How the Fed’s actions after the financial crisis worsened inequality

There are many ways to assess the extent to which the Federal Reserve has exacerbated economic inequality. Some opinions lean towards controversy, even conspiracy, whereas I took a more analytical approach in my recent book, “Engine of Inequality”. Business journalist Christopher Leonard brings a unique perspective to this critical issue — focusing on the personal — in his new book, “Lords of Easy Money.”

Leonard’s book examines how the central bank’s quantitative easing policy after the financial crisis worsened economic inequality in the United States. It mainly focuses on Tom Hoenig, who was then president of the Federal Reserve Bank of Kansas City, opposing this monetary policy which injected billions into the economy and encouraged bankers and others to make riskier loans.

Leonard’s book is not only compelling reading, but also an important contribution to understanding what the Fed has done in the past two cataclysmic crises and why those who needed help the most got the worst. Admittedly, Leonard’s more personal approach unfortunately omits another important angle: the political. So we don’t know if Leonard’s great insights could also tell us what needs to be done in light of the revelations in this book to correct the economic inequalities in this country.

As with any tale based on the personal, “The Lords of Easy Money” draws on internal thoughts and scenes that Leonard could not have observed. The book opens with a compelling, but surely somewhat fictional, depiction of Hoenig waking up in a hotel room in Washington, D.C., getting dressed and presumably bobbed to prepare for the battle against quantitative easing in 2010.

As compelling as some of these details may be, it is not entirely clear that they add much to our understanding of the effects of Fed policy. Do you need to read about Hoenig’s youthful time working in his father’s plumbing business to appreciate the important insights he brought to the Federal Open Market Committee over the years?

Yet for all the cinematic effect, Leonard points to a vital and understated fact that led to Hoenig’s crusade. As Leonard rightly points out, the definition of money and its quantity were once dictated at least as much by political will as by the printing press of the Fed and the might of Wall Street. From now on, money is above all created by the central bank and no longer solely for the transmission of monetary policy. Instead, money circulates abundantly for the financial market and even the allocation of credit. Money is deployed in the trillions for purposes determined exclusively by every modern Fed Chairman’s belief in what he thinks is best, regardless of the consequences.

Leonard’s careful reading of years of FOMC minutes leads him to describe much of the Fed’s reasoning as “wishful thinking” that was remarkably wrong most of the time. Leonard is particularly sour when he points out that the Fed is revered for reining in inflation in the 1980s and for countering the crises of 2008 and 2020. But the central bank often somehow escapes a bad reputation for its market-transforming anti-equality political interventions. it didn’t even work.

Leonard is also scathing – with good reason – about the Fed’s actions after the 2008 financial crisis. He rightly acknowledges that the Fed overcompensated for its pre-2008 regulatory failings at the biggest banks with tough new rules to they. This unwittingly opened up new avenues for even riskier activities, such as leveraged lending, by larger non-banks. These turned the inevitable macroeconomic shock of the pandemic into a firestorm in financial markets.

“The Lords of Easy Money” also provides important and unprecedented insight into the 2019 buyout market crisis, a massive Fed intervention that Leonard aptly calls the “invisible bailout.” No one has yet shown so clearly how the Fed’s easy money has flooded the financial markets so much that even spectacularly leveraged basic trading by the world’s hedge funds has become a risk-free proposition. This market bailout of more than $400 billion was described by Federal Reserve Chairman Jay Powell as simply “maintaining the balance sheet.” Leonard blames Powell and the central bank for bailing out the markets just as they were beginning to self-correct.

Financial crises are, of course, disastrous, but market intervention at the first sign of trouble turns the Fed into a lender and market maker of first resort, and the global financial system into a morally dangerous playground that profits to those who are ready to make the most of it. odds.

Where Leonard goes astray is in his praise not only for Hoenig’s prescient opposition to quantitative easing, but also for his crusade at the Federal Deposit Insurance Corp. to reinstate the leverage ratio as the largest bank’s binding capital constraint. Opposition to this was not only based on banks’ desire to have the least restrictive capital regime, but also on the recognition that the higher a simple capital ratio increases, the greater the unintended consequences. Even with a lower leverage ratio than Hoenig wanted, the sum total of the post-2010 rules redefined banking into a fee-based, commercial and wealth management business that gutted mass financial intermediation even as it enabled the rapid rise of the market of “ghost” banks devoid of even the slightest touch of capital.

Asymmetric rules for companies in the same sector lead to aggressive regulatory arbitrage and experience proves it. In his fight for a leveraged capital standard, Hoenig was stubborn, principled, and determined, but that didn’t prove him right.

It’s clear that Hoenig ran valiant campaigns — some good, some bad — that led him to make some of the most important financial policy decisions of the past 40 years. Leonard’s narration takes us through the years in which the middle class in America was hollowed out. Many things have caused this radical transformation of America from a land of opportunity to a land of creeping opportunism.

The Fed is not the only cause, nor necessarily the most important. However, he played a major, albeit unintended, role in creating an economy that works for the few in a country that most Americans now believe is heading in the wrong direction. Leonard’s book helps us hold the Fed to account and for that it is an important contribution.

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