Thomas Hoenig has been on a policy mission for many years, starting in his 38 years at the Federal Reserve Bank of Kansas City first an economist and in bank supervision, and then moving on to his 20 years as the bank’s president from 1991 to 2011. He also went on to serve as vice chairman of the FDIC, the Federal Deposit Insurance Corporation, from 2012 to 2018.
Notably, in 2010 during the Great Financial Crisis, when the U.S. had its worst recession since the Great Depression, Tom made Fed history when he dissented at all eight FOMC meetings against the aggressive bond purchases known as quantitative easing. He argued that this would do less to boost wage earners than it would to pump money into financal markets which would boost upper income investors, something he and others argue did come to pass.
Now, as Kevin Warsh announces a major Fed task force to examine how these bond purchases are affecting all aspects of monetary and fiscal policy, Tom who is now a Distinguished Senior Fellow at the Mercatus Center at George Mason University in Washington D.C., just released a critical paper on this topic, “The Fed’s Balance Sheet Girth: A Symptom, Not the Problem.”
He has been warning for some time that the the ballooning bond purchases that increase the Fed’s balance made by the Fed to keep the Treasury market “smoothly functioning” and highly liquid, have also made monetary policy makers subservient to fiscal policy and helped fuel an ever growing budget deficit.
Warsh also made Fed history back in 2011 after serving just five years of his eight-year term as he stepped down from the Fed’s board of governors. In 2010 he had opposed the Fed’s second round of QE as an unconventional policy tool that risked distorting markets, fueling future inflation and blurring the line between monetary and fiscal policy.
Sound familiar? Tom sees himself and Warsh as on the same side of the balance debate then and now.
“He and I were on the FOMC at the same time. I think if you go back and look at the transcripts, many of the things he said, I said and vice versa,” he says. “We were concerned about the Fed becoming an instrument of massive printing of money… everyone <else> said you were just talking about inflation and we don’t have it.”
Tom is adamant that in order to maximize growth, the Fed must not be subservient to the government’s fiscal needs. “The reason the Fed is supposedly independent is to do exactly that. We're not going to monetize your debt. That's the message. And they have to step up to the plate and deliver that message.”
As for the many balance sheet issues being researched and debated now, he pushes back proposals he says would push the balance sheet problem into the banking industry. He notes that Silicon Valley Bank which failed in 2023 got into interest trouble because rates rose as it “held all this risk-free interest-bearing government debt and it sank them.”
He sees the balance sheet issue as “a cover story…hiding the real problems… of too much debt in the United States today and tomorrow, and even more so tomorrow.”
As for monetary policy with Warsh at the helm, Tom sees a rate hike rate this year. “Yes it will, as inflation remains well above its 2% target, around 3.5%.”
Spoiler alert: he says with even core inflation at 3% “real rates are extremely low… stimulating the economy in a time where you already have enormous demand.”
Looking forward to task force work 00:02:08:00
Well, I’m looking for some very careful work to be done to help the fed kind of understand what it needs to do, and also give them some ideas about how to achieve their goals once they have findings concluded from these task forces. So it’s two parts number one, knowledge. And number two, how to implement a change for the Federal Reserve and hopefully for the long run US economy.
Warsh and Hoenig on FOMC together with similar views 00:03:05:19
He (Kevin) and I were on the FOMC at the same time. I think if you go back and look at the transcripts, many of the things he said, I said and vice versa. We were concerned about the Fed becoming an instrument of massive printing of money. … everyone said you were just talking about inflation and we don’t have it.
Big balance sheet means lots of distortion 00:03:29:14
I keep saying it would. It’s going to have an effect on the distribution of our resources. It’s going to affect labor, it’s going to affect capital, how those things are deployed. And that distorts the economy. And I think Kevin had the same view. I’m not going to speak for him, but that was my interpretation, and it certainly was my view.
Time has proved our concerns as well placed 00:03:48:11
And I think time has proven he and I mostly correct on this. And so I’m looking forward to Kevin’s tenure. I think he knows what to do. I think his task forces will help him. What I might say codify what needs to be done and therefore give him the heft, if you will, to move forward and at a difficult time, because most politicians do not want to see Fed balance sheets shrunk, nor interest rates ever increase. So it’s a it’s a good combination for him to work, I think, to bring everything I should say to bring things back in balance.
