Book Review: The Fed and Lehman Brothers by Laurence M. Ball

Laurence M. Ball is the Chair of the Economics Department at Johns Hopkins University. He has been researching and writing papers about the events that led to Lehman Brothers’ filing for bankruptcy on September 15, 2008. This research has led to him writing an important book aimed at an audience beyond financial economists and other financial industry professionals, The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster. The thesis of the book is quite simple: the real reason that the Federal Reserve did not extend loans secured by Lehman collateral in order to stave off bankruptcy and give the firm a chance to survive, as it did with other firms before and after Lehman’s bankruptcy, was due to political considerations. He bluntly states that the argument that Ben Bernanke, Timothy Geithner, and Hank Paulson, who, during the 2008 financial crisis were respectively the Chairman of the Federal Reserve Board, the President of the Federal Reserve Bank of New York, and the Secretary of the Treasury, make that the Fed lacked the legal authority to extend a loan to Lehman Brothers due to its insolvency and lacking sufficiently good collateral is flatly wrong.

The first part of the book is important but a bit of a slog to get through. Ball examines in detail Lehman’s balance sheet, the law with respect to Fed loans to non-members of the Federal Reserve System, Lehman’s assets available as collateral for a loan, and the reasons for its liquidity problems. After reading Ball’s analysis of these matters, it is hard to see what convincing rebuttal Bernanke, Geithner, or Paulson could offer. The last part of the book is somewhat easier to read as it analyzes what various officials said to the committees of Congress and to the Financial Crisis Inquiry Commission. The author conclusively demonstrates that the decision not to extend a loan to Lehman to buy time so that Barclays could go through the procedures UK regulators were insisting to purchase Lehman or for some other arrangement, including in the worst case an orderly liquidation, could be made. The person most responsible for this political decision, Ball argues, is the one who had no legal authority in this matter, Secretary Paulson, who from all reports can come on forcefully, making other fearful to oppose him. One does not become the head of Goldman Sachs, his previous job, with a self-effacing or modest manner, as Bernanke, who is obviously a brilliant economist, often does. Geithner, whom I know, is no shrinking violet and can be charming or, if he believes the situation demands it, will display a calculated show of anger, apparently felt it judicious in the fast-moving crisis to defer to Paulson. It is not clear whether Bernanke or Geithner totally agreed with Paulson. They may have, or they may have harbored doubts.

Paulson seems to have come to his decision for two related reasons. The first is that he believed that bailing out Lehman would increase moral hazard. That is jargon for saying that, if firms know that they are going to be bailed out if they get into trouble, they are more likely to take more risks than they otherwise would. The other reason is that Paulson did not want to be known as “Mr. Bailout.” That, one notes, means that even though he lacked the legal authority to decide on Federal Reserve policy in this matter, he was cognizant that public perception, as well as the underlying reality, was that he was the official effectively making the decisions.

After the failure of Lehman, the Federal Reserve and subsequently the Treasury with the creation of the Troubled Asset Relief Program fund bailed out various financial institutions. In particular, Ball points to the bailout of AIG. Ball, though, could have pointed out that there was an enormous exposure of various firms to a unit of AIG, because many of them had entered into credit default swaps with AIG in seeking to reduce their exposure to possible defaults on home mortgages. It is likely that a failure of AIG would have been even more calamitous for the financial system and the economy than Lehman’s was. In this connection, it is worth mentioning, though Ball does not because his focus is on Lehman, that it was a failure of the various financial regulators to notice the risk that firms subject to regulation and oversight were collectively off-loading to AIG. The Office of Thrift Supervision (OTS) was theoretically responsible for overseeing AIG, because its ownership of a savings and loan made it a thrift holding company, but OTS did not have the resources to do this. The other financial regulators had access to the information about the transactions their charges were doing with AIG and could have inquired. They all seem to have missed this and did nothing.

