How did Thomas Hoenig, a onetime career Federal Reserve official, a former top bank regulator, and a monetary and banking policy thought leader, end up being lauded by Scott Bessent in a major article the Treasury Secretary wrote that is highly critical of Fed policy and practice?
Let’s start with the title of Bessent’s piece criticizing the Fed for following what he calls a “New Gain-of-Function Monetary Policy.” It goes far beyond President Trump’s push to get the Fed to start cutting rates and to cut them aggressively. Bessent criticizes the Fed for taking the “extraordinary” monetary policy tools like quanatitative easing and using them in ways that have backfired and calls that sort of policy misuse the real force jeopardizing Fed independence.
As catchy as Bessent’s title is, and as an in-depth and thought-provoking as the analysis may be, that’s not what grabbed me most.
What caught my attention is how Bessent’s article singled out and praised Tom for “his famous 2010 dissent from the Fed’s decision to begin a formal program of asset purchases targeted not at financial stability and augmenting liquidity, but as a tool of monetary policy, which subsequently became known as QE.”
Bessent goes on to highlight Tom’s subsequent realization that the “allocative effect” of the Fed’s policies would shift money between rich and poor, and encourage things “like Wall Street speculation that could lead to ruinous financial crashes,” and has been a major reason for his distaste of QE.
I have known Tom since 1991 when I first met him at the Kansas City Fed’s Jackson Hole symposium when he had just been chosen to take over as president of the K.C. Fed. And I remember very well when he cast the lone dissenting vote against the Fed’s easy money policies at each of the eight FOMC meetings in 2010. (Hard for any other Fed officials to top that one!)
I was at the annual meeting of the Shadow Open Market Committee in April of this year when Tom proposed a system where Congress should have oversight of the the Fed’s bond purchases which at the time seemed like a novel proposal that would step on Fed independence — but now seems more in synch with calls for more Fed accountability and more interchange with the government.
Tom’s presentation on these matters in this podcast is eye-opening, unexpecteed, and takes a potentially groundbreaking turn at dealing with some festering problems related to the reality of Fed independence, including how the desire to remain independent has affected Fed behavior and the reality of real world political pressure. Tom shows how these forces might be dealt with in a more reasonable way to preserve all the elements necessary to suppport good monetary policy including the protection of Fed independence.
So open your eyes and ears and listen to Tom, a former top Federal Reserve Bank president, a former vice chair of the FDIC, a seasoned policy-watcher and a policy-maker as he assesses the tangled web of setting monetary policy and executing regulatory oversight as he shares his vision of a better environment that will enhance outcomes.
Bessent Says Fed does not understand QE - Hoenig disagrees 00:02:02.680
Well, I think they do understand, by this time at least, and I think they understood it when they began it, and the idea was to inflate asset values. And to… The outcome they hoped would be that you would increase The wealth effect. And therefore increase consumption through the wealth effect. I think that, as often is the case, the intentions may have been good. We wanted… at that point, remember in 2010, when they began this Unemployment was still very high, well above 9%. And the whole idea was our dual mandate, our dual mandate, we've got to bring unemployment down as quickly as possible, and therefore we will do this quantitative easing program, and increase asset values, and increase wealth effect, and have more purchases, and create demand. The problem with that is. Not thinking it all the way through, number one.
QE understood...side effects, not so much 00:03:03.300
The fact that you suppress interest rates to zero and you do massive printing of money, you misallocate resources, you engage and encourage speculative activities, you misallocate resources, and the longer-run effects can be quite damaging, and While they may have, in the back of their mind, saw that as a possibility, they just thought that the trade-off was worth it, and engaged in that quantitative easing, despite the fact that the risks were high. And as a result, we did get asset inflation, we did get a misallocation of resources, we did get a division of wealth. If you had assets. Before you began this, and you benefited from the inflation, you were a winner. If you're a wage earner, and you…
Very uneven benefits 00:03:50.200
It kind of didn't benefit, in terms of increased productivity. There wasn't much. And in terms of your ability to stay even with these higher asset values, you were a loser. And that created, I think, a great deal of unrest, and I think led to, Shall we say, a… a… a new kind of suspicion of the Fed and of government overall, and a lot of dissatisfaction among those who did not benefit from the higher asset value. So, unfortunately, the results were not as good as people had hoped for.
