[ProPublica’s Jesse Eisinger interviews law professor Lev Menand
about his new book critiquing the role of the Federal Reserve.]
[[link removed]]

THE FED KEEPS GETTING MORE POWERFUL. IS IT BAD FOR AMERICA?  
[[link removed]]


 

Jesse Eisinger
August 5, 2022
ProPublica
[[link removed]]

*
[[link removed]]
*
[[link removed]]
*
*
[[link removed]]

_ ProPublica’s Jesse Eisinger interviews law professor Lev Menand
about his new book critiquing the role of the Federal Reserve. _

Lev Menand, Courtesy of Columbia Law School

 

_ProPublica is a Pulitzer Prize-winning investigative newsroom. Sign
up for The Big Story newsletter
[[link removed]]
to receive stories like this one in your inbox_.

Law professor Lev Menand has a new book out on that strange
institution, the Federal Reserve, what it does and how its power and
responsibility have grown over time.

Menand is an associate professor at Columbia Law School specializing
in finance and regulation. Before he joined the law school, he held
various roles at the Treasury Department during the Obama
administration and was an economist at the Federal Reserve Bank of New
York, helping to oversee large lenders.

I recently sat down with him to discuss the Fed, the economy, the
capital markets, whether we are facing another financial crisis and
why he thinks the Fed is bad for our economy and our democracy.

This conversation has been edited for length and clarity.

Thanks very much for joining me. Can you summarize the thesis of your
book, “The Fed Unbound: Central Banking in a Time of Crisis”?

The Federal Reserve is an organization created by Congress for a
limited, very important purpose to do a difficult job, which is to
manage the U.S. money supply.

When you log on to a Bank of America or Citigroup account and you see
a balance there, that’s the money that the Fed is managing. Those
are not the same thing as green pieces of paper. And the Fed’s job
is to ensure that you treat them the same, that you think of them the
same. And that the amount of those Bank of America bucks is growing at
a rate that is appropriate for the economy to put all of its resources
to work, including all of its people.

The thesis of the book is that monetary liberalization, deregulation
of the banking system and a lot of choices made during the second half
of the 20th century caused the Fed to become “unbound.” Basically,
what you have is the rise of a “shadow banking” system. All these
financial companies that aren’t under the Fed’s purview, they
start creating money. The Fed doesn’t have the tools to manage them,
and then they run into problems during economic downturns, and the Fed
pulls out all the stops and tries to backstop them — bail them out.

That’s the 2008 financial crisis. And that fundamental dynamic is
still with us.

Essentially what you’re saying is that this institution, which is
about 100 years old, the Federal Reserve, was created to manage money
so that when there was a financial crisis, the Fed would come in and
lend to them and cushion that blow. But over time, the Fed’s mandate
had grown and its power had grown and we’re trying to figure out why
that happened and whether that’s a good thing or a bad thing. Is
that fair enough?

Fair enough.

Following the Great Depression, the Fed was very successful. We
didn’t have intermittent banking panics. Every time there was a
recession, people didn’t run on banks. We thought that we had solved
monetary instability and financial crises until 2008. And what was
2008? It was a run on shadow banks. A whole group of financial
institutions had come along and started to do what banks do. They
started to create deposits of their own called different things. And
they were exposed to the same run dynamics that you saw in the 19th
century before the Fed was created. And the Fed decided if we don’t
come in and backstop this system, it will collapse. But it was never
expected that this would be how the Fed [acted]. The Fed was not
designed to stabilize the shadow banking system.

Let’s just back up. You’ve given a preliminary definition of
shadow banking, but walk us through it. These are not bank deposits
that are backstopped by the federal government, by the Federal Deposit
Insurance Corp. Give us a really simple example. A money market fund
is part of the shadow banking system, right? So it’s not like it’s
an obscure financial system for the elite. Most middle-class Americans
touch the shadow banking system.

Yeah. So there are three major types of shadow banking that I talk
about in the book. You mentioned one, that’s the one that ordinary
Americans are most likely to have encountered. The other types are
primarily wholesalers for businesses, not ordinary individuals, but
basically what they all have in common is they are non-bank firms that
do not have a bank charter that are trying to reproduce the bank
business model. The Fed doesn’t have the same set of tools to ensure
that the money market fund [and other shadow bank institutions
aren’t] taking too many risks.

