The Fed's Extreme Response to the COVID-19 Crisis (w/ Thomas Hoenig & Pedro da Costa)
PEDRO DACOSTA: I'm Pedro DaCosta and it's my pleasure to welcome Dr. Thomas Hoenig. Tom spent all of 38 years I believe at the Federal Reserve, a very long and distinguished career. I got to know him during a little bit before actually and during the 2008 Financial Crisis in his role as Kansas City Fed chair where he was instrumental in making a lot of the decisions about how to deal with that crisis. Subsequently, he went to the FDIC, where he was vice chair there. He is now a Distinguished Fellow at George Mason University's Mercatus Center. Thank you so much for joining me, Tom. I really appreciate it. THOMAS HOENIG: Good to join you this morning. Thank you. Good to see you again. PEDRO DACOSTA: No, it's my pleasure. I wanted to start by asking you what I've been asking everybody, first of all, is how are you doing in this pandemic? How has physical distancing affected your life? Are you and everybody in your family okay? THOMAS HOENIG: Yes, fortunately, we're all okay. The distancing in the isolation is like, I think for most people beginning to wear on us and we have family not very far away and we can't get together with them. That's a small price to pay for health, so we're happy to do it until this thing passes. PEDRO DACOSTA: Absolutely. I feel like we're-- I was looking at the stats, and we're in a blessed minority and can accomplish our work remotely in the first place. THOMAS HOENIG: Very good point, very good point. PEDRO DACOSTA: I wanted to ask you, we seem to get mixed messages from the Fed as far as the economy itself and the strength of the financial system. I understand that this is a special-- this is a very significant shock that is external that we're going through. At the same time, the Fed keeps coming up with a new-- and see, I'm a Fed reporter, pays close attention to this stuff. I can't keep up with all the emergency facilities that seemed to be cropping up on a daily basis. Was the financial system truly healthy going into this crisis? THOMAS HOENIG: Well, the only way I can answer that is say that it is certainly was healthier going into this crisis that it was the last crisis. It has more capital. It's not as healthy as it might have been because I think the industry could have benefited from more capital, which would give them greater staying power and greater flexibility but relatively speaking, it is, I think, better positioned to weather this if it doesn't go on indefinitely. PEDRO DACOSTA: What do you make of the Fed's response thus far? Again, we've revived some of the old facilities that you were right there for their original creation, some of the same policies in terms of launching QE if in a slightly different form, but we're also going beyond the scope of measures undertaken in 2008. What do you make of this alphabet soup of facilities but also the monetary action? THOMAS HOENIG: Well, I think that the basically, the tool's the same. The printing of money, the creation of money to fund whatever is needed. Given the nature of this crisis being started from a natural disaster that seems to be ongoing, I'm not sure that the Fed can enjoy it. As different sectors have become under stress and needing some financial liquidity support, the Fed has felt compelled and I think the public agrees with that at this point that it had to step in, in any way it could, and that's why you're seeing the old tools barely being expanded to a greater number of participants in this, shall we call it, a liquidity provisioning going forward. PEDRO DACOSTA: Could we talk a little bit about some of the specific measures? The market's very interested in the corporate bond buying aspect to it of the program because it is new and because the US corporate bond market is so large. I'm wondering, two things. You as a FOMC member, you are always cautious even about potential credit distortions in terms of the Fed's interventions into the mortgage market. This of course, takes us far way further down the rabbit hole of credit allocation. Two, I wonder how you expect the Fed to construct such a program in the way that makes it fairly neutral and that shields it from political criticism of favoring one corporate sector over another? THOMAS HOENIG: Well, I think to begin with, because the banking industry is tough, a levered industry, have you would-- ideally you would want them to provide the liquidity into the corporate world and given the size of this crisis, they are unable to do so, especially given their own current leverage positions which are better than they were, but not as strong as they might have been. That does leave it to the central bank who can, in fact, create the necessary liquidity to fund and they felt compelled. During the crisis, I can understand that. In fact, I supported intervention during the last crisis. The difficult is that you are setting a precedent and that makes you subject to greater political pressure in the future for whatever crisis comes along. That is the unfortunate part of this and whether they can withdraw themselves from this in a way that says whoops, that was a onetime very special, pandemic created and we're not doing that for just any panic that comes about, that will be very difficult, but I think necessary and something for the Fed to be thinking about. Not now, but very soon as the current crisis recedes, they'll have some major challenges, but I hope they do it, otherwise, they will become subject to greater and greater political pressure. PEDRO DACOSTA: Because the fact that I've heard an interesting point, I spoke to Randy Kroszner, your former colleague recently, he made the interesting point that while the Fed feared the loss of Direct 13-3 emergency lending powers after Dodd Frank and the need to go to Treasury for approval, that disapproval actually enhanced the political backing and cover that the Fed now has, what do you make of that view? Does that give the Fed more leeway