Our Smart but Stupid Economic Masters

A review of The Lords of Easy Money:  How the Federal Reserve Broke the American Economy, by Christopher Leonard, Paperback Edition, Simon & Schuster Paperbacks, 2023, 373 pages.

Your neighbors might object to you reading The Lords of Easy Money.  That’s because it’s a book that will make you want to go outside and howl at the moon, given its brilliant but damning description of the economic havoc wreaked on America’s plebeians by the patricians at the Federal Reserve, at Wall Street banks, at hedge funds, and at government agencies, especially the US Treasury.

The havoc took place and is continuing to take place, while elected Members of Congress were fiddling and continue to fiddle.

It may not have been the intent, but the book shows that both capitalism and democracy are broken.  And they were broken by men and women with advanced degrees, mostly from Ivy League universities.

Author Christopher Leonard is masterful in explaining in layman’s terms the inner workings of the Federal Reserve and how it creates money, controls interest rates, works hand-in-glove with Wall Street, and, in recent decades, developed such monetary “innovations” as quantitative easing (QE), zero-interest-rate policy (ZIRP), and purchases of long-term debt (Operation Twist).

He goes on to describe with a reporter’s skill what these innovations wrought:  the enrichment of Wall Street, inflated asset prices, bubbles in stocks and housing, mountains of debt, and the shifting of capital from productive uses to stock buybacks, financial engineering, and corporate buyouts, which in turn hollowed out companies, closed factories, and threw working stiffs on the street.

Admittedly, I found the voyeuristic parts of the book to be particularly interesting.  The organizational politics, social norms, and even décor within the Federal Reserve’s Eccles building in Washington are described.  Also described are the personalities, communication styles, and monetary philosophies of some of the key players, including past and present Fed chairpersons, governors, and regional presidents.

Reading like a novel, the book features a protagonist by the name of Thomas Hoenig.  The former President of the Kansas City Fed, Hoenig would go on to be vice chairman of the Federal Deposit Insurance Corporation or FDIC.

Hoenig is a Midwesterner and not a coastal elite.  And with a PhD in economics from Iowa State, he’s not an Ivy Leaguer and doesn’t come across as an egghead, unlike Ben Bernanke and Janet Yellen.

While at the Fed, Hoenig consistently warned about the folly of quantitative easing and was often the lone dissenting vote at the regular meetings of the Federal Open Market Committee, or FOMC.

Among other anecdotes, the book describes a speech he gave in 2006 to bankers at a resort in Tucson, Arizona, where he warned the audience that their embrace of easy money would end badly for them and the country.  No one applauded at the end.  The Great Recession and the bursting of the housing bubble followed two years later.

Years after that, while at the FDIC, Hoenig gave speeches and lobbied Congress on the need to break up big banks into smaller ones and to increase banks’ capitalization.  These actions would be much better fixes for what ails the banking system, he said, than the tens of thousands of pages of Dodd-Frank regulations and the Basil III accords.  Naturally, the political power of the big banks kept that from happening.

The chapters on current Fed Chairman Jay Powell can give the reader an urge to rail about white privilege and become a socialist.   Powell grew up in Chevy Chase, one of the wealthiest towns in America and a suburb of Washington.  He attended the exclusive Georgetown Prep, and his family belonged to the hoity-toity Chevy Chase Club, as well as to an exclusive dining club.

In the spirit of honesty, I have to admit that I also grew up with country-club experience.  You see, I worked as a teen at an exclusive country club in St. Louis, Missouri—a club where Jews, blacks, and Italians weren’t welcome as members in those long-ago years.  I was the only non-black on an otherwise all-black janitorial, kitchen, and wait staff in the clubhouse.

Maybe I have a case of class envy.  If so, the rest of Powell’s background makes it worse.

Powell would graduate from Princeton and then earn a law degree from Georgetown University.  After a stint as a legislative aid, he went into investment banking. Eventually, he ended up at the Carlyle Group, one of the richest and most prestigious private-equity firms at the time, a firm that was headquartered in D.C., unlike most private-equity firms, because that gave it a competitive advantage, due to specializing in the buying and selling of businesses that relied on government spending.

Carlyle was an example of the revolving door between the government and the financial industry.  It was co-founded in 1987 by David Rubenstein, a former staffer to Jimmy Carter.  The book names other bigwigs:

Partners included James Baker III, a former Treasury secretary, and Frank Carlucci, a former defense secretary.  President Emeritus George H. W. Bush was an advisor to the firm.  In 2001, Carlyle hired the former chairman of the Securities and Exchange Commission, the former chairman of the Federal Communications Commission, and the former chief investment officer of the World Bank.  These people helped steer deals to Carlyle, and Carlyle helped these people monetize their granular knowledge and personal connections in the industries they once regulated.