Also, while Ball clearly believes that the failure to stave off Lehman’s bankruptcy was a mistake, he could have addressed a contrary argument made by then New York Times financial columnist Joe Nocera in September 2009 in an article headlined “Lehman Had to Die So Global Finance Could Live.” Nocera argues that, even if Lehman had been bailed out, the financial crisis would have proceeded, and the next financial institution to be on the brink of failure would have been a larger, more significant institution (for example, AIG). The failure of Lehman, unfair as it was, turned out to be necessary because its aftermath demonstrated the need to bailout other institutions. Nocera writes: “John H. Makin, a visiting scholar at the American Enterprise Institute, wrote recently, ‘If the Lehman Brothers’ failure had not triggered the panic phase of the cycle, some other institutional failure would have done so.’ I’ll go a step further: it is quite likely that the financial crisis would have been even worse had Lehman been rescued. Although nobody realized it at the time, Lehman Brothers had to die for the rest of Wall Street to live.” Of course, no one knows what would have happened if Lehman had been bailed out. Would the government have bailed out each institution as it came to the brink of failure and avoided the financial calamity that took place?

 I would be a bit more forgiving than Ball of the decision Paulson and others made about Lehman. They were under a great deal of pressure and thought that the market would not react too badly to a Lehman failure. What is more difficult to understand is why the three principals and others have stuck to a story about a lack of legal authority to have done something different. They have not made a convincing argument that this was true, and Ball has demolished this story convincingly. It would have been, and still would be, better to admit that this was not the real reason, or, in the alternative that their understanding of Lehman’s financial situation and the applicable law was imperfect. They could also argue that pursuing another course would also have been disastrous.

Book Review: “American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold” by Sebastian Edwards

For many years, I worked on public debt management issues at the U.S. Treasury Department. One of the things we touted was the safety of U.S. Treasury securities. Of course, Standard & Poor’s downgraded the credit rating of Treasury securities in 2011 from AAA to AA+ in reaction to the debt limit crisis of 2011—I was no longer working at the Treasury then—but Treasury has always held to the line articulated by Secretary of the Treasury Robert Rubin that default was “unthinkable,” which, if you think about it, is a clever bit of ambiguity. 

Lurking usually quite quietly in the background, though, has been the abrogation of the gold clauses on government bonds (and private-sector ones) by the Joint Resolution of June 5, 1933. This resolution stated in part:

Resolved by the Senate and House of Representatives of the Clauses in Congress assembled, That (a) every provision contained in or made with respect to any obligation which purports to give the obligee a right to require payment in gold or a particular kind of coin or currency, or in an amount in money of the United States measured thereby, is declared to be against public policy; and no such provision shall be contained in or made with respect to any obligation hereafter incurred. Every obligation, heretofore or hereafter incurred, whether or not any such provision is contained therein or made with respect thereto, shall be discharged upon payment, dollar for dollar, in any coin or currency which at the time of payment is legal tender for public and private debts. Any such provision contained in any law authorizing obligations to be issued by or under authority of the United States, is hereby repealed, but the repeal of any such provision shall not invalidate any other provision or authority contained in such law. 

Sebastian Edwards new book, American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold tells the story of the Roosevelt Administration’s improvisational approach to handling the Depression and its concomitant financial sector problems with respect to gold. The aim was to combat deflation and, especially, increase the price of agricultural commodities, and this eventually led to the Joint Resolution. The action then moves to the Supreme Court, which effectively, though in the case of government bonds not literally, upheld the abrogation of the gold clauses for both government and private sector bonds in opinions (decided 5-4) written by Chief Justice Charles Evan Hughes. The opinions give different reasons for the two type of bonds. Technically, in the case involving government bonds, the opinion stated that Congress had exceeded its power in abrogating the gold clause but that the plaintiff had not suffered any damages. It relies on the fact that gold was no longer permissible to be used as money in the United States. The reasoning is a bit hard to follow, but here is the key paragraph of the opinion:

