How Big Will the Fed’s Balance Sheet Get? (w/ Thomas Hoenig & Pedro da Costa)
PEDRO DACOSTA: 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.