George F. Will
Washington Post
With a recession deepening and the 1982 midterm elections approaching, Federal Reserve chair Paul Volcker was summoned to the Oval Office, where Ronald Reagan was sitting with his chief of staff, James Baker. When Baker said Reagan wanted to give Volcker an “order” about interest rates, the 6-foot-7 central banker immediately stalked silently from the room. He did not take orders.
Donald Trump is determined to break institutions to the presidential saddle, so people wonder: Could he fire the head of the Fed? (Probably not. Besides, Chair Jerome H. Powell’s term expires in May 2026.) More interesting questions are: What is the Fed for? And is its “independence” a license for mission creep?
John H. Cochrane and Amit Seru of the Hoover Institution think the hyperactive Fed has become too ambitious in its interventions in the economy and social policy. Their proposal is the title of their essay “Ending Bailouts, At Last,” in the Journal of Law, Economics and Policy.
The problematic behavior is a century old and bipartisan: When large financial institutions are in danger of failing, government bails them out by bailing out their creditors. The 1907 financial crisis led in 1913 to the Federal Reserve Act establishing the Fed, which did not prevent the 1933 bank collapse. This led to deposit insurance and many regulations, which did not prevent Continental Illinois Bank’s 1984 failure, the savings and loan crisis of the 1980s, and many other bumps on the road to 2008.
“Never again, we say, again and again,” wrote Cochrane and Seru. Bailouts multiply, larger each time, spreading to highly leveraged industrial companies, as in the auto bailout of 2009. “Too leveraged to fail,” they wrote, “might be the summary of our new regime.” Too leveraged is a consequence of interest rates too low for too long, combined with confidence that the bailout culture is forever and unlimited.
During the pandemic, the market for Treasury bonds became fragile, so the Fed lent bond dealers money to buy the bonds, “then turned around and bought the Treasurys from the dealers a few days later.” Cochrane and Seru wrote that the Fed almost has an implicit policy of buying “whatever quantity” necessary to prop up corporate bond prices.
They noted that the Biden administration’s “paycheck protection” program made “forgivable loans” – Washington-speak for gifts – “to small businesses with 500 or fewer employees to cover their business costs, including mortgage interests, rent, utilities, and up to 8 weeks’ payroll costs.” It is one thing for the accountable political institutions to do this, quite another for the Fed to lend “on lenient terms to the real economy, not just the financial sector.”
Throughout the economy, Cochrane and Seru wrote, leverage has been rewarded: “If you saved and bought a house with cash, if you saved and went to a cheaper college rather than take out a big student loan, or if you repaid that loan promptly, you did not get money.” In today’s permanent central-bank-run credit system, “Borrow. Borrow especially if you are big or part of a big and politically influential class of borrowers. As with student loans, borrow from the government.” You might not have to pay it back.
When Silicon Valley Bank accepted many large, uninsured deposits, then got in trouble, the Federal Deposit Insurance Corporation – the government – guaranteed all deposits. So now, wrote Cochrane and Seru, “effectively markets expect all deposits of any size to be guaranteed going forward, at least during any newsworthy event.”
The Congressional Budget Office projects budget deficits of 5 to 8 percent of gross domestic product forever. And this, Cochrane and Seru correctly believe, is too unrealistic. CBO assumes no crises, recessions, wars, pandemics or – most laughably – spending increases. But even this optimistic debt path “simply cannot happen.”
“Everything is finite, including the U.S. government’s ability to borrow real resources in a crisis,” wrote the authors. Student loans, mortgage and rent forbearance – “it seems impossible for our democratic government to lend money to its citizens and demand repayment, especially in bad times.” And bad times are when money might be tight for the government.
“We have,” Cochrane and Seru wrote, “once in a century crises every 10 years these days.” “Crisis” has come to mean “the possibility that someone, somewhere might lose money.” And “contagion” now denotes a vague fear that “any ripple anywhere might bring down the financial system.”
Societies get what they incentivize. Moral hazards — incentives for perverse, risky behaviors — are now sown throughout American life. Cumulatively, they might break the government before Trump’s eccentric Cabinet nominees can.