Jerome Powell Believes As Economists Do, Without the Ph.D.
After all the rumors and whispers of a surprise, President Trump intends to nominate Jerome Powell for Chairmanship of the Federal Reserve. Mr. Powell will, if confirmed, replace Janet Yellen after just one term. Consensus seems to believe that short of Yellen’s renomination, which may have been politically impossible for the President given his campaign stance on her, Powell’s ascent is as close to continuity as possible.
I also believe that is true, but very oddly so. Their backgrounds, Powell and Yellen, could not have been more different. The current Chairman was an academic economist, a PhD in every sense. The likely next Chairman was, as he told Congress in testimony in support of his nomination to the Federal Reserve Board in 2012, a lawyer, an investment banker, and an investor (private equity).
On the surface, they should be night and day. Yet markets so far, as well as most commentary, find them to be roughly equivalent. Most focus on the perceived “hawkishness” or “dovishness” of each person as their defining standard, and finding them in equal measure, but it’s actually much more basic than all that.
For some, this diversity in background appears to be a problem. Academic economists like Paul Krugman, for example, can’t fathom how another academic economist might not get a shot to continue in this 21st century tradition. Writing in the New York Times earlier last month, in the view of Dr. Krugman the next Fed leader should be another PhD because the past monetary doctor(ate)s have been so successful so far:
“In particular, both Bernanke and Yellen responded effectively to a once-in-three-generations economic crisis despite constant heckling from back-seat drivers in Congress and on the political right in general. And their intellectual and moral courage has been completely vindicated by events.”
What made them able to so “courageously” navigate the worst of circumstances politically as well as the rest was in Krugman’s mind the characteristics he finds most appealing, and therefore in his view consistent with those who are most likely to succeed. “For more than a decade the Fed chair has been a distinguished academic economist — first Ben Bernanke, then Janet Yellen.” Unless Congress takes a strong dislike to Jerome Powell, that’s going to change.
But will anything actually change? Had it been someone other than Powell, the possibility of answering yes would be (slightly) higher. Krugman doesn’t want it to change, but the rest of the world, including that quite significant part which elected Mr. Trump, means that it must at some point. Instead, the likely new nominee, again, is practically indistinguishable from the current regime at least by all current appearances in all the ways that really count.
If we are talking about central banks and central bankers, then what does matter is money. It seems obvious to the point of absurdity in having to write it, but the last ten years and for even longer than that central banks have, to put it mildly, become less familiar with the subject.
Contrary to Dr. Krugman’s assessment of the Fed’s performance, there was at the very least that little problem about ten years ago the US central bank failed to resolve beneficially long before it spiraled into a multi-generational global affair (we will still be talking about August 2007 for a long time). They had one job to do, and we still try to cope today with the consequences of their utter failure to do it.
Outwardly, Jerome Powell’s experience seems to be fitted well with that problem. Given his work history, he brushed up against it at several key points in the evolution of money these past decades. Unlike academic economists, Powell has had actual contact with the shadows.
In his 2012 testimony, he recounts one such experience in 1991. As Assistant Secretary of the Treasury for Domestic Finance under President George H. W. Bush, Powell was front and center in one of the most misunderstood Wall Street scams of modern history.
“I also led the Administration's response to a major bidding scandal in the Treasury markets in 1991-92, which resulted in the Government Securities Act of 1992, as well as substantial revisions to the Treasury's auction rules.”
He was referring to the last hurrah for one of the most notorious firms of the go-go eighties, the final gasp of Solly and the BSD bond kings of lore. Salomon Brothers was a legend, and what happened in the early nineties describes very well how even legends can be caught up in drastic systemic change.
I wrote about this particular episode a few years back:
“There is a lot more here than just one bank looking to circumvent what may seem arbitrary rules and restrictions. The government has an indisputable duty to ensure good function of its debt issuance processes, but what few people then could understand was why Mozer [Salomon Brothers] was going to all the trouble. From the outside, convention saw very little, if any, upside to these activities and actions. Instead, it was largely left as a matter of ego, the Masters of the Universe simply flexing their muscles in a game of power.”