to intervene in corporate bond markets and muni bonds in a way that it was maybe not able to do when you were there THOMAS HOENIG: Well, I think that's one good way of looking at it. I always had the feeling that having to go to the Treasury was hardly a handicap, your greatest difficulty is resisting the Treasury because it's a political entity. That's a challenge. The Fed's independence is less than it was because of that, and because of other actions that's taken in the past. PEDRO DACOSTA: I wonder what memories about the last crisis does this bring up for you, and how do you see this as a different phenomenon? Because obviously, this is we're talking about whether or not it's a manmade. I guess, if the pandemic is in any way linked to climate change, which it might be, maybe it's manmade, but it's not quite as manmade as subprime mortgages, right? THOMAS HOENIG: Right. It's different in the sense of the source of the immediate source, the trigger source for this crisis is quite a bit different and therefore, that puts everyone in a position. Both parties are in that position, the Fed's in that position, the administration that-- Yes, this was not anyone's fault except this pandemic and therefore, we have to do all we can, that gives them a lot of leeway. The downside of that is it also sets precedent for the future, which will be more difficult to manage, I suspect going forward. Very similar to the last crisis in terms of the need to do something broader than the last crisis in the scope of what they're willing and able to do, and more acceptance by the public and the politicians that they do it. PEDRO DACOSTA: The reason I asked you is, I guess, as a reporter, as a much younger reporter back then, I covered the crisis. Of course, when we were living in that closely, I assume you felt the same way. We're like, this is as bad as things can get. Of course, now we're living through a public health crisis that seems much more severe. I wonder if you have any recollections of what the phone calls were for emergency measures, like how those things came about. Give us a peek into how the Fed and global central banks were able to rally behind the scenes to act in fairly coordinated and aggressive fashions. THOMAS HOENIG: Well, I think the methods then are the same today. I wouldn't be on their meetings today, but I suspect they're the same. Basically, you have the chairman and his folks, the staff around him and his colleagues talking to different central banks, then there are many, many phone calls and video conferences where the chairman and the FOMC members would gather. They would discuss what to do. Here's what we're thinking we can do. Let's see about doing this. There would be a discussion around that. I think in that period, there were probably more give and take in the sense that are you sure this is right? What are we doing? I'm wondering if we should do this much. There's more hesitancy. What I would guess this time, and if I were sitting in that room, I would have been much more willing to say, all right, let's do it. We have to do it because of the nature. The same mechanism is in place, I'm sure. The discussions are more one way than they were back then. I think that's probably an important difference. PEDRO DACOSTA: That makes sense. One of the other differences that strikes me is that as much as financial authorities have been quick and aggressive, both on the monetary and also the fiscal side, it's surprising, considering how long it took to get a bill last time, this was a pretty herculean and rapid effort to get this $2 trillion out the door. At least initially, we know there are hiccups. I wonder how much of that was-- the thing that I find also is that you can't really put a financial floor on a health crisis and therefore, you can't find the bottom until you find the bottom on the health side and the financial authorities are helpless on that, can you speak to that a little bit? THOMAS HOENIG: Well, I think I'm not-- you mean, in terms of the fiscal support that we-- PEDRO DACOSTA: Yeah. I guess I'm looking at it, the following [?]. You said, the Fed can do this as long as it doesn't last too long. We don't know how long it's going to last. It's not like the Fed's actions can be a determinant of how long it's going to last. It's really up to the health patterns that are out of everyone's control. It seems to be a more fickle animal to cage. THOMAS HOENIG: Well, I think here's how I would approach that. I would tell you, first of all, the Fed can do what they're doing, they can print money as long as it takes. I think they're willing to do that, the difficulty is that if this pandemic and the health crisis, the longer it lasts, the worse the economy gets. I suspect though that what you're going to see-- you saw this very quick response on the fiscal side. The Fed will support that by keeping interest rates low to find that, and I think there's already discussions underway now, I think I know there's discussions underway for another fiscal stimulus package to help small businesses, to help fund employees and so forth. The Federal Reserve will support that. I don't think that's a question, and they'll do that in the sense of keeping interest rates very low. They will, if the government has to issue this debt to do it, they will be the ultimate buyer of that debt to make sure they are able to get the cash they need to spend this money at low interest rates. I think that is what we will see until this ends. Now, the more difficult part will be the timing of the exit because you can't just pull it back. You'll have that and then how you avoid having precedents that are so entrenched that you can't pull out at all. There are many challenges currently which the Fed and the government are going to face without any reservation, then the hard ones come down the road, and that'll be difficult a period for us as well. PEDRO DACOSTA: I know forecasting is a fool's errand even in good times. Right now, it's just