rate deposits, when the Great Inflation of the 1970s resulted in double-digit interest rates—with 3-month Treasury bill rates reaching 15% in 1981—such a balance sheet was an obvious formula for disaster.

The savings & loans and other thrifts were, for example, financing assets yielding 6% with liabilities costing 10% or more, spilling an ocean of red ink. The savings & loan regulator of the time, the Federal Home Loan Bank Board (FHLBB), tried earnestly, frantically, and unsuccessfully to avoid the fate of the industry, but it was too late.

Thomas Vartanian, a General Counsel of the FHLBB during the 1980s crisis, looking back from 2021, reflected on the culpability of the government, which had promoted and tried to protect the thrifts, but ended up first trapping them and then charging the taxpayers for their losses.

“In this government-made economic biosphere,” Vartanian wrote, “Savings & loans generally had portfolios of thirty-year fixed-rate that they normally held to maturity. Variable rate mortgages were disfavored and actually prohibited under federal law until 1981”—that applied to federally-chartered savings & loans. “A few states did permit state-chartered savings & loans to make variable rate mortgages…but most savings & loans were compelled by law to do what no sane businessperson would ever advocate: borrow short…and lend long”—very long.

Vartanian concluded, perhaps not too diplomatically, “This financial gross negligence had been imposed on savings & loans by federal law.”4 Of course it was all imposed with good intentions and with cheering from housing interest groups.

By 2000, the more than five thousand thrift institutions had shrunk to 1,589, a nearly 70% attrition. By 2022, the total had been reduced to 602, 88% fewer than as the 1980s began.

This was a dramatic shift in industrial structure from the days of the great post-World War II American housing boom, when savings & loans were the most important mortgage lenders. In this golden age of the savings & loans, the American home ownership rate increased dramatically, from about 50% in 1944 to over 64% in 1980. Waving the banner of housing and home ownership, the savings and loans were politically potent. Their national trade association, the U.S. League for Savings, was a political lobbying force to be reckoned with.

They had their own government deposit insurance fund and their own governmentsponsored liquidity facility, the Federal Home Loan Banks.

The list of the 25 biggest savings & loans in America in 1983 contained many names famous in housing finance circles in those days. How many do you think still exist, thoughtful Reader? Make your guess before you read the answer.

The answer is that of these 25 formerly industryleading institutions, the number still existing as independent companies is zero. Of the 25, 17 failed or were acquired by institutions that later failed. The other eight were acquired and became just a part of much bigger commercial banks. These 25 formerly well-known names are unheard of now, a good lesson for the young in the fragility of institutions and a source of nostalgia, perhaps, for old housing finance veterans.5

The U.S. League for Savings no longer exists, having first changed its name to the Savings and Community Bankers of America, then to America’s Community Banks, then joining with the commercial banks by becoming part of the American Bankers Association.

The Federal Home Loan Bank Board was abolished by Congress and replaced by the Office of Thrift Supervision (OTS). The OTS was subsequently abolished, and its responsibilities moved to regulator of national commercial banks, the Comptroller of the Currency.

FSLIC was abolished by Congress and its deposit insurance fund first taken over by, and then merged into, the Federal Deposit Insurance Corporation, the guarantor of commercial bank deposits.

The Federal Home Loan Banks (FHLBs) remain large and active, but the thrifts, which used to represent all of the FHLB stockholding members, now are only 9% of the members, while commercial banks are 58%.

Lea and Diamond concluded that “Political and market forces seem to have eroded the reasons for having special circuits and the ability to maintain them.” In the U.S. savings & loan case, they certainly did.

Applying Volcker's Lessons

Published in Law & Liberty:

The year 2022 has certainly been a tough one for the Federal Reserve. The Fed missed the emergence of the runaway inflation it helped create and continued for far too long to pump up the housing bubble and other asset price inflation. It manipulated short- and long-term interest rates, keeping them too low for too long. Now, confronted with obviously unacceptable inflation, it is belatedly correcting its mistake, a necessity that is already imposing a lot of financial pain. 

Sharing the pain of millions of investors who bought assets at the bloated prices of the Everything Bubble, the Fed now has a giant mark-to-market loss on its own investments—this fair value loss is currently about $1 trillion, by my estimation. It is also facing imminent operating losses in its own profit and loss statement, as it is forced to finance fixed-rate investments with more and more expensive floating rate liabilities, just like the 1980s savings and loans of Paul Volcker’s days as Fed Chairman.

In short, the Fed, along with other members of the international central banking club, sowed the wind and is now reaping the whirlwind. Comparing the current situation with the travails of the Volcker years grows ever more essential.

Samuel Gregg, Alexander Salter, and Andrew Stuttaford have provided highly informed observations about the past and present, and offer provocative recommendations for the future of the “incredibly powerful” (as Gregg says) Federal Reserve—the purveyor of paper money not only to the United States, but also to the dollar-dominated world financial system. 

Stuttaford considers the issue of “Restoring the Fed’s Credibility?” with a highly appropriate question mark included. He points out that Volcker did achieve such a restoration of credibility and ended up bestriding “the [wide] world like a colossus,” although, we must remember, not without a lot of conflict, doubt, and personal attacks on him along the way.