Task forces: A good spread of opinion and expertise 00:05:04:14
And then Jeremy Stein he was on the board of governors. He spoke recently at the Atlanta Fed’s of conference and talked a lot about all these issues. What just broadly is this the kind of people that people that markets and economists and citizens should want to see? Because I think there was a lot of concern, oh, that worship is just going to appoint a bunch of really conservative people who will support what he thinks now.
High caliber members 00:05:32:09
Well, if this is pretty much a blue ribbon group of people, I would say well established, thoughtful, good judgment, deep experience. And I think he chose well. Now, are they going to agree on everything? Probably not. But I think they will come to, I think, consensus that are designed to help Kevin and the FOMC more broadly chart a path forward.
Blue ribbon talent/ hoping for quick decisions 00:05:59:13
And I think that’s a that’s a very useful guide now he said. Year end for this to wrap up, I hope it’s sooner than that because between now and year end, the folk has lots of challenges to confront. So I’m hoping for a speedier deliberation process so that we can all benefit from it. But I do think these are blue ribbon individuals.
Very hopeful on task force results 00:06:21:22
They’ll bring a lot of judgment and have a lot of respect in the United States and globally, and I think it will help they have him see better. Explain to the American people why we need to make certain changes, not just in the size of the balance sheet, but on how we conduct monetary policy for the long term and how we cannot be, how the Fed cannot be subservient to fiscal needs, which are only growing.
Unsustainable…00:06:47:11
I mean, our debt, our deficits are now above $2 trillion. Our payment of interest on the debt is over a trillion. These things can’t continue. And these blue ribbon members know that...
Fiscal dependency: has it arrived? 00:07:22:07
Well, I think the way I would explain it is a balance sheet is the Federal Reserve’s means of implementing monetary policy through increasing the amount of money that’s in the economy, and how they manage that affects your daily life. It affects not just inflation, it affects real wages. It affects real output, national income. That balance sheet is critical to how we get a economy that grows systematically at a acceptable pace for full employment, but the full employment only follows the responsible management of that balance sheet towards stable prices.And that’s how I would explain it. Now. There would be more to the conversation because I’m sure they have questions and and further explanations worn it, but that would be my basic message.
Needs a char with Congress 00:08:41:08
Well, the thing about a smaller balance sheet, depending on how they decide they’re going to manage the balance sheet, is that they would they would have to sit down with Congress and explain that we’re not going to monetize the debt as we have in the past, and we’re also not going to continue to allow the banking industry to lever up as much because they’ll take on the new debt issuance, because you’re spending so much more than you’re taking in as revenue, that the only thing we can do is inflate. If we try and continue to put your, your, your debt on our balance sheet, it’s only going to inflate the economy and harm the economy in the long run. So we have to say to you. We’re not going to grow our balance sheet at the rates we have been growing at any further in the future, and get that across.
Time for tough love 00:09:35:15
It’s a it’s a tough message, but it’s a message that has to be delivered in my opinion.
Earth to Congress, earth to Congress 00:10:03:16
I can say that they could do it. And I hope Kevin does that. Now, I don’t mean shock the economy immediately. I mean, we’re not we want to work with you. You’ve got to bring your spending and revenues into better alignment. We will, we will we will respect that. But we cannot continue to fund your increase in spending and your increasing debt levels.
Another aspect of Fed independence 00:10:28:18
It just cannot work for the US economy in the long run. And I would do it in that way. But Kathleen, the reason the I keep saying the reason the Fed is supposedly independent is to do exactly that. We’re not going to monetize your debt. That’s the message. And they have to step up to the plate and deliver that message.
An obvious policy move and need 00:11:18:09
Well, it’s it’s not the right thing to do in the sense that you’re continuing your you’re spending more than you’re taking in. It has to be funded. So you’re funding at the short end. And the reason you have to fund it at the short end is who wants to have a long term treasury. If you think inflation is going to go on up and eventually you’re going to lose money, I mean, the bondholder will be the one who takes the pain at some point if interest rates eventually have to go up.
Right now it must be the short end 00:11:50:19
So it has to be down at the short end. That’s not good management, fiscal management that’s necessary. Fiscal management for your problem that you are not willing to address. And so they really need to take a heart. They be in the Treasury needs to take a hard look, and the Fed needs to take a hard look.
Need a new Accord 00:12:10:19
That’s what the that’s what the original 1951 Treasury Fed accord was about. And what Kevin actually has brought up in his own speeches and writings prior to becoming chairman. And that is we need a new accord with the Treasury. And I agree with him. They need a new accord that says no. And then you need to talk with Congress, as happened after the accord in 1951.
