The Fed’s Lack of Appreciation for the Healing Power of Markets

In my recent Cato Institute policy analysis, “Requiem for QE,” I analyze the transcripts of the 2008 and 2009 Federal Open Market Committee (FOMC) meetings in some detail.  Among them, the March 2009 transcript stands out as particularly troubling, as it reveals the FOMC’s failure to appreciate an economy’s ability to heal itself through market mechanisms following an adverse macroeconomic shock.

Yet market economies do have self-correcting mechanisms: relative prices change, resources get reallocated, and consumer and business expectations adjust to new realities.  In the case of the financial crisis, expectations had to adjust to the fact that house prices were significantly out of line with economic fundamentals.  As they did,  perceptions of wealth declined in line with house prices.  Workers, particularly those in construction, began the process of acquiring new skills, finding alternative employment, starting new businesses, and so on.  That these self-correction processes were already at work prior to the March 2009 FOMC meeting is one reason why the recession ended just three months later, in June 2009.

The same self-correcting mechanisms can be seen in the very markets in which the financial crisis began.  Put simply, the financial crisis was precipitated by a decline in house prices which, in turn, sparked concerns about the default risk of banks and other financial institutions with large holdings of mortgage-backed securities (MBS).

The Dowager Countess of Grantham Denounces Statism

Libertarian fans of Downton Abbey got a special treat last night when Violet, the Dowager Countess of Grantham, let loose with an excoriation of statism right out of John Stuart Mill. Debating whether the village hospital should be merged into the larger regional hospital in 1925, Lady Grantham exclaimed:

For years I’ve watched governments take control of our lives, and their argument is always the same — fewer costs, greater efficiency. But the result is the same, too. Less control by the people, more control by the state until the individual’s own wishes count for nothing. That is what I consider my duty to resist….

The point of a so-called great family is to protect our freedoms. That is why the barons made King John sign Magna Carta.

Rosamund: Mama, we’re not living in 1215. And the strength of great families like ours is going, that’s just fact. 

Countess: Your great-grandchildren won’t thank you when the state is all-powerful because we didn’t fight.

Of course, the Dowager Countess is not a libertarian, nor a liberal, but a reactionary aristocrat. Still, libertarian ideas crop up wherever people feel their liberties being infringed. And such ideas were being enunciated by genuine liberals in that era. An editorial in The Nation in 1900, thought to have been written by its founding editor E. L. Godkin, mourned the decline of liberty and liberalism:

To the principles and precepts of Liberalism the prodigious material progress of the [19th century] was largely due.  Freed from the vexatious meddling of governments, men devoted themselves to their natural task, the bettering of their condition, with the wonderful results which surround us.  But it now seems that its material comfort has blinded the eyes of the present generation to the cause which made it possible.  In the politics of the world, Liberalism is a declining, almost a defunct force. 

Liberalism was giving way, he said, to the forces of socialism and imperialism; and “international struggles on a terrific scale” were the likely result, struggles that indeed had already begun by 1925 and would only get worse in the lives of Lady Grantham’s grandchildren and great-grandchildren.

Fed Disclosure

Earlier this month, the Federal Reserve released FOMC transcripts and related materials from 2010. One of the issues—an important one—discussed in October and November of 2010 concerned Fed disclosure of inside information. Those transcripts hit one of my hot buttons. Fed leadership, instead of being defensive as shown in the 2010 transcripts, should be vocal in explaining why non-public activities further the cause of sound monetary policy.

Consider first an extreme view, a view that will help to frame disclosure issues. Would we want the Fed to confine its contacts with outsiders to public meetings at which press were present, or could be present? In that case, the FOMC would make its policy decisions solely on the basis of publically available information, such as that released by the Bureau of Labor Statistics and other statistical agencies. Keep in mind that under this view Fed officials would not only cease to have any non-public meetings with private sector individuals but also with government officials.

I add government officials to the mix because it is well known that some members of Congress and congressional staff make stock trades based on inside information.

FOMC practice has long been to gather nonpublic information, some of which is presented in FOMC meetings. The beginning of every FOMC meeting is occupied with presentation, and discussion, of anecdotal information. I always made an effort to smoke out expectations about the future from my sources. Forward-looking information is especially important because there is little formal statistical data on business plans for hiring and investment. As an example, I routinely asked my contacts at FedEx and UPS about their plans to add capacity in the busy holiday season and what their customers were telling them about their expectations. I asked my Wal-Mart contact about his interpretation of retail sales. Did he think that recent sales reflected idiosyncratic issues for his own company or were the trends more general?