The Fed should do away with the concept of QE 00:06:03.490
Well, that's unfortunate, because they should do away with the concept of QE as a monetary policy tool. But remember, QE was not called QE in the past. It was called a liquidity facility. That's what the lender of last resort is all about, and that's what entering the market in a crisis to provide liquidity into the market is all about. So, in 2008…
I voted for it originally as a liquidity facility 00:06:28.790
When we had the meltdown. The Fed did enter it, and I voted for it, providing liquidity into the market to keep the market from collapsing. Now… That was… that was called… after the fact, was called QE1. But the fact of the matter is, that… What you want to do is Provide the liquidity until the crisis is over. Now. The economy of the United States was in recovery in the third quarter, 2009.
But then the policy continued and it was a mistake 00:07:01.890
And it was recovering through 2010. And it wasn't until November of 2010 For my objections that they engaged in quantitative easing, too. And that's the real beginning of quantitative easing as a policy tool. Because the unemployment numbers were so high. But they said, well, yeah, but they're high, and we've got to take care of it, and we've got low interest rates, so we're going to do quantitative easing to cause asset values to appreciate, and we'll solve this problem through quantitative easing. And that was a mistake.
Zero rates were maintained for too long 00:07:33.290
Zero interest rates cannot be maintained indefinitely without inviting a misallocation of resources, which I said would happen, and then eventually inflation. So quantitative easing 2, quantitative easing 3, quantitative easing 4, we're almost at. So now you come to the pandemic. And in March of 2020, you have a meltdown. People panic. And the Federal Reserve did enter the market and provide liquidity into the market broadly. More broadly than perhaps it needed to, but nevertheless, it did so. And that was March of 2020. Well, by the August of 2020, the market had settled down. The economy was stabilizing. But they continued quantitative easing through the rest of 2020, all of 2021.
Add in monetarized fiscal stimulus… 00:08:19.200
They didn't really stop it until March of 2022. Well, that was way past the needs for bailing out the bond market, or being a lender of last resort. And as a result, what you found that the Fed was doing. Either deliberately or by… Accident, whichever you want to choose as your reason. They monetize an enormous fiscal stimulus That was brought into the economy. And it was brought into the economy following the great financial crisis, and it was brought in again following the pandemic. And the Fed monetized all that debt to make sure that the bonds stayed at low interest rates, and as a result, you got a major inflationary expansion. The second time around. Mistake? Yes. Should be admitted, and we should stop using quantitative easing as a monetary policy tool, rather than a temporary liquidity tool.
Temporary facilities should have limits 00:09:55.860
There should be limits on how long you can use emergency facilities like QE. To a temporary facility. And if you want to use it beyond that, you have to have a law passed. You have to have the Congress pass a law that says, yes, we want you to do that, and the president signed it. Now you know where responsibility lies again
The authority starts with Congress…which has a role 00:11:42.750
Well, first of all, my rationale is that the Constitution actually assigns the monetary authority to the Congress the mining of coin, the… basically, the money value. So it's their responsibility. Now, what Congress did is it delegated that responsibility to an institution called the Federal Reserve System. And structured it very carefully to try and give it a certain degree of autonomy. But it's like any other institution. It should not be free of any kind of boundaries.
The Congress isn't free of boundaries, supposedly. I mean, you still have to pass laws… you know, the President of the United States can veto that, the Supreme Court can check that, so you have to have boundaries around everything, and boundaries should be around the Fed.
And my boundaries are the Fed should be limited on how much it can do. In terms of interest rates, and how much it can do in terms of its money printing process, and its ability to facilitate the money printing process. And that is, for example… they should not be allowed to lower interest rates below 2%, nominal. Or 6% above… 6% nominal. And they should not be allowed to allow the… they should not be allowed to increase or allow the reserves in the financial system, or in the banking system, to increase more than 3% on the annual rate.
The Fed SHOULD conduct policy but within constraints 00:13:09.610
Now, that gives you enough… enough liquidity, enough flexibility for the economy to grow at its potential over time. Now, if you have a crisis, and they will occur. You… at that point, you say to them, okay, you have a lender of last resort, yes, you can provide liquidity into the market. At a rapid pace, For up to…I'm picking a number, I think it should be debated, but I would pick a number of, say, 6 months. By that time, you should be able to get through the crisis, and you should no longer be able to expand the reserves or use quantitative easing. indiscriminately any longer. Or lower interest rates. below 2% any longer. Should stop, and you should have…
Now, if you say, well, yeah, we're still… we're worried about unemployment, then okay, Congress, we're coming to you and say, here's our reason for why you should extend this. And Congress should debate it, pass the law, and should go to the President of the United States to sign it. Now, we have put the responsibility back where it… the Constitution places it, with the Congress of the United States and the President.
