Tuesday, January 23, 2018

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.