The FOMC has long believed that such information strengthened the policy process. I know of no study that has attempted to quantify the policy value of anecdotal information, but have to believe that this approach is sound. Fed critics remind me of the old saw about the weatherman. Look out the window. Can’t you see that it is snowing? Do you want the Fed to stop looking out the window? Would it not have been helpful in 2008 if the Fed had had some detailed inside information about the condition of Lehman and AIG?

The Federal Reserve has long had robust policies, and active internal controls, to prevent insider trading by all employees, especially those with access to confidential policy information. Yes, nonpublic contacts with industry insiders do raise the risk of improper disclosure. What is the evidence on that score?

I know of only three prominent, evident or possible violations of this confidentiality. One is ongoing today: an unresolved case concerning an alleged leak of FOMC information in 2012 to Medley Global Advisors. In the second case, Rohit Bansal, a former Goldman-Sachs employee, was convicted this past November of obtaining inside information from Jason Gross, a former bank examiner at the New York Fed, who was also convicted. In the third case, Robert A. Rough, a former director of the New York Fed pleaded guilty in 1989 to disclosing discount rate actions to securities traders while he was in office. The New York Times story on the case noted that, “Samuel A. Alito Jr., the United States Attorney for New Jersey, said Mr. Rough was the first director in the 75-year history of the Federal Reserve System to be convicted of criminal wrongdoing.”

As far as I know, that is it. A damn good record, I would say. I challenge anyone to find an agency of this size and longevity with a superior record. The very highest level of integrity is built into the Fed’s day-to-day procedures and its DNA. Fed leadership should be defending its disclosure and research policies rather than dancing away, dodging the issue.

A CBS segment on 60 Minutes in November 2011 discussed insider trading by some members of Congress and congressional staff. Public outrage ensued and led Congress to pass the Stock Act, which became law April 4, 2012. By April 15, 2013 Congress had modified the Act, largely gutting it.

The most gentle way I know to summarize the concerns of some members of Congress over Federal Reserve disclosure is that they represent rank hypocrisy.

Ultimately, “School Choice” Must Be about Freedom

It is National School Choice Week, and this ever-growing event-of-events will feature discussions throughout the country tackling test scores, competition, empowering the poor, efficient use of taxpayer dollars, monopoly breaking, and numerous other, very important topics. But ultimately just one goal must be paramount: maximizing freedom. In the end, it is defending liberty – the true, bedrock American value – that school choice must be about.

This is first and foremost a normative conviction. Freedom must have primacy because society is ultimately composed of individuals, and leaving individuals the right and ability to control their own lives is fundamentally more just than having the state – be it through a single dictator, or majority of voters – control our thoughts, words, or actions.

Of course, children are subject to someone’s control no matter what. But a corollary to free individuals, especially when no one is omniscient and there is no unanimous agreement on what is the “right” way to live, or think, or believe, must be free association – free, authentic communities. We must allow people and communities marked by hugely diverse religious, philosophical, or moral views, and rich ethnic and cultural identities and backgrounds, to teach their children those things. Short of stopping incitement of violence or clear parental abuse, the state should have no authority to declare that “your culture is acceptable,” or “yours must go.” Indeed, crush the freedom of communities and you inevitably cripple individual liberty, taking away one’s choices of how and with whom to live.

Of course, the reasons to demand educational freedom are not just normative. They are also about effective education, and it is not hard to understand, at a very basic level, why.

If there are things on which all agree, choice is moot – all will teach and respect those things. But if we do not all agree, forcing diverse people to support a single system of “common” schools yields but three outcomes: first, divisive conflict; then, either inequality under the law – oppression – when one side wins and the other loses, or lowest-common-denominator curricula to keep the peace. Forced conflict and curricular mush no one should want. And inequality under the law we should all loathe and fear, even if we do not care about the rights of others and think we will come out the victors today. Tomorrow, we may not.

School choice is something for which all Americans should fight. But ultimately, it is too limiting. What we need is freedom for all.

National School Choice Week Roundup

This week is National School Choice Week, the annual celebration of policies that empower families to choose the education that best meets the individual needs of their children. There have already been several important school choice developments this year, not all of them positive. Below is a roundup of the good, the bad, and the ugly.

Florida expands its education savings account program

It will be hard to top 2015 (the Year of Educational Choice), but 2016 has already seen a flurry of legislative activity. Last week, Florida Governor Rick Scott signed legislation expanding the number of students with special needs who can receive education savings accounts. The bill also renamed the Personal Learning Scholarship Accounts to honor their legislative champion, Senator Andy Gardiner. 

