Welcome to our Friday mailbag edition!
Every week, you send us great questions. And every Friday, I answer as many as I can.
This week, the Federal Reserve is top of mind for readers.
Up first, reader Rainer M. continues the conversation around Ben Bernanke, the former Fed chair who just won the Nobel Prize…
The Fed has a mandate from Congress since the late 1970s to keep the economy going. Since such a mandate is contrary to the way the world really works, the only way the Fed can keep the economy going for a really long time is to keep pumping ever more money into it.
That is what the Fed has been doing. Nomi Prins talks about “reckless monetary policy. And for that, we can thank Alan Greenspan, Bernanke’s predecessor at the Fed.”
The reason Alan Greenspan was doing it was because of the law passed by Congress years earlier. It really is that simple.
When one is trying to keep an economy going forever, it becomes necessary to do exactly what they’ve been doing. The problem is that it leads to ever greater extremes. Extremes that Nomi has pointed out.
The problem is that the extremes are inevitable. And in the context of the continued enforcement of the mandate that the Fed has from Congress for full employment at low inflation, the extremes will just keep getting worse over the course of time until they can’t be sustained anymore.
And then there is going to be a really big problem. I think we are actually really quite close to that point in the big picture.
– Rainer M.
Hi Rainer, thank you very much for your comments.
Yes, the Fed’s dual mandate, as it was required by Congress in 1977, was to ensure full employment and price stability. That’s been its official dual mandate ever since.
But there’s also a wide range of interpretation for that in terms of what the Federal Reserve can or should do.
I find it hard to believe that, back then, Congress thought the Fed would eventually fabricate trillions of dollars in order to adhere to that dual mandate.
Now, Alan Greenspan reduced rates to 1.5% in the early 2000s. This allowed for extreme borrowing at low rates throughout the corporate market, and Wall Street.
As a result, Wall Street wanted to find ways to squeeze more interest out of people. And that’s the real reason the subprime mortgage market took off.
This did not help the real economy.
We have been taught to believe that, since the Fed’s mandate is to help the economy, whatever the Fed does goes to that goal.
But the markets receive much more of the cheap money the Fed fabricates than the real economy does.
I discuss this at great length in my new book, Permanent Distortion. (If you missed my sneak preview in these pages, catch up here.)
But the Fed can’t really control employment or inflation, caused by things like supply chain disruptions, geopolitical tensions, or trade wars.
What they can do is create trillions of dollars in a manner which is not capped by Congress, when they deem there to be a crisis that warrants this.
So I agree with you. The reaction to any major crisis will be to print money.
And the periods in between those major bouts of printing will be inherently less and less stable.
That’s because of the market’s reliance on this money manufactured by the Fed, rather than on real economic growth.
Creating so much money – the lion’s share of which flows into markets and financial assets – leads to distortion between the markets and the economy.
This is what the Fed is doing, especially since the financial crisis of 2008 and the pandemic-induced crisis of 2020.
And that brings us to our next question. Reader Gino B. doubts whether we can trust the Fed…
Absolutely agree with Nomi. Bernanke did nothing to avoid the crisis that Greenspan and Clinton initiated before him.
Bernanke was also well aware of what Clinton’s policy of “everyone gets a mortgage no matter what” was doing to the housing market and how banks were packaging these loans into AAA assets.
Now what I would like to know is how can we trust the Federal Reserve when it is owned and run by the very banks it is supposed to control? It looks more like a syndicate to me. Great work, Nomi.
– Gino B.
Hi Gino, thank you so much for your comments.
Yes, it’s true that Bernanke would have been aware of the Clinton administration’s policy regarding lending to those who could not otherwise afford lower interest rate mortgages.
And banks certainly were able to buy and repackage many of those mortgages.
Plus, rating agencies bestowed a mark of “AAA,” or ultra-high-quality, on the new assets that were created from them.
There were so many problems in the financial system that compounded and magnified the risk of those mortgages.