the uncertainty levels are off the charts but in terms of how big the Fed's balance sheet is likely to get, what number would you put on that in terms of the fiscal expansion that might be needed? Under different scenarios, say, if this last three months versus six months, how far could we go? THOMAS HOENIG: Well, first of all, remember that there was a trend for greater fiscal spending even before this occurred. In 2010 period, there was about $11 trillion of debt. Last year, there was $22 trillion of debt. I suspect with what's going on now, we'll have $24 trillion of debt, then depending on how long this lasts, it could be as high as $28 trillion of debt or more. I think the Fed's balance sheet, which back then was a trillion dollars rounded up, was 4.5 trillion in 2015, it came down a little, is now 6 trillion. I would not be surprised at all to see the balance sheet grow to $10 trillion over the next two years or so. It will be very dramatic, because even after the pandemic, you have to get through the recovery. That will put enormous pressure on the Federal Reserve to make sure that interest rates remain low, both for the government to borrow and for the economy itself to recover. It's going to be under a lot of pressure to increase its printing the money, its creation of reserves, and I could see it being $10 trillion, fairly easily see that coming our way. PEDRO DACOSTA: It doesn't sound like you think we're headed for a V-shaped recovery. Because this seems like something that's going to have a fairly severe at least short term impact on the economy. THOMAS HOENIG: I hope it's a V-shaped recovery. I don't expect it to be, because what I'm hearing and when I talk to people, in the energy industry which is under pressure to begin with, but now is really under pressure. The hospitality industry is really under deep, pressure small businesses so. Those aren't easy just to bounce back, it takes time. I think even the recovery for the pandemic itself will be stepwise. I think it's going to be a slow, I hope not overly difficult recovery, but a slower recovery than people would like. Certainly, slower than I would like. PEDRO DACOSTA: Watching some of the reporting out of Wuhan as to how gradual the reopening is is fairly sobering. I saw one reporter based out there talking about how he has a two-hour daily freedom pass to go out. THOMAS HOENIG: I hope we don't come to that, but I think people will be cautious. I hope they're cautious because if you have a repeat, then things will be so much worse. I think it's going to be a difficult recovery. PEDRO DACOSTA: In that context, have you been thinking about long term patterns and changes in the economy that might emerge from this? We would have been sitting down having this conversation in the studio, probably, but now we're doing it remotely. There's a lot of teleworking going on in attempts to even make a workable work that was previously only doable in person. What long term changes have you been thinking about and reading about that might actually? Ben Bernanke mentioned yesterday during his Brookings Zoom conference that he thought there might be a depression like effect where people remain more cautious and more-- a greater propensity to save and after a time of extreme distress. THOMAS HOENIG: I think that's certainly possible. My own view is that I find through many crises now that people rebound more quickly than we ever anticipate they will and I think what this is doing is it will accelerate certain trends like home officing, perhaps, that was already underway, other kinds of advantages of technologies, but I think those will accelerate. I think we will also see a continued acceleration in some of the consolidations going on in the economy and the use of remote access like Amazon services and so forth. I think those are already in play, and those will accelerate forward. I think one thing that will happen, is happening and will be hard to reverse is the role of government in business. This is a big step of government. Each of these programs in the relief bill has a leash to them. Here's the money, here's the conditions. To withdraw from that will be hard. We'll see more of government into the system, but I do think overall, the economy will, at first, slowly come back, but then will regain its footing as we move through 2021. Hopefully, with as little fallout as possible. PEDRO DACOSTA: Do you have a sense of how deep the GDP hit could be and how high unemployment could get in this phase? THOMAS HOENIG: Well, I've seen lots of estimates. I don't think 15% is unreasonable at all, it could be higher than that if this does extend through the first part of the summer, but I saw I'm thinking 15% unemployment, maybe 20%. Then the GDP will fall at least 5% and could be greater than that but I have a crystal ball in my office, it so far has served me poorly and so I won't rely on that. I just know we have to be prepared for an extended tough recovery. Once it gets going, I'm more hopeful it'll come back very quickly. PEDRO DACOSTA: Sounds good. Well, my crystal ball is cracked and on the ground, so I'm not even looking at it. I like to use the magic eight ball for answers myself. THOMAS HOENIG: Absolutely. PEDRO DACOSTA: My interview is one of those. Now, I'm going to jump into the more lighthearted portion of our conversation called The Intersection where I'll ask a series of slightly more personal questions that we asked all of our guests. Thank you for indulging us here. The first one is whether there's any person dead or alive that you'd like to interview, have a sit down with, beyond the other end of the camera here, I guess at the moment? THOMAS HOENIG: Well, I'm an admirer of Paul Volcker and Alan Meltzer. Both of them. I would love to talk with them because who else could help us think about this current pandemic and crisis better than they would? I would love to get their wisdom at this point. Unfortunately, they've recently passed and can't do that, but