Does Drug Prohibition Inhibit Economic Development?

Even the most dedicated opponent of drug prohibition might not guess that this policy harms economic development.

Yet claims in a recent WSJ story, combined with research on the relation between banking and development, suggests just such an impact.

The reason is that drug prohibition fosters anti-money laundering laws; which then discourage U.S. banks from doing business in Mexico; which then impedes Mexican banking; which then negatively impacts development.

The WSJ story says,

U.S. banks are cutting off a growing number of customers in Mexico, deciding that business south of the border might not be worth the risks in the wake of mounting regulatory warnings.

At issue are correspondent-banking relationships that allow Mexican banks to facilitate cross-border transactions and meet their clients’ needs for dealing in dollars—in effect, giving them access to the U.S. financial system. The global firms that provide those services are increasingly wary of dealing with Mexican banks as well as their customers, according to U.S. bankers and people familiar with the matter.

And why are U.S. banks worried about regulation?  Because 

U.S. financial regulators have long warned about the risks in Mexico of money laundering tied to the drug trade. The urgency spiked more than a year ago, when the Financial Crimes Enforcement Network, a unit of the Treasury Department, sent notices warning banks of the risk that drug cartels were laundering money through correspondent accounts … Earlier, the Office of the Comptroller of the Currency sent a cautionary note to some big U.S. banks about their Mexico banking activities.

As for evidence that banking is important for economic development, see this paper by Scott Fulford of Boston College (featured soon in a Cato Research Brief).  Fulford writes:

Do banks matter for growth and how? This paper examines the effects of national banks in the United States from 1870–1900. I use the discontinuity in entry caused by a large minimum size requirement to identify the effects of banking. For the counties on the margin between getting a bank and not, gaining a bank increased production per person by 10%. National banks in rural areas improved agriculture over manufacturing, moving counties towards geographic comparative advantage. Since these banks made few long-term loans, the evidence suggests that the provision of working capital and liquidity matter for growth.

Bad policies (drug prohibition) breed more bad policies (anti-money-laundering laws), which have additional adverse consequences that few could plausibly have forseen.  This is one reason why any government interference with liberty, no matter how well intentioned or seemingly well justified, should face extreme skepticism.

Conservatives and a Lone Libertarian Take on Donald Trump

National Review cover "Against Trump"Today I join some 20 other writers in making the case against Donald Trump’s presidential candidacy. The venerable National Review, founded by William F. Buckley, Jr., assembled a group of diverse critics to argue that Trump is not a conservative, not an advocate of limited government, but rather (as the editorial asserts) “a philosophically unmoored political opportunist who would trash the broad conservative ideological consensus within the GOP in favor of a free-floating populism with strong-man overtones.”

The symposium is understandably being described in the media as “conservative thought leaders take on Trump.” I of course consider myself a libertarian, as my book The Libertarian Mind would indicate, and not a conservative. But part of the impact of this symposium is that people of such widely varying views – I have a lot of disagreements with religious rightist Cal Thomas and neoconservative Bill Kristol – nevertheless regard Trump as dangerous. 

In my own contribution I emphasize two points:

From a libertarian point of view — and I think serious conservatives and liberals would share this view—Trump’s greatest offenses against American tradition and our founding principles are his nativism and his promise of one-man rule.

Not since George Wallace has there been a presidential candidate who made racial and religious scapegoating so central to his campaign. Trump launched his campaign talking about Mexican rapists and has gone on to rant about mass deportation, bans on Muslim immigration, shutting down mosques, and building a wall around America. America is an exceptional nation in large part because we’ve aspired to rise above such prejudices and guarantee life, liberty, and the pursuit of happiness to everyone. Equally troubling is his idea of the presidency—his promise that he’s the guy, the man on a white horse, who can ride into Washington, fire the stupid people, hire the best people, and fix everything. He doesn’t talk about policy or working with Congress. He’s effectively vowing to be an American Mussolini, concentrating power in the Trump White House and governing by fiat. It’s a vision to make the last 16 years of executive abuse of power seem modest.

This isn’t my first sally against Trump. After hearing him in person at FreedomFest in July, I wrote about his nationalism, protectionism, and megalomania in the Washington Times. And in August I reviewed his support for and use of eminent domain at the Guardian.

The National Review symposium was posted last night at 10 p.m., and I took note of it on Facebook and Twitter. It drew a lot of reaction. And I must say, I was surprised by how many of the responses, especially on Twitter, were openly racist and anti-Semitic. That did nothing to make me reconsider my deep concerns about the damage Trump is doing, and could do, to America’s libertarian heritage.