It remains astonishing to me that the Fed did not acknowledge or perhaps, care, about the major mess being made on Wall Street.
But that gets us to your question of whether or not we can trust the Fed when it is owned and run by the banks it’s supposed to regulate.
Banks do own shares in the Fed. The CEOs of banks are also able to access leaders of the Fed and Treasury Department, in ways we mere mortals cannot.
This is why I believe we must scrutinize the Fed’s actions and interactions much more than we are.
I don’t trust their motives. And as regular readers know, I believe the Fed’s third (unofficial) mandate is to protect Wall Street and the markets.
I’ve studied what the Fed does for decades – both while I worked on Wall Street for 15 years, and in the 20 years since then.
There is always an external narrative to accompany the Fed’s actions, and those actions ultimately benefit the banking system.
This goes back to the Fed’s inception in 1913. Back then, President Woodrow Wilson had a conversation about the Fed with Thomas Lamont, the acting head of the J.P. Morgan Bank. I wrote about this in my 2014 book, All the Presidents’ Bankers.
Even now, Wall Street banks have been able to extract higher interest payments from regular consumers since the Fed began aggressively raising rates this year.
All the while, they’re not paying anything near as much on savings accounts.
In other words, they benefit from Fed policies no matter what. Meanwhile, ordinary consumers and taxpayers wind up footing the bill – whether that’s in bailouts, a lagging real economy, or unstable financial conditions.
This situation lies at the crux of The Great Distortion. Which, as I cover in my new book (read an excerpt here), has now become permanent.
Finally, reader Tom S. asked us to crunch the numbers on the payments the Fed makes to big banks and the government – so we did…
The Fed is a non-profit that pays its net income to the government. Have you calculated the difference between these payments and the interest the government pays the Fed?
Those who speak of the cost of the federal government’s borrowing never seem to take into account the income from the Fed, which has other sources of income as well as the federal government.
The net cost is much lower than the apparent cost. I got lost trying to figure this out on the Fed’s website. Thanks for your work,
– Tom S.
Hi, Tom. Thanks for your question and observations! You touch on an interesting topic.
The Fed is indeed viewed as a non-profit institution. That’s because it returns any excess income it earns from holding Treasury securities back to the U.S. Treasury.
But, as I explained in yesterday’s essay, the truth is a little more complex than that. For one, the Fed sends earnings to the U.S. Treasury only after backing out expenses, dividends, among other things (catch up here, if you missed it).
Now, getting back to your question, I think the difference between these payments and the interest the government pays the Fed isn’t what we should really be paying attention to here.
That’s because the Fed’s profits come mainly from the interest on government bonds that it purchases through open market operations. So, what you basically have is cash moving from one government pocket to another.
Put another way, once the Fed buys government-issued Treasuries, it’s as if the government never issued them in the first place.
But there’s something interesting happening with the Fed’s profits right now.
For the last eleven years straight, the Fed has netted four to ten billion dollars to the government every month.
On an annual basis, it transferred back $109 billion for 2021. That was well over the $86.9 billion in so-called remittances returned to the U.S. Treasury back in 2020.
But, suddenly, the Fed’s profits turned negative in September. That’s for the first time in over a decade. More losses followed last month.
The reason? The central bank is currently paying out more in interest expenses than it earns in interest income. If the Fed keeps raising rates, higher interest rates will continue fueling its losses.
In fact, economists at Barclays expect the Fed’s net interest losses to reach $60 billion next year and $15 billion in 2024, before it posts a surplus again in 2025.
Now, even though these losses shouldn’t affect the Fed’s day-to-day operations, they could cause political problems for them down the line.
I actually think it’s a great topic for a future essay, so thanks a lot for bringing this up.
And that’s all for this week’s mailbag. As always, thanks to everyone who wrote in.
If I didn’t get to your question, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Editor, Inside Wall Street with Nomi Prins