This past week’s bailout of depositors at Silicon Valley Bank will remain hotly debated, but one thing is likely: this latest expansion of the powers of the US Federal Reserve is setting up the next crisis, and the one after that.
Jeanna Smialek, a New York Times reporter covering the Fed, has a new book out, “Limitless: The Federal Reserve Takes on a New Age of Crisis”. Her account mainly focuses on the Fed under the current chairman, Jay Powell, and its response to the Covid crisis.
She frames questions about the Fed’s role and mission in terms of technocratic rule versus democratic accountability, and whether it should act when other arms of government cannot or do not.
These are important questions. But she doesn’t stop to ask whether the emergence of the Fed as the world’s backstop is necessary or not, and whether it is a boon or the manifestation of a broken system.
Feds are people too
The strength of her account is to portray the Fed’s various executives as muddling through, as human beings doing their best. She is trying to explain the Fed to a general audience, and does a good job at simplifying narratives and technical points.
She is clearly against demonizing the Fed. She does try to understand criticisms of its policies. These are usually framed in the context of Republican resistance to the expansion of the Fed’s powers. She is a NYT reporter and an American, so she accepts the system that has bred the Fed into the vast, powerful institution it is today.
DigFin is partial to this view. But we hear criticisms of the Fed that perhaps Smialek does not. Yes, from the libertarian crypto industry, which she gives short shrift (easy target); from CBDC adherents who see Asia building a competing infrastructure, a topic she doesn’t mention; and from Asian bankers and officials who chafe at their reliance upon the US dollar, for whom Fed actions sometimes feel like an elephant going berserk – serious, sober people who appear to be beyond the author’s network.
On the one hand, these other people might do themselves a favor and read her book, particularly the crypto bros. They’d probably learn something. But Smialek’s acccount feels incomplete.
Last resort of what?
For the most part, the Federal Reserve acts as a stabilizer. To some outsiders, though, it is stabilizing a house of cards, rather than promoting a general prosperity.
Take the latest act: this month it extended its role of “lender of the last resort”, there to rescue troubled but solvent banks, to “insurer of the last resort”. The very system that the Fed is meant to backstop keeps lurching from one damn thing to the next. Is this inevitable of any system? Or is there something about US capitalism, with the Fed as its guardian, that has lost its moorings?
Smialek does not wonder about this. Which suggests neither do the Fed officials whom she brings to life for us.
“Limitless” is the story of how various crises have shaped the Fed. Most of these crises led it to assume more powers. Smialek only briefly acknowledges moral hazard. She is stronger at exploring the questions of central bank independence, the threat of politicization, and how it responds to demands that it often “do something” in the absence of Congressional action.
Indeed, Fed officials worry about these things and often try to resist pleas for them to take on new roles. It took its boldest moves, such as the 2008 rescue of the US financial system, only after it saw no alternative. People who complain about quantitative easing are loud but tend to lack good alternatives.
But where does it stop? Take the SVB affair.
The fine print of the Fed’s moves to save SVB’s depositors come with limits (the new facility only recognizes a troubled bank’s US bond holdings at par rather than at market rates, and only debentures issued before January 2023). Those technicalities, however, probably don’t matter. If a US retail bank looks like it’ll go under, the Fed surely must then extend its bond-insurance scheme to those depositors as well.
The Greenspan put
This takes moral hazard to a new level. It probably means the US commercial banking system will operate with the same kind of assumptions that investment banks did under Alan Greenspan: that is, with confidence in the “Greenspan put”. The only way to curb excess risks will be through lots of red tape, which will make finance less efficient and more expensive.
The biggest problem with this book is skimming over one event that arguably was an intervention of choice rather than necessity: the 1998 bailout of Long-Term Credit Management. Greenspan followed this deal with rash rate cuts. These actions led to the market’s belief in the Greenspan put, and sparked the dot-com IPO craze.
The LTCM bailout merits only a paragraph or two in Smialek’s narrative of Fed rescues. But this was of a different character. Greenspan got all the big investment banks in a room and kept them there until they agreed to cover a $3.6 billion bailout of the failed hedge fund. (Only Jimmy Cayne of Bear Stearns refused, a karmic error that would haunt him when Bear went under in early 2008.)
This took place at the height of the Great Moderation. The world was at peace. America had won the First Gulf War. The Soviet Union was gone. China under Deng was turning capitalist. There were plenty of emerging-market crises (LTCM was undone by risky bets on Russian rubles, which itself lost their moorings in the wake of the Asian Financial Crisis). But the US was never more stable, prosperous, and confident.
Yet Greenspan panicked. LTCM’s demise would be shocking, but it was not going to wreck Wall Street, and certainly not Main Street. Enron’s bankruptcy in 2001 would be far more serious. That spurred Congress to pass Sarbanes-Oxley, but the Fed was not needed.
But LTCM changed the Fed’s job. Benjamin Strong, Marriner Eccles and Paul Volcker had all run the Fed well, expanding its powers in a bid to maintain stability, support the value of the currency, and keep markets open. Under Greenspan, the Fed’s job became one of bailing out undeserving fat cats.
Limits
Is it possible that, had the Fed caught hell for the LTCM bailout – if this had been regarded at the time as a mistake – there would not have been a calamitous shock in 2008? Maybe better regulation would have ringfenced the excesses in securitizing subprime mortages, and instilled proper controls over credit rating agencies.
Who knows?
But it’s a good question to ask. Smialek isn’t really asking these existential questions. And now we have the Fed as the insurer of last resort.
Another example of a missing question: the Fed’s slow response to central-bank digital currencies. Smialek spends a little time on this, noting Powell’s hesitancy to do something rash, and other officials’ concerns that it’s unnecessary. She references the prospect of Europeans experimenting with digital currencies, and leaves it at that.
But nothing about China or how a digital renminbi might (or might not!) become a tool to displace the dollar in global trade. Or debates over its impact on commercial banks. Or the possibility that the US could rely on regulated USDC or other dollar-based stablecoins. In other words, Smialek only understands the Fed from her conversations with Fed insiders and a few interested politicians.
This is probably how these debates sound inside the US – with little comprehension of what happens beyond. Such is the limit of “Limitless”.
But with this month’s latest expansion of its remit fresh in mind, we could use a book that does more than recount the Fed’s recent history. We need one that puts the Fed atop a global dollarized world, where the US has morphed from being the system’s anchor into a source of instability. Looked at from a global perspective, how limitless is the Federal Reserve?
“Limitless: The Federal Reserve Takes on a New Age of Crisis”, by Jeanna Smialek, Knopf, 2023, 384 pages.