That was, too, the official position that Powell had a large hand in crafting. They looked at it from the perspective of government funding – and no further. The Treasury, along with the Fed, SEC, OCC, NYSE, and NASD collectively reduced the scandal to only that which they could understand, the extremely narrow view of government and GSE bond auctions. They never bothered to get to the real issue and thus really, truly grasp what was actually going on a quarter of a century ago, and really why it might have mattered both then and now.
We know Powell remained in the dark about it because he told us in a speech given on August 3, 2015, just one week before China would shock global markets and central bankers, igniting the latest “global turmoil” in a string of turmoils dating back to 2007. Having been confirmed as Federal Reserve Board Governor and on the job for a few years already by then, the central bank thought it would be reassuring to have Governor Powell go out in public to talk about Treasury market liquidity at that particular moment.
To bolster his qualifications as an authority to speak on the topic, Powell started his lecture by once again recounting Solly and the 1991 bidding scandal. What was on people’s minds at the time, however, had less to do with auctions and a lot to do with general market liquidity, even in UST’s. While today many people seem to have forgotten, the “buying panic” in Treasuries on October 15, 2014 still loomed large in liquidity circumstances that were deteriorating all across the world.
Rather than help the situation, Powell all but confessed he didn’t get it, still, and that the lessons the Treasury Department and all those other government agencies learned back in 1991 were all the wrong ones.
“The events of October 15 last year have been folded into the more general debate about market liquidity across a number of markets. I take the concerns about a decline in market liquidity seriously. Hard evidence on the level of liquidity in secondary Treasury markets is mixed, with some measures at or above pre-crisis levels and some suggesting a reduced ability to buy or sell large positions without material price effect--a reasonable definition of liquidity. It is also possible that liquidity may be more prone to disappearing at times of stress. On October 15, for example, market depth declined sharply, and we saw a sudden spike in prices that was without precedent for a period with little relevant news. Other events--such as the 2013 "taper tantrum," the "bund tantrum" last spring, and the sharp moves on March 18 in the euro-dollar exchange rate--all broadly show the same pattern: rapidly diminishing liquidity, and large price moves for a given quantum of news. But the causes and implications of these events are unclear. Is this the new normal? We don't know.”
But he should have known. What connected Salomon Brothers’ long-forgotten disgrace with the now-forgotten turmoil of autumn 2014 was the repo market. The issue way back when was collateral, and it was especially so three years ago.
And it wasn’t really difficult to figure that out. A “panic” in any given market usually means intense, unrelenting selling. On October 15, however, it meant the opposite, a scramble to buy all the Treasuries one could possibly handle – and few were willing to sell even at skyrocketing prices (hoard).
It was, in short, a systemic margin call on collateral, a wave of global dollar illiquidity that had been intensifying for quite some time before. As I wrote barely a month afterward, in November 2014:
“So the day after there is an enormous scramble for treasury bonds, which are now the primary form of collateral, there are no bids in corporate credit, even investment grade. Further, as we know from other anecdotes, the inability to trade in anything other than massive size continued for some days thereafter. All of which means that for some period around and after October 15, dealer and even financial ability to maintain flow and leverage was severely impaired - none of which has anything to do, again, with electronic trading.
“If we look beyond the settling convention, the events start to make sense. A huge rush of buying right at the open indicates, to me, collateral calls either from the previous day's positions to be settled or, more likely, counterparties thinking ahead toward settling that day's collateral imbalances before 2pm. The reason there was such a rush at that moment had nothing to do with the retail sales report or anything that was "news", but rather the crush of reverse pricing in illiquid corporate credit (among other "risky" places) that had been building for some time prior to October 15.”
What the Salomon Brothers episode really demonstrated was that already by the early 1990’s control of repo collateral (in MBS as well as UST’s) was just that important. The October 15 “buying panic” showed that in reverse, the liquidity dangers for when collateral flow gets way out of control and how that might reverberate long past a single day’s peculiar trading. The repo market problems would play a central role in the “rising dollar”, including what happened in China, Russia, oil, and eventually a full-blown global economic downturn at the very moment the FOMC and Governor Powell was expecting economic acceleration and something nearly like recovery.
For all the talk about Powell’s familiarity with the shadows, it doesn’t appear to be anything truly meaningful and deep. Instead, you would be hard pressed to find much difference in his speeches as compared to, say, Yellen’s.