The shadow banking system is huge, right?

In 2007, which was the peak of the shadow banking system, a peak we
will eventually return to if further reforms are not made, it’s
estimated that there were about $15 trillion of shadow bank-issued
money instruments against $7 or $8 trillion of bank deposits and less
than $1 trillion of government-issued cash.

In the aftermath, the shadow banking system got a lot smaller because
we had a lot of major shadow banks fail like Lehman Brothers. And then
over the last 10 to 15 years, it has grown again.

So now we’re back where the banking system is much bigger. There’s
$18 trillion of deposits. And the shadow banking system is probably
around the same size, maybe slightly smaller. It’s very hard to
estimate the size, well, because it’s in the shadows.

You say that this is in the shadows, which is another way of saying
it’s not fully regulated. So we had a financial crisis in 2008. You
write that they essentially have two failures coming out of this. One
is to not recognize the true nature of the crisis. They think of it as
a 100-year flood rather than a fundamental aspect of structural
fragility. And then the second thing is that we pass a sweeping
financial reform, the Dodd-Frank act, that touches every corner of the
financial system and yet is, I think your view would be, woefully
inadequate. What does the Fed do right? What does the Fed do wrong?

So a stable and, in fact, growing money supply is an absolutely
critical precondition for the sorts of economies that we live in
today. If the money supply shrinks rapidly, our entire economic
structure falls apart. People owe each other money. And if the amount
of money in circulation starts to shrink rapidly, because the entities
that have issued it are failing, then debtors can’t pay back their
debts and they start defaulting. That turns into a vicious cycle.

You can think of the failure of banks a bit like the failure of power
plants. If the Long Island Power Authority just shut down and stopped
working, it would be very hard for any business on Long Island to
continue to produce goods and services. The Fed and Congress
ultimately stepped in to bail out and prevent the further collapse of
this grid. Now that was necessary, otherwise we would have ended up in
a great depression of the same scale or probably a larger, worse
depression than in the ’30s.

So the Fed’s hand in 2008 was more or less forced. If we wanted to
continue to operate this economy, we were held hostage by the players
that were providing the infrastructure upon which the economy was
operating. Where things went wrong was a failure to grapple with the
deep problems with continuing to have an economy in which the public
and households and businesses are at the mercy of unregulated power
plants that are able to basically profit off economic activity during
good times, and then hold the entire society as it were hostage for
public support during bad times. We ended up making some changes but
not addressing that fundamental problem.

Today we continue to have a dynamic where a very large financial
sector is profiting off implicit and explicit public backstops and is
fundamentally fragile in its design.

The pandemic was exactly such a shock. The lesson that the Fed learned
from 2008 was to offer even more public support for the financial
sector, even faster. And in one respect that was successful. But the
dynamics of that, the implications for all of the rest of us of having
this government agency making $3 trillion available for a bunch of
financial firms that aren’t operating in the public interest, this
is deeply troubling. It’s a dynamic that will eventually lead to
either the failure of our democracy or the failure of our economy.

A dynamic leading to a failure of our democracy seems pretty dire and
significant. I want to obviously explore that in a second and explore
the implications of this, the quiet crash, the silent crash of March
2020. In some ways the Fed never stops bailing out the economy
throughout that period from late 2008 through to March of 2020.

I do think in critical respects, we are still living in a 2008
financial crisis world. The acute phase of that crisis ended in early
2009, but we have not recovered from the damage.

The last 15 years are characterized by anemic growth, worsening
inequality that is in part a byproduct of the Fed’s effort to juice
economic growth, which disproportionately enriches asset owners. [We
have] a financial sector that is not investing in expanding the
productivity of the American economy.

We didn’t actually use this period to invest in expanding capacity.
And we continue to have a financial system that is fragile.

By the time 2009 comes around, you have a financial system that is
very weakened. Fed officials launch a program called quantitative
easing. That’s initially targeted at the housing market. And so they
go and buy hundreds of billions of dollars of mortgage-backed
securities.