Plaintiff demands the “equivalent” in currency of the gold coin promised. But “equivalent” cannot mean more than the amount of money which the promised gold coin would be worth to the bondholder for the purposes for which it could legally be used. That equivalence or worth could not properly be ascertained save in the light of the domestic and restricted market which the Congress had lawfully established. In the domestic transactions to which the plaintiff was limited, in the absence of special license, determination of the value of the gold coin would necessarily have regard to its use as legal tender and as a medium of exchange under a single monetary system with an established parity of all currency and coins. And, in view of the control of export and foreign exchange, and the restricted domestic use, the question of value, in relation to transactions legally available to the plaintiff, would require a consideration of the purchasing power of the dollars which the plaintiff could have received. Plaintiff has not shown, or attempted to show, that, in relation to buying power, he has sustained any loss whatever. On the contrary, in view of the adjustment of the internal economy to the single measure of value as established by the legislation of the Congress, and the universal availability and use throughout the country of the legal tender currency in meeting all engagements, the payment to the plaintiff of the amount which he demands would appear to constitute not a recoupment of loss in any proper sense, but an unjustified enrichment.

For those really interested, the government bond opinion can be found here, 294 U.S. 330 (1935), and the private sector bond opinion can be found here, 294 U.S. 240 (1935).) It is worth noting that this is the same Supreme Court which infuriated FDR in its decisions on some other cases involving laws implementing the New Deal, leading to his failed court packing scheme. In the event, personnel changes at the Supreme Court during FDR’s long presidency ultimately resolved the Administration’s problems with the Court.

I became aware of these cases early in my tenure of working in the Domestic Finance section of Treasury. At the beginning of the Reagan Administration, there was pressure from supply siders and conservative economists, most prominently Milton Friedman, for the Treasury to sell bonds linked to gold. The aim was to return the U.S. to an ill-defined gold standard, the last vestiges of which had been ended by President Nixon in August 1971. A gold commission was set up by the Administration, but, for those in the know, it was clear that the idea of returning to some sort of gold standard was going to be rejected, given the makeup of the commission. Secretary of the Treasury Donald Regan was not keen on the idea. (As an aside, I hated Secretary Regan’s management style of creating discord among Treasury staff, but he usually made reasonable decisions after all the fighting. He did understand finance and was no dummy.) 

In our commenting on gold backed bonds, Domestic Finance did mention the abrogation of the gold clauses, thought not as the main argument against issuing gold backed bonds. (I wrote these memos but am now relying on memory since I do not have access to them.) The abrogation of the gold clauses also came up in public presentations of Treasury’s plans to issue inflation-indexed bonds in the 1996 and 1997. Some people publicly complained about Treasury having “defaulted.” Treasury’s position of course is that the Supreme Court in 1935 had upheld Treasury’s payment on these bonds as payment in full.

For those interested in this subject, Edward’s book provides a wealth of information. It is an interesting episode in the financial history of the United States, and, while, at least to the lay reader, the Supreme Court opinion on government bonds appears somewhat tortured, one can understand why Chief Justice Hughes wrote it given the times. 

Unfortunately, though, I cannot recommend this book for the general reader. The book was obviously written and produced in a hurry. I have never read a book with as many typographical errors as this one. Also, graphs are not clearly labelled, which puts an unnecessary burden on the reader to figure out what is being shown. More importantly, the author demonstrates in his introduction that he can write well, but the rest of the book in not as engaging as the introduction. As a commenter on the Goodreads said, the book is not a “page turner.”

The author, who is an economics professor at UCLA, writes that he became interested in this subject when working on Argentinian debt issues in 2002. While he concludes at the end of the book that some emerging nations are likely to default on foreign currency obligations on their debt, he does not provide much in the way of analysis of the similarities and differences between what the U.S. did in the 1930s and what some countries have done and may do in the future. 

In short, the book is useful as a starting point for a discussion of these issues given the research the author undertook, but it does not present a fully formed argument. If Edwards returns to this subject, I hope he has more to say than that it is a myth that the U.S. has never defaulted on its debt (a proposition that can quickly turn into a legal and semantic argument.)

