On the Hidden Fight Inside the Federal Reserve That Reshaped American Economic Life
Christopher Leonard on the 2010 Policy That Widened the Gulf Between Rich and Poor
Thomas Hoenig woke up early on November 3, 2010, knowing what he had to do that day, and also knowing that he was almost certainly going to fail. He was going to cast a vote, and he was going to vote no. He was going to dissent, and he knew that this dissent would probably define his legacy. Hoenig was trying to stop something: A public policy that he believed could very well turn into a catastrophe. He believed it was his duty to do so.
But the wheels were already turning to make this policy a reality, and the wheels were far more powerful than he was. The wheels were powered by the big banks on Wall Street, the stock market, and the leadership of America’s Federal Reserve Bank. Everyone knew that Hoenig was going to lose that day, but he was going to vote no anyway. Hoenig was 64 years old, and he was the president of the Federal Reserve Bank of Kansas City, a position that gave him extraordinary power over America’s economic affairs. He was in Washington that morning because he sat on the Federal Reserve’s powerful policy-making committee, which met every six weeks to effectively determine the value and quantity of American money. Most people in America don’t think very much about money—meaning the actual currency, or that thing we call a dollar.
The word dollar is, in fact, just a slang term for American currency, which is actually called a Federal Reserve Note. People spend Federal Reserve Notes every day (if they’re lucky enough to have them), but they rarely think about the complex, largely invisible system that makes money appear out of thin air. This system is the US Federal Reserve System. The Fed, America’s central bank, is the only institution on Earth that can create US dollars at will.
Because he was a senior official at the Federal Reserve, Thomas Hoenig had to think about money all the time. He thought about it in the same way that a very stressed-out building superintendent might think about plumbing and heating. Hoenig had to think about money as a system to be managed, and to be managed just right. When you ran the system that created money, you had to do your job carefully, with prudence and integrity, or else terrible things might happen. The building might flood or catch on fire.For a year now, Hoenig had been voting no. If you tallied his votes during 2010, the tally would read: no, no, no, no, no, and no.
This is why Hoenig felt so much pressure when he woke up that November morning in Washington, DC. He was staying at a very nice hotel, called the Fairmont, where he always stayed when he traveled from his home in Kansas City to the nation’s capital. Hoenig was in town for the regular meeting of the Federal Open Market Committee, or FOMC for short. When the committee met in Washington, its members voted and set the course of the Fed’s actions. There were 12 members on the committee, which was run by the powerful chairman of the Federal Reserve.
For a year now, Hoenig had been voting no. If you tallied his votes during 2010, the tally would read: no, no, no, no, no, and no. His dissents had become expected, but they were also startling if you considered Tom Hoenig’s character. He wasn’t, by nature, anything close to a dissident. He was a rule-follower. He was born and raised in a small town, where he started working at the family plumbing shop before he was ten years old. He served as an artilleryman in Vietnam, and when he came home he didn’t protest against the war. Instead, he studied economics and banking at Iowa State, earning a PhD. His first job out of school was as an economist with the Federal Reserve regional bank in Kansas City, in the supervision department. At the Fed, he went from being a rule-follower to being a rule-enforcer.
Hoenig rose through the ranks to became president of the Kansas City Fed in 1991. This was the job he still held in 2010. His responsibilities as one of 12 regional Fed bank presidents illuminate the structure of America’s money system. The Federal Reserve system is unlike any other in the world; it is a crazy genetic mashup of different animals, part private bank and part government agency. People talk about the Fed as if it were a bank, but it is really a network of regional banks, all controlled by a central office in Washington, DC. Hoenig had all the fiery disposition that one might expect from a regional Fed president, which is to say none at all. He was soft-spoken, civil, wore cufflinks and pin-striped suits, and spent his days talking about things like capital requirements and interest rates. Hoenig was an institutionalist, and a conservative in the little “c” sense of the word.
And yet here he was, in late 2010, a dissident.
After he woke up in his hotel room, Hoenig had some time alone before the big day started. He gathered his thoughts. He shaved, put on a suit, knotted his tie, and gathered his papers. If he had any doubts about what he was going to do that day, he didn’t advertise them. He had spent months, years, even decades preparing for this action. His vote would reflect everything he’d learned during his career at the Fed. He was trying to apply what he knew to help the Federal Reserve navigate through extraordinary times.
The American financial system had broken in late 2008, after the investment bank Lehman Brothers collapsed. That moment marked a threshold for people like Tom Hoenig. Economists and central bankers describe the ensuing panic as the Global Financial Crisis, eventually bestowing the moment with its own biblical label, the GFC. The world of central banking was neatly divided into two eras. There was the world pre-GFC and the world post-GFC. The GFC itself was apocalyptic. The entire financial system experienced a total collapse that risked creating another Great Depression. This would mean years of record-high unemployment, economic misery, political volatility, and the bankruptcy of countless companies.
The crisis prompted the Federal Reserve to do things it had never done before. The Fed’s one superpower is its ability to create new dollars and pump them into the banking system. It used this power in unprecedented ways after Lehman’s collapse. So many of the financial charts that capture the Fed’s actions during this period look like the same chart—a flat line that bounces along in a stable range for many years, which then spikes upward like a reverse lightning bolt. The upward spikes capture the unprecedented amount of money the Fed created to combat the crisis. Between 1913 and 2008, the Fed gradually increased the money supply from about $5 billion to $847 billion. This increase in the monetary base happened slowly, in a gently uprising slope.