“Quantitative easing” is this wonky phrase, but there are two
things about it. One is the Fed is buying securities and it didn’t
used to do that; it used to just move short-term interest rates up and
down. And then the second thing is it’s buying assets to help
certain sectors of the economy. It’s a dramatic change that’s
happening here with the Fed, right?

Yeah. Look, the Fed is operationally a bank. It’s supposed to be a
bank just for banks. And it’s generally the way that it operated
from the Second World War up to the 2008 crisis was to adjust the
constraints on bank balance sheets.

Then there are subsequent rounds of QE where the Fed buys Treasury
securities, the federal government’s debt, in an effort to bring
down longer-term interest rates in the economy and further juice
economic activity. So there’s not sufficient fiscal stimulus and the
economy is coming back very slowly. And the Fed has moved its interest
rates down to zero so that the banks can expand their balance sheets,
but they’re not expanding their balance sheets at a rate sufficient
to allow the economy to rebound.

The mechanism by which QE works is to increase asset prices. So you
have a booming stock market, a booming government debt market, a
booming housing market, even though you have an economy, an underlying
economy that is still weaker than it was before the 2008 crisis.

It’s a troubling way in my view to do economic policy. It might be
the ninth-best approach. It’s making one group of people who are
already very well off even more well off. It is a very unhealthy place
for society to be.

My friend, Chris Leonard, has written a book called “The Lords of
Easy Money” about how the Federal Reserve “broke the economy.”
Here in this interregnum between crises, what you’re saying is that
the Fed was flooding the markets with purchasing power that was
stimulating the asset markets and it was flowing to the wealthiest
people, asset holders already. And we got something that looked like
bubbles too, right? We get the crypto markets, we get NFTs, we get
SPACs. The Fed in some ways is trapped into this because governments
around the world are not spending wisely. They’re not helping the
Fed out. They’re not helping the economy. In fact, they’re
counterproductive. They’re embracing austerity.

Yeah. The failure of the fiscal authorities of legislatures in the
United States and also in Europe to address economic weakness is a
source of the pressure and the motivation on the Fed to experiment
with massive asset purchases as an alternative approach to avoiding an
even weaker economy.

We need to recognize this was a very bad policy mix that we ended up
in, to inject huge amounts of liquidity into the financial system as
opposed to, say, writing people checks or helping keep people in their
homes or investing in infrastructure the way that Chinese government
does.

There’s so many other ways to manage economic weakness. But if your
approach is not to do any of those things and actually to restrict the
amount of money available to governments and state and local
governments to spend, and to cause layoffs of public-sector
employment, if you’re not going to do any of those things and you
just want to flush the financial system full of liquidity, one of the
problems you’re going to have is that you’re going to get bubbles
in financial markets.

So let’s go back to March of 2020. It’s poorly understood. Because
in some ways the government and the Fed have learned from this
critique that you’re leveling. The Fed does a bunch of things it had
never done before, even in the financial crisis of 2008.

Yeah. In part the lesson they took from 2008 was never let things get
so bad that we have a failure of a major firm like Lehman Brothers,
because that’s a disaster. And so when things started to deteriorate
in March of 2020, when there was just a run on the shadow banking
system, just like there was in 2008, the Fed stepped in quickly.

It expanded its own balance sheet enormously, very rapidly. It
didn’t do anything like this in 2008. This was a shock-and-awe
approach to suggest to anybody running on a shadow bank that there was
no need to run, that the Fed could take all the assets onto its own
balance sheet, that there wasn’t going to be a repeat of Lehman
Brothers.

With some encouragement from Congress, it also sets up facilities to
lend to ordinary businesses and to state and local governments. But
the actual dynamic, when you look at it carefully, is they’re
getting breadcrumbs and these additional programs are helping to
legitimize the much, much larger and fundamentally problematic lending
programs for the financial sector.

Our politics are calcified. Our political system is subject to
numerous veto points. The Fed in contrast is a committee run by one
guy, Jerome Powell. A defender of the Fed would say: “Look, they can
act very quickly. Yes, it goes through the financial system, which
helps financiers and asset holders and the wealthy disproportionately,
but eventually it trickles down and saves the economy. Your criticism
really is with the political system, not the Federal Reserve.”