Bring back discipline 00:12:34:12
We actually ran fiscal surpluses during the 50s. And it was and guess what, Kathleen? Our growth rate in that decade was closer to 4% than 1.8%, which we’re talking about today. So there’s lots of advantages to carefully, methodically bringing discipline black back to fiscal and monetary policy of the United States.
The Fed no longer is engaging in yield curve manipulation 00:13:16:11
Well, I think from the Treasury’s point of view, I think it’s to help keep interest expenses down for the time being. From the Fed’s point of view, when you start buying along the yield curve, as they have during the period, you’re suppressing interest rates, you’re you’re you’re taking the market and the bond market out of action, out of providing its own discipline because you’re managing the yield curve.
Fed is dominating 00:13:42:13
The Fed is is dominating and it’s become even more dominant. It it is a major player in the in the money markets and the treasury market in in its earlier period, even with Open Market Committee, it was on the margin. It wasn’t dominating these markets. And that needs to change.
How to let the banks load up… 00:14:40:06
Well, number one, the motivation for that is if you if you ease the capital requirements and you ease the liquidity, the banking industry can take more of the debt because it isn’t constrained by capital, in other words, the size of their balance sheet. And it isn’t constrained by liquidity because the Fed is going to be right there for you to take it on, folks.
But deficit financing is the problem 00:15:02:09
We’re going to be right there. So you’re really not solving the problem. The problem is the United States is spending more than it’s taking in every year by dramatic amounts. And the consequence of that has been to lower the real growth rate, give us an implicit inflation rate that is far beyond price stability and far beyond 2%. And those are those are adverse consequences.
Balance sheet is an issue but fiscal excess is the problem 00:15:26:11
So switching out who’s going to grow their balance sheet doesn’t solve the fundamental problem. And that’s where I, I know Darrell and I know he’s absolutely right about this. But my point is Darrell that pushes the problem into the banking industry. Maybe that’s better. Maybe maybe it is. But it also means it’s going to be more leveraged and more exposed.
Banks can hold too much government debt’ its not risk free 00:15:48:22 -
Take for example, Silicon Valley. You know, that bank had mostly government debt, I mean, on as an asset, but it’s still got into interest rate trouble because interest rates rose and they held all this risk free government debt and it sank them. Bank of America had almost half its capital and unrealized losses. Those are hidden problems. And shrinking the Fed’s balance sheet doesn’t solve those problems.
Shrinking the balance sheet is no panacea 00:16:17:17
It merely hides them more. And I think that’s what the United States has to be aware of and what policymakers, fiscal and monetary, have to step up to.
Pushing the problem onto bank balance sheets does not solve it 00:16:50:03
I think that the balance sheet is important, but I think right now in terms of a solution, it is it is a cover story. It is it is hiding the real problem. We’ll shrink the balance sheet by pushing it on into the banking industry. Doesn’t solve the fundamental problems of too much debt in the United States today and tomorrow, and even more so tomorrow.
Too much focus on the balance sheet is misplaced interest 00:17:19:12
And that’s what we’re ignoring, and that’s where I worry about.
Strengthen banks’ balance sheets 00:17:37:24
Well, yes. And it’s what that is. Basically, Kathleen is a much tighter monetary policy. And of course, you can see what the consequences will be if they do that all at once. I think what they at least should do… I’ve argued for some time that you should strengthen the capital accounts of the banks and ease the liquidity requirements.
Fiscal Dependency undercuts a central bank 00:20:06:12
Well, I think the fact of the matter is that fiscal, the fiscal dependency on the central bank is a very serious issue because it doesn’t allow the central bank to operate as a provider of sufficient reserve growth for the real economy to grow. It’s now has to provide sufficient monetary based growth to accommodate not only growth in the economy, but growth in the national debt.
Fed is forced to play the debt accumulation game 00:20:38:07
That’s a that’s another mission. And I have argued for some time that the Fed has implicitly, by not saying no to the Treasury or to the Congress, has implicitly accepted a number. I what I’ll call a fourth mandate, that is that you will have a fully functional, highly liquid treasury market for debt, and therefore the Fed has to intervene.
