THE BASIS POINT

Final Words From Thomas Hoenig, Lifetime Fed Dissenter

I’ve cooled to NYT’s Gretchen Morgenson over the years because she’s taken the easy populist path of evil institutions out to destroy consumers. That theme attracts readers but she’s not on the ground at the financial, mortgage and real estate advisor levels so she’s unaware that there are armies of advisors out there who see it as their purpose in life to protect the consumer and help them make smart decisions.

But Morgenson lived up to her potential this weekend with a piece on Thomas Hoenig, Kansas City Fed President who’s retiring next month. Up to last week’s Fed meeting where three FOMC members—the most since 1992—voted against low-rate policy, Hoenig was the only consistent dissenter in the post-crisis era. Thankfully, he’s looking to engage in some new public service-related job after he retires. Here are some key excerpts from Morgenson’s exit interview with Hoenig, and the full piece is linked below.

“Extremely powerful institutions, both financially and politically, undermine the long-term strength of our system and make us look like a financial oligarchy,” he told me. This view, of course, receives little applause in Washington and on Wall Street.

Mr. Hoenig has espoused this view for more than a decade, and he has grown accustomed to being ignored or criticized for it. Back in 1996, in a speech at the World Economic Forum in Davos, Switzerland, he presciently warned about the dangers of expanding the federal safety net to cover financial institutions trading complex derivatives and structured finance vehicles.

Pushing for a new regulatory regime that would deny a safety net to institutions engaged in risky activities, he told the attendees: “The threat of failure keeps a bank honest and inhibits it and the industry from trending toward excessive risks. Without this market discipline provided by creditors willing to withdraw their funds when they suspect a bank of being unsafe, banks have an incentive to take excessive risks.”

Mr. Hoenig’s prescription was to bar institutions that engage in risky business from offering government-backed deposits and to minimize their access to emergency Fed loans. Although he has been vindicated in this view, big bankers howled and regulators yawned at the time.

“I was trying to point out that these kinds of activities are beyond management’s control,” he recalled, “and that if you want to do this, you cannot have the taxpayers subsidizing it.”

He added: “It was controversial. It was not well received by some.”

In 1999, as Congress was finally doing in the Glass-Steagall rules that had separated investment banking from old-fashioned commercial banking, Mr. Hoenig made another public warning about big, interconnected financial companies. “In a world dominated by megafinancial institutions, governments could be reluctant to close those that become troubled for fear of systemic effects on the financial system,” he told an audience at the European Banking and Financial Forum in Prague. “To the extent these institutions become ‘too big to fail,’ and where uninsured depositors and other creditors are protected by implicit government guarantees, the consequences can be quite serious.”

We sure found that out.

More recently, in the aftermath of the 2008 crisis, Mr. Hoenig has continued to counter the conventional wisdom in Washington. “The Dodd-Frank legislation, for all its 2,300 pages, does not fix the fundamental problem of too-big-to-fail banks,” Mr. Hoenig said last week. “I think the post-Depression response was the answer — you break them up. If you are going to have access to the safety net, you are going to limit your activities.”

Last year, when he was a voting member of the open market committee, Mr. Hoenig dissented on monetary policy decisions at every meeting. Because he is no longer a voting member of that committee, his current views on the Fed’s most recent policy decision were not reflected in the dissents registered last week by three other regional Fed bank presidents, Richard W. Fisher of Dallas, Narayan Kocherlakota of Minneapolis and Charles I. Plosser of Philadelphia.

“My objections have been based on the fact that the central bank has to think about what its policies mean for the long term,” Mr. Hoenig said. “We as a nation have consumed more than we produced now for well over a decade. Having very low rates for an extended period of time encourages us to continue focusing on consumption, but to correct our imbalances, we have to focus on production.”

Creating jobs and finding ways to keep American businesses from fleeing abroad is not exactly the domain of the Fed, Mr. Hoenig conceded. But neither should the Fed’s actions work against the goals of generating a more productive economy, he said.

“The central bank has to be, in a way, a neutral player, and yet we find ourselves trying to stimulate, and the effect is further leveraging,” he said. “If I thought zero rates would bring jobs, I’d want it forever. But it distorts the economy.”

Conventional Fed Wisdom: Defied – New York Times