There is this dynamic in which the more the Federal Reserve tries to
use its financial system-based tools to respond to economic problems,
the more pressure it takes off the political system to produce
legislative solutions that are more egalitarian and more effective at
solving these same problems. A key predicate of this is our democracy
doesn’t work, that our politics don’t work, that fundamentally
legislators can’t make good policy, that we need to rely on a couple
of unelected technocratic experts to make policy that most Americans
don’t understand that benefits the financial sector
disproportionately, and that’s the best we can do as a society and a
polity.

I reject the idea that’s the best we can do.

We are dooming ourselves to very bad dynamics over time, a declining
economy really, and potentially a declining society. To reinvigorate
our economy and our society, we have to move beyond our reliance on
central bank medicine and to revive a meaningful economic, legislative
agenda and politics. And one thing that’s encouraging in this regard
is that the last couple of years you’ve seen some of that. You’ve
seen the legislature act in ways that it did not act between 2008 and
2020, reflecting some sense that mistakes were made during that
period.

Now we have a very interesting and troubling period because we have
the Fed confronting something much more traditional. We have an
overheated economy. What do you think about the Fed’s job right now?
Is the Fed doing the right thing? Is this a product of the shadow
banking systems frailty or is this completely separate?

I think it’s important to recognize that the current inflationary
dynamic is primarily a supply-side shock. The pandemic just scrambled
the normal patterns of demand for goods and services, and we ended up
with shortages in certain important goods and services, which caused
prices to rise.

Then we have spiking commodity and energy prices due to geopolitical
conflict and also due to the pandemic in various ways. The driving
factors of this inflationary dynamic are not loose financial
conditions.

Here again, we stand the risk of over-relying on the Fed to solve a
set of problems that require action by the government through a
variety of other tools. So it’s certainly the case that some amount
of interest rate hiking is necessary. Interest rates were too low and
should be hiked. But the big question is should they continue to be
hiked to the point where they choke off the whole overall economy, to
shrink the overall economy so that it can match up in size with the
amount of oil and natural gas that’s currently being produced and
the amount of key goods and services that are coming through our
supply chains?

We don’t need the Fed to tighten to such an extent that it induces a
recession. Instead, we need other government policies targeted at
supplying more of the goods and services that are experiencing this
shock. It would be very unfortunate if because of the high price of
oil and gas, we cause people to lose jobs all across the economy.

I am cautiously optimistic that policymakers understand this now
better than they have. We will be better off tolerating some amount of
inflation for some period of time while the economy adjusts to an
enormous shock rather than overreacting and trying to eliminate that
inflation by creating a certainty of high unemployment and a bad
investment outlook and climate for the economy going forward.

It’s so frustrating. The Fed functions through the financial system
disproportionately helping the wealthy. It creates asset bubbles all
throughout the economy. It then starts to tighten. And in doing so, it
disincentivizes companies from investing and growing while courting a
recession that will throw millions of average people out of work after
those millions of average people have only barely begun to benefit
from a decade of loose financial conditions by having their wages
grow.

Let me just add one more piece that will really make your head
explode. There’s a very good chance that to the extent the Fed
follows through on aggressive tightening in the coming months, that it
leads to financial instability. And so at the same time, as you have
the Fed pursuing policies that push up unemployment, weaken the labor
market and reduce business investment, the Fed may well find itself
standing up all of its emergency facilities again to support the
shadow banking system.

Essentially because they created bubbles and now…

The shock of removing them, yes, is going to cause a run dynamic in
the shadow banking system. It could happen at any point really.

Well, that was where I was going to end this conversation, which is:
Do you think we’re headed for another financial crisis? Because the
fundamental fragility of the economy — the shadow banking system —
has not been dealt with, and you have a Fed that is using these very
blunt tools.

I think it’s entirely possible. Part of the problem we have is
it’s very hard for officials or academic observers and even market
participants to have a handle on the balance sheet strength of
financial institutions that fund themselves in the [shadow banking
system]. And so it’s difficult to anticipate when a run might
happen.