they were real heroes of mine. I will tell you also, being from Kansas City area, I would love to talk with Harry Truman who had his own crisis to deal with and a great man of integrity also. PEDRO DACOSTA: That's great. Okay, so next, what is the book or books that have changed your view of the world, and what are you reading right now? THOMAS HOENIG: Well, books have changed my thinking of the world have been when I was younger, I did begin to read High [?] work, became much more impressed with how he thought about decentralized systems and how they work. I have found that very worthwhile. More recently, I read a book entitled The Wright Brothers, which I found inspiring, even for today, because here are these bicycle manufacturers and they invent this airplane and how they went about it gives me great hope for the future in this world of technology. I just finished it not too long ago. It's just a tremendous book. I recommend it to everyone. PEDRO DACOSTA: That's great. I'll check it out. As an individual or a leader in your field, how do you remain engaged and relevant in a fast moving world, and especially now that you've left public life officially, how is that going? THOMAS HOENIG: Well, I'm enjoying it. I'm associated with Mercatus, which is an opportunity to interact, engage with academics and other policy individuals frequently and that's of tremendous value to me. Under this isolation environment, I do make it a point to read everything I can in the morning early to catch up on how quickly things are changing. Then I talk to my colleagues a great deal, sometimes like video, other times one on one on the phone to get the detail, the sense of things. Then I try and write because the discipline that has you get your thinking out of the chaos mode into more discipline projection, I'll say. That's it and I'm enjoying it. I don't enjoy the isolation, but I do enjoy the interaction with people and staying engaged as I [?]. PEDRO DACOSTA: I actually like as much as semantics might be meaningless at times, that goes important distinction they've made recently to talk about physical rather than social distancing. Because in a way, I've become more social and caught up with different people in different ways now that we're stuck. THOMAS HOENIG: Yeah, I'm spending a lot of time on the phone talking to friends and colleagues and so forth. It's very-- I enjoy it a great deal. In fact, it makes your days pass a little faster than I anticipated. PEDRO DACOSTA: It does, it does. It focuses whatever research questions are focused on or in my reporting, really helps you figure out what's next. That's great. Some of our guests can tie their professional success to a single key breakthrough or a meeting they had or a person that gave them a lift. Is there such a moment in your career that you can think back to? THOMAS HOENIG: Well, first of all, I would say that I've been very fortunate in my career, because I've had wonderful mentors who would have helped guide me all the way from grad school through my role as president of the bank. I would suspect that out of crisis comes opportunity. One of the crisis that took place in the early '80s was the oil crisis, that period which affected our region. I was a young officer at that time in the bank of the Federal Reserve Bank of Kansas City and got very much involved in dealing with that crisis and was given more responsibility than I might have otherwise been given. I think that did help put me forward as someone to think about for the future at the bank, and it served me very well. Unfortunate as those circumstances were, and as much as I would have liked to have had the crisis evolved, it was probably a boost to my career. PEDRO DACOSTA: That's great. Can you identify a failure, I like to talk about it more as a set potential setback that you had to overcome that was significant to you? THOMAS HOENIG: Well, I can't-- I've had, believe me, I've had my share of setbacks over time that I've learned from, that's the idea of it. I have had in my career, analytical, shall we say, incorrect, felt thoughts that were completely wrong and that I had put forward that people kindly forgave me for, but those were cloudy days, as a friend of mine used to say, but I did get through them and learn from them. That's the benefit of it, so I'll put it that way. PEDRO DACOSTA: Last one, what view do you hold professionally that you'd say is most controversial? THOMAS HOENIG: Well, let me begin by saying in the last crisis, I was supportive of the immediate relief programs in 2008. I became very strongly in disagreement with the majority of the FOMC when they initiated QE1 and 2 and so forth in a recovering economy. They were putting massive amounts of reserves into the system in a recovery, keeping interest rates low and I was concerned then that it was going to create the next excess with increased leverage, misallocation of resources that would follow from that and that was very controversial at the time inside the Fed. I still feel very comfortable with my position. Nothing's changed if anything, in my mind, has been confirmed. We are more leveraged today than we would have otherwise been. That has not served as well in this pandemic crisis itself. It's not the cause of the crisis. That is the leverage isn't the cause, but it makes dealing with it more difficult than I think it otherwise would have been. Very controversial view in its time, but I feel very comfortable with it. PEDRO DACOSTA: I do remember the controversy. Thank you so much for joining me, Tom. I really appreciate it. That was Thomas Hoenig. He's a Distinguished Fellow at the Mercatus Center at George Mason University, and he's the former president of the Kansas City Federal Reserve. Thank you so much again. THOMAS HOENIG: Thank you also. JUSTINE: If you're ready to go beyond the interview make sure you visit realvision.com where you can try real vision plus for 30 days for just $1. We'll see you next time right here on real vision.