Book Review: “Blue Dreams: The Science and the Story of the Drugs That Changed Our Minds” by Lauren Slater

Lauren Slater is a practicing psychotherapist and writer. As a psychotherapist, she cannot, and does not want, prescribing privileges, but she knows a tremendous amount about the drugs psychiatrists have used and now use in their practices, due to both her research and her personal experience with some of these drugs. She has suffered from severe depression, which at times has resulted in hospitalization, and the drugs she has been prescribed have helped but with a significant toll on her body. When she started taking Prozac, it helped, but over time she had to take increasing amounts to achieve the same effect. She is now on a cocktail of other drugs. She says that the pills she has taken and is currently taking have ruined her physical health, making her overweight and diabetic, but she would not have been able to have a productive life without them. She is hopeful that new approaches, some involving hallucinogenic drugs popular in the counterculture of the 1960s, may prove to be better treatments, but the new approaches will not, she has been told, work for her because of the drugs she is currently taking and dares not quit.

In February, I attended her book talk at a Washington, DC bookstore, Politics and Prose. (The video of this talk can be viewed here.) The talk took the form of an interview by Olga Khazan, a writer for The Atlantic. I found what she had to say interesting and was motivated to read the book, Blue Dreams: The Science and the Story of the Drugs That Changed Our Minds.

Blue Dreams is very well written, and, even though I found myself having to look up more words than I usually do, mostly technical terms, the book is entertaining to read. She weaves her own personal story with the history of various psychiatric drugs, beginning with Thorazine. All the drugs had promise, but they all came with severe side effects. 

One of Slater’s main points is that the medical community does not know how or why these drugs work. For example, the selective serotonin reuptake inhibitors (“SSRIs”, such as Prozac. Paxil, and Zoloft) were promoted to cure low serotonin levels, which was said to lead to depression. However, Slater notes that there is no correlation between serotonin levels and depression. Depressed patients can have lower, average, or higher levels of serotonin than average, as can the non-depressed. To the extent that SSRIs work better than placebos, and this is a subject of debate, something else is going on.

Slater points out that the analogy that doctors give their patients when prescribing antidepressants, that it is similar to taking a medication to cure some physical ailment, is all wrong. There is no blood test or other objective test one can administer to detect depression or to determine what is causing it. Perhaps it is reassuring to some to hear that depression is due to a chemical imbalance rather than something else, particularly because of the stigma depression has had, which in recent years seems to have been diminishing somewhat. The truth is that, when doctors prescribe these drugs, they are guessing, and if the first prescription does not work, they guess again.

Another point Slater makes is that with the heralded introduction of Prozac, depression has been on the increase. Of course, it is not clear whether that is due to more reporting of depression or because of other factors, such as a decline of community institutions and increased loneliness in the U.S. What is clear is that current drug treatments for depression do not work for everybody, their long-term use comes with physical costs that have not been fully studied, and the mechanism by which they help some is not understood. 

While the book is interesting and the author makes valid points, there are some weaknesses. Though much of the book is about depression, the discussion is wide ranging to include other mental ailments, which prevent normal functioning and can necessitate institutionalization. And depression, as the author at times states, is not one disease but a symptom which can arise from different causes. Also, there is dysthymia, or mild depression, making for people who are often unhappy but can function normally, and more severe, or major, depression, which affects the ability to deal with the necessities of daily life. These are not the same thing and probably should not be lumped together, even if some psychiatrists think these symptoms fall on a continuum. The author also discusses some non-drug treatments, such as deep brain stimulation. The wide range of topics is interesting, but it dilutes the focus of the book, making it more difficult to tease out the argument she is making. Nevertheless, the book is well-worth reading for those interested in the subject. The author writes well, conveys a great deal of information in an accessible way, and is very good storyteller. 

One comes away concluding from reading this book that antidepressants are over-prescribed. Dysthymia or general malaise may be a reaction to objective conditions of life, and, while we do not know why some people have much stronger reactions than others to bad situations, drugs are often not the answer, especially after considering their physical costs and potential for addiction,  as well as their possible benefits. The other main message delivered at the end of the book is the author’s optimism about progress in psychiatric research. She sees great potential in psychedelic drugs, whether old ones or newly discovered. I have no way of knowing whether that optimism is justified, but, while these powerful drugs may be useful for certain conditions, I doubt that such treatment will achieve the popularity of SSRIs or benefit many of those taking SSRIs for mild depression. That is perhaps just as well, since powerful drugs and other interventions, such as electroconvulsive therapy, should probably be used sparingly.