Then, between late 2008 and early 2010, the Fed printed $1.2 trillion. It printed a hundred years’ worth of money, in other words, in little more than a year, more than doubling what economists call the monetary base. There was one very important characteristic of all this new money. The Fed can create currency in just one way: it makes new dollars and deposits them in the vaults of big banks. Only about 24 special banks and financial institutions have the privilege of getting these pristine dollars, making those banks the seedbed of the money supply. The amount of excess money in the banking system swelled from $200 billion in 2008 to $1.2 trillion in 2010, an increase of 52,000 percent.The Fed had created a new foundation for the American financial system, built on extraordinary amounts of new money.
In doing all of this, the Fed had created a new foundation for the American financial system, built on extraordinary amounts of new money. Hoenig had a chance to watch firsthand as this system was created because he sat on the very committee that created it, the FOMC. In the beginning, during the crisis years of 2008 and 2009, he had voted to go along with the extraordinary efforts.
The dispute that Hoenig was preparing for, on that morning of November 3, 2010, was about what the Fed would do now that the days of crisis were over. A difficult and slow recovery was just beginning, and it was one of the most important moments in American economic history. It was the moment when one phase of economic conditions was ending and giving way to the next. The Fed had to decide what the new world was going to look like, and Hoenig was increasingly distressed by the path the Fed was choosing.
It is commonly reported that the FOMC meets every six weeks to “set interest rates.” What this means is that the Fed determines the price of very short-term loans, a number that eventually bleeds out into the entire economic system and has an effect on every company, worker, and household. The basic system works like this: When the Fed raises interest rates, it slows the economy. When the Fed lowers interest rates, it speeds up the economy. The FOMC, then, is like a group of engineers in the control room of a nuclear power plant. They heat up the reactor, by cutting rates, when more power is needed. And they cool down the reactor, by raising rates, when conditions are getting too hot.
One of the most important things the Fed did during the Global Financial Crisis was to slash the interest rate to zero, essentially for the first time in history (rates had briefly flirted with zero in the early 1960s). Economists called the 0 percent interest rate the “zero bound,” and it was once seen as some kind of inviolable boundary. You couldn’t go below zero, it was believed. The rate of interest is really just the price of money. When interest rates are high, money is expensive because you have to pay more to borrow it. When rates are low, money is cheap. When rates are zero, money is effectively free for the banks who can get it straight from the Fed. The cost of money can’t get lower than zero, economists believed, so the zero bound reflected the limits of the Fed’s power to control interest rates. The Fed hit the zero bound shortly after Lehman Brothers collapsed, but the more important thing is what happened next. After hitting zero, the Fed didn’t try to lift rates again. The Fed even started telling everyone very clearly that it wasn’t going to try to lift rates. This gave the banks confidence to keep lending in a free-money environment—the banks knew that life at the zero bound was going to last for a while.No single policy did more to widen the divide between the rich and the poor.
But by 2010, the FOMC faced a terrible dilemma. Keeping interest rates pegged at zero didn’t seem to be enough. The economy had revived but remained in terrible health. The unemployment rate was still 9.6 percent, close to the levels that characterize a deep recession. The people who ran the FOMC knew that the effects of high and sustained unemployment were horrific. When people are out of a job for a long time, they lose their skills and they lose hope. They get left behind, compounding the economic damage of having been laid off in the first place. Even the kids of people who lose their jobs suffered a long-term drop in their earning potential. There was an urgency, inside the Fed, to stop this process. There was also the risk that the economic rebound might stall altogether.
That is why the committee began considering ways to break past the zero bound in 2010. The Fed’s leadership was going to vote in November on a radical experiment, one that would effectively take interest rates negative for the first time, pushing yet more money into the banking system and shifting the Fed to the very center of American efforts to boost economic growth. No one knew what the world might look like after that. The experimental program had, like all things at the modern Fed, a name that was intentionally opaque and therefore difficult for people to understand, let alone care about.
The plan was called “quantitative easing.” If the program was enacted, it would reshape the American financial system. It would redefine the Federal Reserve’s role in economic affairs. And it would make all of the things that Hoenig had been voting against look quaint. He was planning to vote against quantitative easing, and his dissent was going to be a lonely one. There was a tense debate inside the FOMC about quantitative easing, but the public barely knew about it. Political fights over America’s money supply had become increasingly insular, even hidden, as they were decided by the Fed’s leaders.
As it turned out, Hoenig was almost entirely correct in his concerns and his predictions. Perhaps no single government policy did more to reshape American economic life than the policy the Fed began to execute on that November day, and no single policy did more to widen the divide between the rich and the poor. Understanding what the Fed did in November 2010 is the key to understanding the very strange economic decade that followed, when asset prices soared, the stock market boomed, and the American middle class fell further behind.
Excerpted from The Lords of Easy Money: How the Federal Reserve Broke the American Economy. Used with the permission of the publisher, Simon & Schuster. Copyright © 2022 by Christopher Leonard.