Powell gave another one in September 2014 on the topic of LIBOR. This was perhaps his best-known address, one delivered at the start of the government’s official endeavor to replace LIBOR as the benchmark for pricing the hundreds of trillions in US bank derivatives.
To many, the issue with LIBOR has been another bank scandal, this time with several banks sitting on the panel that fixes those rates having admitted to malfeasance in undertaking that task. While that was a problem, to be sure, it was in the scheme of things a much smaller one. The real issue was, as Powell said in 2014:
“A second problem is that unsecured interbank borrowing has been in a secular decline that predates the global financial crisis. Changes in bank behavior following the crisis exacerbated the decline and further weakened the foundation of LIBOR. The result is a scarcity, or outright absence in longer tenors, of actual transactions that banks can use to estimate their daily submission to LIBOR.”
LIBOR was originally meant to be set by the actual borrowing rates banks had used on any particular day, the rate at which they had in real transactions lent to their interbank counterparties. It had evolved especially after August 2007 to become instead a theoretical rate, the interest at which any one panel member might have lent had that member any willingness to lend on an unsecuredbasis.
But we aren’t really talking about dollars here, though you wouldn’t know it from Jerome Powell’s speech. He never once, not once, mentioned the words “eurodollar” or “offshore.” These are very peculiar omissions because LIBOR pertains only to eurodollars. It is a set of money market rates that applies to offshore money denominated in dollars (and a few other currencies).
The Federal Reserve, in particular, has been trying to ignore that distinction at every opportunity, mostly through what is really a lie of omission. Even the Great Financial Crisis, and the global monetary panic at the center of it, was a eurodollar event; a Lombard Street debacle that spread to Wall Street and beyond. We know that unequivocally because of LIBOR!
As unsecured global interbank lending in eurodollars declined, what rose, partly, to take its place? Yep, secured lending, or repo. In other words, as the one fell off to a large extent because of the Fed’s bungling August 2007 forward, the other became even more important. Collateral that had been established as a vital component by Salomon Brothers long ago has been for the last ten years so much more so.
A man well-acquainted with the shadows should have in 2014 easily been able to make these connections, and then warn the rest of the FOMC that maybe they shouldn’t be blowing what was left of their credibility on “raising rates” right smack in the middle of a global downturn. They might have instead looked at the repo market and what it was saying (nothing good) rather than focus entirely on the unemployment rate for all that it got wrong.
For an academic economist, this is standard stuff. You don’t make any distinction whatsoever where money is, or what money is, because all that matters, to you, is what the central bank does. It’s a viewpoint that is entirely backward. They believe that the central bank takes care of the monetary input, and therefore it matters not the output – even if it crosses all sorts of boundaries, geographic as well as functional (collateral, footnote dollars, derivatives, etc.).
That’s exactly the view Powell took as Assistant Treasury Secretary in handling the Solly scandal only from the view of auction integrity rather than the view of monetary function and the ascending role of collateral within it. And it’s much more than what I have included here, a more comprehensive review of his work shows the same mind of a bureaucrat rigidly focused in ideology rather than openness on the crucial topics of money and global plumbing. He is familiar with the shadows in exactly the same way Ben Bernanke was, and Janet Yellen is, which is to say not familiar at all.
The unwavering support for Bernanke and Yellen from inside the academy is ridiculously transparent, full marks given for what they have done rather than the results of all that. They frame the Fed’s performance in as positive terms as possible (reduced by reality to some form of “jobs saved”) because they are defending more than Bernanke and Yellen; they are defending Economics in its current form of econometrics. Nowhere has it been put to practical use more than at the central bank.
Paul Krugman may be upset with Jerome Powell as the choice to replace Janet Yellen because he’s not the preferred academic economist steeped his whole career in the orthodox regressions that govern their view of the world – and the central bank’s assumed central role in it. Then again, Dr. Krugman and the rest of the academics might be enthusiastic about President Trump’s choice for all the same characteristics he rigorously displays in common with his immediate predecessors.
In other words, Powell may not have had the same statistical, mathematics background as the others, but on the topic of money in the economy they are all the same empty suit.