Note: I have updated this post to refer to Lauren Slater as a psychotherapist rather than a psychologist. I recieved an email that attached a letter stating definitively that  Slater is not licensed as a psychologist in Massachusetts. However, apparently there is no licensing requirement in Massachusetts to call yourself a psychotherapist, though it is not clear from the material provided to me what an unlicensed "pschotherapist" is permitted to do in Massachusetts. Whether Slater has or had a license  in Massachusetts other than for "psychologist"  to provide counseling is also unclear. Ms. Slater seems to be using the term psychotherapist now to refer to her profession.

Book Review: Lost Connections: Uncovering the Real Causes of Depression—and the Unexpected Solutions by Johann Hari

Johann Hari’s new book on depression has received a considerable amount of attention, much of which has focused on the first fifty pages or so of the book which criticizes the chemical imbalance theory of depression and casts doubt about the efficacy of and the reliance on antidepressant drugs. In fact, despite the pharmaceutical advertising implying that depression is caused by too little serotonin in the brain, there is no evidence of that. To the extent that selective serotonin reuptake inhibitors work, there is something else going on. Moreover, they don’t alleviate depression for everyone, and, in many cases, they do not work much better, if at all, than a placebo.

The debate about antidepressants is fierce. Irving Kirsch, a psychologist who is currently the Associate Director of the Program in Placebo Studies and a lecturer in medicine at the Harvard Medical School and Beth Israel Deaconess Medical Center, ignited the debate in a 2009 book, The Emperor's New Drugs: Exploding the Antidepressant Myth. Marcia Angell, a former editor-in-chief of the New England Journal of Medicine and is also currently affiliated with Harvard Medical School, promoted Irving Kirsch’s book in two long 2011 articles for the New York Review of Books. (I wrote about this here.) 

The debate has recently been reignited on the other side by a recent study in The Lancet which argues that antidepressants are effective, some more than others. Andrea Cipriani, a psychiatrist who led the study, told the BBC: “This study is the final answer to a long-standing controversy about whether anti-depressants work for depression.” Of course, that is wishful thinking on his part. The controversy will continue. (For example, see this, this, and this.)

Moreover, what is not known is the effect of long-term use of antidepressants. The studies that have been done focus on what happens after eight weeks; most people who use these drugs use them for much longer than that.

To focus solely on Hari’s chapters on antidepressants though is to miss his main point; the prevalence of depression in modern societies is due to how we live, not to chemical imbalances. He lists nine causes of depression and anxiety in modern life. The first seven are “disconnection from meaningful work,” “disconnection from other people,” “disconnection from meaningful values,” “disconnection from childhood trauma,” “disconnection from status and respect,” “disconnection from the natural world,” and “disconnection from a hopeful or secure future.” Each of these rates a chapter. Causes eight and nine, “the real role of genes and brain changes,” are consigned to a short and not very informative single chapter.

Hari argues persuasively about the travails of modern life. But there is a confusion in the book between what individuals should do about their individual circumstances and what we should be trying to do to change society. As a result, the book is neither a self-help book nor a guide on how to effectuate societal change.

For example, Hari does not address what a mental health professional is supposed to do when a patient walks in desperately unhappy. It is not in the professional’s power to change society or working conditions. In many cases, if there are no clear solutions about the objective conditions that patients face which are causing distress, I would guess in many cases mental health professionals will likely focus on helping patients to adapt better to the environment in which they find themselves. Hence, the temptation to prescribe antidepressants, tranquilizers, and other drugs. 

Another problem with the book is that it is unclear what we mean by depression. There is a difference between people who are chronically unhappy because of unsatisfying jobs or unsatisfactory personal relationships (or lack thereof) but who can still function on a day-to-day basis and people who spend most of their time in bed and can barely function and need help in meeting their daily needs. The author thinks this is a continuum, but it is not clear that they are the same thing, only differing by severity. 

Furthermore, when it comes to troubling, exogenous factors impacting daily life, why do some people manage to cope while other become mildly or severely depressed? No one really knows, though Hari does say there is a genetic component. There probably is in some or many cases, but the solution for the individual is not obvious. Saying that society is sick does not help the individual.