The Fed needs to be very cautious. It’s not actually dealing with a
financial system that can necessarily go to that speed and absorb that
shock. We’re in a very uncertain and risky time from an economic and
financial perspective right now. Everybody should be on high alert and
people should demand that their Congress try to tackle these issues
and think about these problems, because it’ll be much better to
start moderating now than to wait for another big crash, to put in
place safeguards and structures that are necessary for a healthy
economy and flourishing society going forward.

_Jesse Eisinger is a senior editor and reporter at ProPublica. He is
the author of the “The Chickenshit Club: Why the Justice Department
Fails to Prosecute Executives
[[link removed]].”_

_In April 2011, he and a colleague won the Pulitzer Prize for
National Reporting
[[link removed]] for a
series of stories on questionable Wall Street practices
[[link removed]] that
helped make the financial crisis the worst since the Great Depression.
He won the 2015 Gerald Loeb Award for commentary
[[link removed]].
He has also twice been a finalist
[[link removed]] for the
Goldsmith Prize for Investigative Reporting._

_He serves on the advisory board of the University of California,
Berkeley’s Financial Fraud Institute. And he was a consultant on
season three of the HBO series “Succession.”_

_He was a regular columnist for The New York Times’s Dealbook
section. His work has appeared in The New York Times, The Atlantic,
NewYorker.com, The Washington Post, The Baffler, The American Prospect
and on NPR and “This American Life.” Before joining ProPublica, he
was the Wall Street Editor of Conde Nast Portfolio and a columnist for
the Wall Street Journal, covering markets and finance._

_He lives in Brooklyn with his wife, the journalist Sarah Ellison, and
their daughters._

* _ [email protected]_
*  
* _ @eisingerj [[link removed]]_
*  
* _ Signal: 718-496-5233_
*
_ProPublica:- - Our mission: To expose abuses of power and betrayals
of the public trust by government, business, and other institutions,
using the moral force of investigative journalism to spur reform
through the sustained spotlighting of wrongdoing._

_ProPublica is an independent, nonprofit newsroom that produces
investigative journalism with moral force. We dig deep into important
issues, shining a light on abuses of power and betrayals of public
trust — and we stick with those issues as long as it takes to hold
power to account._

_With a team of more than 100 dedicated journalists, ProPublica covers
a range of topics including government and politics, business,
criminal justice, the environment, education, health care,
immigration, and technology. We focus on stories with the potential
to spur real-world impact [[link removed]]. Among
other positive changes, our reporting has contributed to the passage
of new laws; reversals of harmful policies and practices; and
accountability for leaders at local, state and national levels._

_Investigative journalism requires a great deal of time and resources,
and many newsrooms can no longer afford to take on this kind of
deep-dive reporting. As a nonprofit, ProPublica’s work is powered
primarily through donations. The vast bulk of the money we spend goes
directly into world-class, award-winning journalism
[[link removed]]. We are committed to uncovering
the truth, no matter how long it takes or how much it costs, and we
practice transparent financial reporting
[[link removed]] so donors know how their dollars
are spent._

_ProPublica was founded in 2007-2008 with the belief that
investigative journalism is critical to our democracy. Our staff
[[link removed]] remains dedicated to carrying
forward the important work of exposing corruption, informing the
public about complex issues, and using the power of investigative
journalism to spur reform._

* federal reserve
[[link removed]]
* banking
[[link removed]]
* big banks
[[link removed]]
* Financial Crisis
[[link removed]]
* Markets
[[link removed]]
* U.S. economy
[[link removed]]
* money
[[link removed]]

*
[[link removed]]
*
[[link removed]]
*
*
[[link removed]]

 

 

 

INTERPRET THE WORLD AND CHANGE IT

 

 

Submit via web
[[link removed]]

Submit via email
Frequently asked questions
[[link removed]]

Manage subscription
[[link removed]]

Visit xxxxxx.org
[[link removed]]

Twitter [[link removed]]

Facebook [[link removed]]

 




[link removed]

To unsubscribe, click the following link:
[link removed]