Many pressures on the Fed to cut rates - 00:16:16.730
I hope that Secretary Bessett means what you said, and I'm sure he does… I would question whether the Fed, right now, with a massive debt coming…should… have pressure put on them to… to bring interest rates down at this point. And to print more money, should it be necessary… should doing so require… funding a $2 trillion new debt this year, this coming year, whether they should be printing money to do that. And, I think therein lies the question, should you… should they be lowering rates now? Should they be, putting pressure on to engage in quantitative easing again? There's… nothing to prevent that from happening, and the pressure that I see coming at the Fed will be increasing pressure to do exactly that.
Implement rules to protect the Fed-freedom within parameters 00:18:15.280
Well, what I'm saying is, you can't protect the Fed without rules, of conduct. that the Treasury… I'm not saying they need to coordinate, I'm saying the Treasury needs to know what those rules are, and the Fed needs to know what those rules are, and obey them. And the rules should <impose> limits to how much we can ease policy, and how much we can grow reserves over a period of time without congressional action and presidential action. So that if you're <Congress or the President are > going to put pressure on the Fed to do it, by God, you're going to take responsibility for it, too. And if you're… and the rules say you have to stay out of it. And the Fed can't go beyond those rules. And if you wanted to go beyond those rules. Then you have to pass a law that says so and take responsibility for it. And I want to allow enough discretion within the rules for the Fed to conduct policy on an ongoing, normal, conditioned basis.
For example: the Great Moderation 00:19:16.820
So that, you know, during the so-called period of great moderation, the Fed moves interest rates between the two and, say, 5% level. They let reserves grow at 3% a year. The economy grows. The Fed does its job. Now you have a crisis, all right? You can engage, but only for so long, and after that, you have to get out of it unless Congress says, oh, we want more. And then you put the responsibility where it belongs.
Banking regulation: who should regulate? The Fed? Agencies? 00:20:27.780
Well, here again, so who's responsible? The Congress passed the laws. They came out there. And then, once they're in place, they argue about whether or not they should have it. Let me give you an example. Now, is it just the Fed, or is it the OCC and the FDIC who have a proposal out to reduce the capital standards for the banks? So, capital is essential to financial stability, having strong capital base. It's… right now, they use this risk-weighted system, but right now, the leverage ratio, that is how much capital do you have against total assets, there's a proposal out. to ease that. That it shouldn't be a binding constraint, it should be a backs, whatever that means, but the fact of the matter is, all three agencies want to ease the capital standards, which are essential to financial stability. So am I going to blame the Fed for that? Or do I blame the pressure that's being brought to the regulators overall, no matter who they are, to ease the requirements and benefit the banks? And who's doing that?
It's not who regulates banks - it’s where the pressure originates 00:21:32.760
Is it the Congress? Is it the Treasury? Who's pushing for this? You have to answer that question. People will say it's the… it's the Fed, people will say it's the FDIC, people will say the Comptroller, who happens to be within the Treasury. You know, you're asking… the wrong question. Why is it that we keep easing financial standards to allow the economy to leverage up, at the worst possible times? And right now, we want the economy to be more leveraged. That's why we have these proposals to ease the capital stand. So, you know, if you're going to blame someone. You know, Congress writes the laws. And I think that's where you have to look.
Taking bank-regulation away from the Fed will change nothing 00:22:24.990
Well, here's how that's going to work. You're going to take it away, as they did at the Bank of England prior to the Great Financial Crisis….do you have the knowledge, then, of the individual institutions that get into the crisis? Do you have the wherewithal to know whether they're solvent or not? And there'll be an argument, well, they should at least have some knowledge. Will they get it from the other agency, or will they have to have it direct? We're going to go through that whole argument all over again. And the question <Answer> is, you know… Keep the rules simple. Simple and understandable. And take simple very seriously.
Capital is basis for financial stability: how about risk-weighted standards 00:23:00.460
Capital is a fundamental basis for financial stability. Stop undermining it! For example, you have these very complicated risk-weighted capital standards that no one understands, and you keep going forward with it. So should the Fed be it? Well, you can take it away from them, and it won't change the outcomes… you're still going to have the pressure to ease the capital standards, you're being too tough controller of the currency, you're being too tough FDIC, you've got to ease that.
The problem is shifting rules and standards: Living Wills 00:23:33.990
You know, look at the source of the problem. The problem is we don't stick to our guns in terms of financial standards. We make it more complicated. Look, and I'll give you an example. The living wills. Part of Dodd-Frank. We're going to make sure these people know how to go into bankruptcy. They've never been used. There are thousands of pages of complicated, almost incomprehensible organizational what you're going to do stuff that no one understands. The board of directors doesn't understand them. The regulators may have some knowledge of them, but they never use them.