The problem for the medical profession in treating depression is that there is nothing to see except an unhappy individual. There are no blood tests or x-rays doctors can order to help them diagnose the condition. They can ask questions or ask patients to fill out a questionnaire, but this is all in the realm of subjectivity. Some lucky patients may benefit from drugs; others may find that talk therapy works; others may in time get over their distress; and others may have to suffer. Various forms and severity of what we call depression may more accurately be described as symptoms that are the result of various factors, depending on the individual and circumstances.

Apparently, no new antidepressants are likely to come to market anytime soon. There is some promising research in using psychedelic drugs to treat some forms of depression, but as Hari mentions, this does not work for everyone and there are risks. Those who remember the sixties will likely recall that some people had “bad trips” when taking LSD. That apparently is still a problem.

Another therapy which is currently used for severely depressed patients who have been “treatment-resistant” is electroconvulsive therapy (“ECT”), which is an attempt at a non-alarming way to refer to shock therapy. Currently, ECT is practiced in a way that is less painful to patients than the horror stories one remembers from Ken Kesey’s novel (or the movie), One Flew Over the Cuckoo's Nest. It apparently often has good results, but how it works does not seem to be that clearly understood. The tradeoff of long-term costs and benefits are not clear. It appears to make permanent, physical changes to the brain. Hari, though, does not discuss ECT. 

I wanted to like this book more than I did. Hari, though, is a good writer and an engaging speaker. His criticisms of modern society are worth pondering, even if many will not fully agree with them. His criticisms of antidepressant drugs are especially cogent and convincing, and, it needs to be noted, that Hari does indicate that they are helpful to some people. 

Note: I was motivated to read this book by an event I attended at Washington, DC’s premier independent bookstore, Politics and Prose. At this book talk, Andrew Sullivan interviewed Johann Hari. The video of this event can be found here.

Probably because of a plagiarism episode in his past, Hari has provided extensive endnotes to the book and additional information on a website. At that website, one can listen to the audio of interviews Hari conducted in researching the book.

Book Review: Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America by Danielle DiMartino Booth

Harsh critics of the Federal Reserve come to their views from different perspectives. There are the libertarians, such as Ron Paul who wrote the 2009 book, End the Fed; there are the hard money types who are critical of fiat money; and there are those on the left who view the Fed as part of a capitalist conspiracy to enrich the financiers and impoverish the working class. Most of the people espousing such views seem to have a rather fragile grasp of how a modern economy and its banking system work. At times, even some prominent economists seem confused about the mechanics of the monetary and banking system, as I discovered early in my career while studying Eurodollars.

Most people only have a dim understanding, if that, about the nuts and bolts of monetary policy.   Moreover, it is a subject of vehement debate among economists and policymakers on how to formulate the correct monetary policy in the face of different economic conditions. If you ask Paul Krugman what the Fed should do, you’ll get one answer; if you ask John Taylor or Martin Feldstein, most of the time, you’ll get a different answer.

There is no reason to believe that Danielle DiMartino Booth, a former Federal Reserve Bank of Dallas employee, does not understand the mechanical aspects of monetary policy, but her ability to make a cogent monetary policy argument is lacking based on the evidence in her book, Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. The book’s title is perhaps hyperbolic; she is not advocating to end the Fed but to reform it. Among her suggestions: redraw the Federal Reserve Bank District lines so that they “better reflect America’s economic powerhouses,” such as California; reduce the terms of Federal Reserve governors to five years; give all Federal Reserve Bank presidents a permanent vote on the Federal Open Market Committee (“FOMC”); and “slash the Fed’s bloated Research Department.” Of course, none of this is likely to happen, and the idea of the Federal Reserve Bank presidents able to outvote the governors (there are seven governors when the Board is at full strength and twelve presidents, of which five have a vote at any one time on the FOMC) is particularly problematic. The Federal Reserve Bank presidents are not federal government employees, nor are they appointed by the U.S. President. (They are though approved by the Federal Reserve Board.) Having representatives of the private sector directly involved in deciding on government policy with respect to interest rates and the money supply raises, it has been noticed, Constitutional questions which so far have been ignored or dismissed by courts for lack of standing of potential litigants. But the issue would be more vigorously debated if the FOMC were to outvote the governors, especially if that happened often. But Booth’s proposal is not going anywhere, and the FOMC will likely continue to operate as it has without significant challenge.