The menu of choices puts the Fed on the spot 00:21:07:14
That’s why you have standing repo facilities. The Fed has to intervene. That’s why you have immediate access to the discount window. Because if you go underwater with your securities and you need liquidity, you can’t sell the securities. You’ve got to come to the Fed. So you’re increasingly making the central bank a central part of your debt financing at a tremendous cost to the economy long term.
Circular reasoning with the buzzards circling 00:21:34:21
And that’s where I have major concerns for our future. And when you look at the CBO’s projections of ten years from now, right now, our total debt is is soon going to be $40 trillion. It will be closer to $55 or $60 trillion at the end of a decade. How are you going to deal with that? Unless the Fed prints base money to facilitate the growth, the acceptance of that debt on its balance sheet and the acceptance of that debt in the in the banking system and in the financial industry more broadly.
The more you bail the deeper the water is next time 00:22:11:15
And that’s where I have concerns. Remember, we have a whole hedge fund market, a whole based on repos that are around financing government debt, highly leveraged. We saw what happened in 2019 when people began to worry about that. You saw fed funds rate shoot up, liquidity dry out, and a crisis began to develop. And that’s what we are asking for in the future, putting more and more pressure on the central bank to print money, always to bail out the financial system and the Treasury and the Congress at a call. It’s kind of a call for it.
FinRegRag! 00:22:54:06
So let me mention ‘FinRegRag.’ I don’t know if I mentioned at the beginning, but I want to because a great it’s a great piece. It’s a great. All kinds of thinking there on from the Mercatus Center. And you are frequently writing blogs about this. And again, you just had another one to kind of bring the balance sheet back into the picture this week.
FinRegRag: Location 00:23:25:12
It’s on Substack, Red rag and. Yeah. Feel free to access ità. (here)
Is one party more responsible for fiscal excess than the other? 00:23:43:01
Well, I think both parties have every reason to take credit for this excess, whether it’s a Democrat. And I’ve always said the Democrats and I’m an independent of the Democrats, they want to they want to spend more money and they know they can’t get tax increases to do it. So, they accept spending the more money not not paying for it. Republicans, they want tax cuts, and yet they know they can’t get spending reductions that they need. Therefore, they will take the tax cuts and let the spending go forward. So from their different perspectives, they’re both guilty of what I call questionable judgment about our long term debt position and spending position going forward.
Communications problem and an issue focusing 00:25:21:21
Well, just go through it. Number one, they have a communications problem. It’s and Kevin recognized that. So I think forward guidance I agree with that that with his views on that I think it’s been very harmful. It’s bound the Fed to certain actions that they knew they shouldn’t take but were afraid to disrupt the market. That needs to go away.
Productivity – the blessing and curse 00:25:45:03
Next, productivity. So there’s a lot of people talking about how much productivity is going to solve our problem. I think that’s a mistake. I like AI as much as anyone, but to get 6% productivity gains would be unreasonable to expect. If we get 3%, I would be pleased with that. And so productivity, they have to think about that because it does affect how you manage monetary policy for the future.
Some task force recommendations are more pressing than others 00:26:12:06
So it’s a very, very good point. And then of course monetary policy itself. Very important point. I do think these are these are significant and will affect how the Open Market Committee thinks about policy in the future. Some of them probably could be put off to the end of the year. But some of them like, you know, forward guidance that needs to be thought through quickly in terms of letting the world know how the Fed is going to communicate. So these are things that are critical. I really think it’s a good idea to do it. I think it’s if possible, to do it more quickly than less will serve us all very well.
Fed rate hike expected 00:26:57:02
Well, let’s see I do <expect a rate hike> because I think inflation is well above the target of 2% and well above price stability. You cannot bring that down probably with rates where they are now at 3.5%, because inflation right now even core inflation is 3%, which means real rates are extremely low. And with real rates extremely low, you are stimulating the economy in a time where you already have enormous demand.
Lots of stimulus to build out AI..then what? 00:27:32:13
In this economic world we live in now, look at the capital expenditures for AI. Then you have other capital expenditures you need. We know that the wealth effect is putting great demand on consumption and retail sales. Those are still growing. So what’s going to moderate those those factors if we keep interest rates negative or very close to zero going forward.
Rate increase before year-end 00:27:55:18
So I suspect there needs to be a rate increase before year end. I think the real hard part will come before the election or after the election. And that I can’t answer. That’s something the FOMC, I’m sure is thinking about as we speak. And maybe at a hint of that at the next meeting, not in terms of forward guidance, but in terms of what actions they do take or don’t take.
Thomas Hoenig
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.