The book goes on to detail how Powell took the lead in Carlyle’s leveraged buyout of Rexnord, an industrial conglomerate headquartered in Milwaukee that made high-precision equipment used in heavy industry, such as specialty ball bearings and conveyor belts.  He and Carlyle loaded the company with unsustainable debt and made millions from the deal.

At the time of the buyout, Rexnord’s headquarters was in a bare-boned, modest building near a company factory in an industrial area.  After Powell became a member of the company’s board of directors and helped manage the company, the management team began holding meetings at hotels and country clubs instead of the headquarters building.  In 2014, he made the class separation complete between company minions and fat cats.  As companies across the land have done, the executives moved into a renovated downtown office building.

It was in one of those up-and-coming areas where once-empty storefronts were being repopulated with wine bars, microbreweries, and Mexican takeout joints.  During Lunch breaks, the Rexnord executives could stroll along the winding pedestrian path across the street, overlooking the Menomonee River, which snakes through downtown [Milwaukee].  The new offices were a self-contained environment, elevated above the middle layers of management and the thousands of employees who worked at Rexnord’s global network of factories.

Such downtowns are a modern version of a Potemkin village.  They hide the economic distress in working-class neighborhoods and the hinterlands.

Tellingly, a new Rexnord chief executive was hired with a background in finance and not in engineering or manufacturing.  Financial engineering was key to Carlyle’s strategy for the company.  “The management team’s biggest maneuvers had to do with leveraged loans and rising stock prices, rather than conveyor belts or ball bearings.”

Carlisle later sold the company to another private equity firm for more than twice what it had paid for the company four years earlier.

As has become a common tragedy in America, Rexnord workers were fired, factories were closed, and operations were offshored.  The book tells the story of a machine operator who lost his job when a factory in Indiana was transplanted to Mexico.  He was offered a severance bonus if he would train his Mexican replacement.  He refused.  The book did not say if he later voted for Donald Trump.

All of this destructive financial engineering was facilitated by the easy money and cheap debt created by the Federal Reserve, where, ironically, Jay Powell would become chairman.

Powell was nominated by Donald Trump in 2018 to replace Janet Yellen.  To Powell’s credit, he began normalizing the Fed’s monetary policy by winding down quantitative easing and raising interest rates.  But the financial system had become so fragile that the stock market fell and economic conditions became precarious.  In typical fashion, Trump contradicted himself on his earlier position on monetary policy and began attacking Powell on Twitter and in the news media.

Powell retreated from the normalization.  He retreated further when the repo crisis hit, and then further still when the pandemic hit.  (The author does a great job in explaining what the repo market is, how it works, and how the Fed’s actions led to the crisis.)

Author Christopher Leonard is better than most authors at being nonpartisan in laying blame, but he’s not a perfect 50-50.  He’s about 53% left and 47% right.  A sure giveaway is when he uses the adjective “far-right” in describing conservatives who railed against the Fed but doesn’t use “far-left” in describing liberals.  This is in keeping with the convention of media and academia in using “right-wing” far more often than “left-wing.” 

Leonard also unfairly criticizes the Tea Party for keeping Congress from addressing the nation’s problems,  because of the other party’s focus on cutting taxes. That’s a curious criticism in a book that exposes the economic carnage from the Fed’s easy money, a regimen that enabled the government to live beyond its means.  Tea Party members may not have known how all the gears of government work, but at least they knew that the gear shift is not in the hands of middle- and working-class Americans.

But these are minor flaws in an otherwise excellent book.

My conclusion is that Congress has delegated too much economic policymaking to the unelected Fed, as well as to humongous federal agencies.  At the same time, 70% or so of the federal budget is for non-discretionary spending and thus on automatic pilot and politically untouchable.  But these failures haven’t kept metro Washington from being one of the top three richest metro areas in the nation.

Incidentally, Chevy Chase, the boyhood home of Jay Powell, has a median household income of $207,971 and a poverty rate of 1.7%.  No doubt, residents don’t have to worry about their jobs being exported to Mexico, and few undocumented migrants from Latin America live in the town.  By contrast, here in my adopted hometown of Tucson, close to the southern border, the median household income in the city is $48,058, and the poverty rate is 19.8%.

There I go again with my class envy.

Signing off now.  Heading outside to howl at the moon.