Booth believes that the Fed under Greenspan, Bernanke, and Yellen has been too loose, and she is particularly critical of the quantitative easing programs. While she argues that this has had terrible effects, she is not clear what these effects are or why she thinks this. A perusal of FOMC transcripts shows that a man she clearly admires and for whom she worked, Federal Reserve Bank of Dallas President Richard Fisher, was continually worried about QE causing inflation. He has been wrong, a fact that Booth does not discuss. One can argue that QE has not been that effective, since large increases in the Federal Reserve’s balance sheet did not lead to large increases in the money supply (M2), but given the aversion of Congress to do more than it did in providing fiscal stimulus, what choice did the Fed have but to do what it could? One senses that Booth is not in favor of fiscal stimulus because of fear of federal deficits. A tighter monetary policy and less federal spending would have been a disastrous combination of policies to counter the Great Recession.

At one point, Booth blames Fed policy for income inequality. She does not explain how she thinks monetary policy plays a role in that. Part of the problem is that she seems to think monetary policy is all that matters when it comes to economic policy. Tax policy, regulation, fiscal policy, international trade agreements, and various government programs all have their role, which she generally ignores. As for growing income inequality, there is no consensus among economists why this is occurring. For example, there was a focus on this issue at the IMF-sponsored seminars at its recent annual meeting. It was clear from those seminars that there is confusion among economists as to the causes of growing income inequality, which is not just a U.S. issue.

Booth is on firmer ground when she criticizes Federal Reserve supervision of financial institutions. It has at times not been as rigorous as it should be, and the Fed missed and did not address the increasingly risky behavior taking place in the buildup to the financial crisis. Other regulators, such as the Office of the Comptroller of the Currency and the SEC, also did not use their authority to address the increasing risks.

With respect to regulation, Booth makes a major factual error early in the book when she states that collateralized debt obligations (“CDOs”) were not regulated because they were derivatives. In fact, CDOs are securities over which the SEC has jurisdiction. It is true that derivatives, such as credit default swaps, are not securities and these instruments prior to the enactment of the Dodd-Frank legislation, were not directly regulated; however, many of the financial institutions making markets in or using these derivatives were regulated. The SEC should have used its regulatory authority to address the inflated credit ratings of some of the tranches of CDOs, and the bank regulators should have used their regulatory authority to rein in the banks. Also, the Fed should have used its authority on mortgage lending to address the abuses that were occurring, but Greenspan famously rejected doing so.

While I am highly critical of this book, it is fun to read. The author writes well, and her criticism of Fed culture which tends to suppress ideas that do not coincide with the internal consensus likely has some merit. Her recounting of her experience working at the Dallas Fed are interesting, though she does go overboard in her criticism of economists who have Ph.Ds. I think she does have a point about the consensus culture of the Fed (though it may be exaggerated for effect) based on my years of working at the U.S. Treasury, which included working with Fed staff, but I also think Fed economists were right in rejecting her ideas as well as those of Richard Fisher. 

Finally, there is a useful debate about whether and how the Fed should react to asset bubbles. A particularly egregious failure of the Fed was not to recognize that a housing bubble, partly fueled by reckless mortgage lending, was occurring before the financial crisis. It was obvious, if the severe fallout that would occur when the bubble burst was not. At the time, Fed economists minimized what was happening and argued that any local, frothy housing markets did not pose severe risks to the U.S. economy. Examining this failure as well as considering the Fed’s responsibilities concerning asset bubbles when inflation is contained is worthwhile. Unfortunately, this book does not do that. Though the Fed did some things that I would criticize to pull the country out of the Great Recession, overall, I would give the Fed high marks. Booth would not. The main problem with Fed policy was prior to the financial crisis, and the groupthink that Booth criticizes contributed to that.