The solution to getting better monetary, banking policy 00:24:21.320
Fewer conflicts between monetary policy and supervision. So that's my argument. Sure, take it away from the Fed, it's not going to get better.
Game for control of the Fed: what President doesn’t think they know better? 00:24:56.940
Gee, what's going on at the Fed? You know, they're trying to control who the next governor is, and try to get rid of the Board of Governors, so we can fill it with one of our people who's going to do what the president wants, start cutting rates, et cetera, et cetera. I don't know of any president who doesn't think they know better than the Fed. I mean, start with Johnson, go to Nixon, you know, Truman, you know, that's the thing. So, yeah, if you want, an independent Commission can look at it. The Fed has made mistakes. You can't deny that. So has the Congress. Congress has made some terrible mistakes. We have a debt problem that's overwhelming the Fed.
Good fences make good neighbors- and protect independence 00:26:00.410
So, yeah, okay. Now, let me… let me go back to Simpson-Bowles on the fiscal side of things. They did a great job, they had a great plan, and the Congress turned it down. So much for commissions. So, yeah, I would like to see a commission, and I actually have said at you and others, here's what I propose. You put boundaries around what the Fed can do so that you secure its independence. <So> fine, let's do it. Let's have a commission, let's do something like that. And I think you'll have a better outcome for it. However, if you then… if you then have the commission, and it has these recommendations, you say, yeah, but I don't want that. I want more control, well. So <this will…be the end of the commission.
The Fed is in danger! 00:27:35.200
The Fed is in danger. But let me… let me give you my biased personal experience. I'd like to think it's objective, but everyone knows I'm from a reserve bank. But the Federal Reserve's structure was designed To compensate for these Various Interests as we go forward. the Fed was under… This is the Federal Reserve System, it is the third central bank in the United States.
The Fed SYSTEM IS solid and SHOULD NOT be changed 00:28:05.580
So, since the founding of the country, there's always been suspicion of a central bank. That's where the money is, that's where the power is, and so you are very careful about it. So, when they decided to put this central bank together, they recognized that you're going to have these interests.
So, what did they do? they divided authority. They put the Board of Governors in place, politically appointed, and they put these 12 Reserve Banks, which I'm very proud of, to be a part of, have been a part of, who have a… more of a populist basis. More of a… from around the country a populist base, right? Okay, so they're out there, and they have local input. And so you have this base. So, over time, these presidents had independence. they're out there, and they have local input
Then, over time, you tend… the thing about centralized power…. is it wants more power. And so over time, you move more of that power of decision-making to the Board of Governors, to the Chairman. The Chairman has enormous power, power of the bully pulpit and so forth.
Well, I think the structure should be, shall we say, the infrastructure should be given further support, should be rebuilt to strengthen these reserve banks, not weaken them, as everyone seems to want to do, so that you have different input from the west coast, from the North central, from the South Central, from the Plain states, from the Southeast, and you come into this meeting, and you have this input.
Thomas Hoenig
Thomas Hoenig is a Distinguished Senior Fellow at the Mercatus Center at George Mason University. Mr. Hoenig engages in research and comment on economics, money and banking, and related policy topics and provides economic outlook and related services to investment firms and businesses across the country.
Prior to joining the Mercatus Center, Mr. Hoenig served as Vice Chairman of the Federal Deposit Insurance Corporation from 2012 until 2018. In that capacity, he oversaw FDIC operations and policy related to deposit insurance pricing, bank supervision, and financial stability and bank resolution. He served as Chair of the FDIC’s Bank Appeals and Audit Committees, and served as Director of NeighborWorks America, which was established by Congress in 1978 to address housing issues nationwide. He also served as a member of the International Association of Deposit Insurers’ board from 2012 to 2017, and as the President and Chairman from October 2015 to October 2017.
Previously, Mr. Hoenig was President and Chief Executive Officer of the Federal Reserve Bank of Kansas City and a member of the Federal Reserve System's Federal Open Market Committee from 1991 to 2011. Mr. Hoenig was with the Federal Reserve for 38 years, beginning as an economist and then as a senior officer in banking supervision. As President and Chief Executive Officer, he led the Federal Reserve Bank of Kansas City during the Great Recession and the banking crisis of 2008 and 2009.
During his time with the Federal Reserve, Mr. Hoenig chaired several key committees including the Conference of Presidents, the Committee on Bank Supervision, Regulation and Legislation, and the Information Technology Oversight Committee. Also, during his tenure, Mr. Hoenig organized and hosted the Federal Reserve Bank of Kansas City’s Jackson Hole economic symposium for global central bankers.
Mr. Hoenig is from Fort Madison, Iowa and received a doctorate in economics from Iowa State University.