But is it good for the Fed to have too much credibility? Is it good for people to believe that the Fed always knows what it is doing, when in fact it doesn’t—when it manifestly does not and cannot know how to “manage the economy” or what longer-run effects its actions will have and when? Is it good for financial actors to believe in the “Greenspan Put,” having faith that the Fed will always take over the risk and bail out big financial market mistakes? It strikes me that it would be better for people not to believe such things—for the Fed not to have at least that kind of “credibility.”

Stuttaford elegantly and correctly, as it seems to me, suggests that “the price of a fiat currency is—or more accurately, ought to be—eternal vigilance against inflation.” Such eternal vigilance requires that we should never simply trust in the Fed and poses the central question of who is to exercise the eternal vigilance.

It is often argued, especially by economists and central bankers, that central banks should be “independent,” thus presumably practicing by themselves the vigilance against inflation, making them something like economic philosopher-kings. Indeed, inside most macro-economists and central bankers there is a philosopher-king trying to get out. But the theory of philosopher-kings does not fit well with the theory of the American constitutional republic.

Those who support central bank independence always argue that elected politicians are permanently eager for cheap loans and printing up money to give to their constituents, so can be depended on to induce high inflation and cannot be trusted with monetary power. But if the central bank also cannot be trusted, what then? Suppose the central bank purely on its own commits itself to perpetual inflation—as the Fed has! Should that be binding on the country? I would say No. The U.S. Constitution clearly assigns to the Congress, to the elected representatives, to the politicians, the power “to coin money [and] regulate the value thereof.”

We are left wondering, as always, who will guard the guardians. There has been no easy answer to that question since Juvenal posed it to the ancient Romans.

Salter suggests we should follow this constitutional logic. “The Fed should have a single mandate,” he recommends, that of price stability, and “Congress should pick a concrete inflation target.” The Fed wouldn’t get to set its own target: “Since the Fed can’t make credible commitments with a self-adopted rule, the target’s content and enforcement must be the prerogative of the legislature, not the central bank.” In sum, “As long as we’re stuck with a central bank, we should give it an unambiguous mandate and watch it like a hawk. Monetary policymakers answer to the people’s representatives, in Congress assembled.” 

Along similar lines, I have previously recommended that Congress should form a Joint Committee on the Federal Reserve to become highly knowledgeable about and to oversee the Fed in a way the present Banking committees are not and cannot. I argued:

“The money question,” as fiery historical debates called it, profoundly affects everything else and can put everything else at risk. It is far too critical to be left to a governmental fiefdom of alleged philosopher-kings. Let us hope Congress can achieve a truly accountable Fed.

This still seems right to me. As I picture it, however, neither the Federal Reserve nor the Congress by itself would set an inflation target. Rather, on the original “inflation target” model as invented in New Zealand, the target would be a formal agreement between the central bank and the elected representatives. New Zealand’s original target was a range of zero to 2% inflation—a much better target than the Fed’s 2% forever. Since an enterprising, innovative economy naturally produces falling prices through productivity, we should provide for the possibility of such “good deflation.” Hence my suggested inflation target is a range of -1% to 1%, on average about the same target Alan Greenspan suggested when he was the Fed Chairman, of “Zero, properly measured.”

In his insightful history of the Fed, Bernard Shull considered how the Fed is functionally a “fourth branch” of the U.S. government. The idea is to put this additional branch and the Congress into an effective checks-and-balances relationship.

Among other things, this might improve the admission of mistakes and failures by the Fed, and thus improve learning. As Gregg observes, “Admitting mistakes is never something that policymakers are especially interested in doing, not least because it raises questions about who should be held accountable for errors.” And “central bankers do not believe that now is the time for engaging in retrospectives about where they made errors.” Of course they don’t.  But are you more or less credible if you never admit to making the mistakes you so obviously made?

Gregg is skeptical of the ability to control central banks by defined mandates, since we are always faced with “the ability of very smart people to find creative ways around the strictest laws (especially during crises).” The politicians, he points out, often want the central banks to use creative rationales for stretching and expanding their limits, and this is especially true during crises. As a striking example, “the European Central Bank has engaged in several bailouts of insolvent states and operated as a de facto transfer union.” But “governments…say as little as possible about such ECB interventions (and never question their legality),” and this “has everything to do with European governments wanting the ECB to engage in such activities.”

We are left wondering, as always, who will guard the guardians. There has been no easy answer to that question since Juvenal posed it to the ancient Romans.

Another Roman, Velleius Paterculus, expressed another fundamental central banking problem: “The most common beginning of disaster was a sense of security.” It is most dangerous when the public and the central bankers become convinced of the permanent success of the latest central banking fashion, especially, as Volcker pointed out in his autobiography, if that involves accommodating ever-increasing inflation.

We can conclude our review by stressing that the price of having fiat money is indeed eternal vigilance against inflation. But we don’t know very well how to carry out that vigilance and we can’t count on a new Volcker appearing in time to prevent the problems, or belatedly to address them, or appearing at all.