Even If They Do 'End the Fed', Little to Nothing Will Change
Back when he was at or near the top of Goldman Sachs, Henry Paulson would plant a question in the audience when presenting to different groups within GS. Someone would ask him what keeps him up at night, and he would respond that he feared one or two bad apples inside Goldman could commit an egregious error that would be a serious blow to the firm’s reputation, or that was financially crippling, or that might even take the investment banking powerhouse down in total.
Paulson’s crucial point was that the business of finance is ephemeral in the specific business sense. Translated, the history of investment banking is littered with countless firm failures. To underscore the point, senior executives at Goldman would frequently hand out deal tombstones from the past. It was striking how many investment houses from the past were no longer. The message in all of this to GS employees was for them to be wise in their actions. The firm’s present prosperity hardly ensured a prosperous future for the blue chip investment bank.
Which leads to a basic question: have the failures in the financial sector impoverished finance? Quite the opposite. Failure is the norm in any business where pay is high. The impressive compensation is the surest sign that many individuals and many firms won’t measure up. The failures don’t weaken finance or cause crises when it’s remembered that mistakes provide the crucial information that enable those who commit errors to fix what they’re doing wrong. Within the best companies, it’s the norm for the employees to rush to errors, realize them, and correct them in order to progress. And for those that go under altogether, Wall Street is made great by the people who show up for work each day. By extension, company failure exists as an opportunity for competitors to bid for the services of quality individuals temporarily sidelined by the failure, and who were likely being employed in sub-optimal fashion by the failed company to begin with.
The above explains why it’s so hazardous when politicians armed with the money of others promise to fight recessions. When they do they’re fighting recovery. The recession is the cure when it’s remembered that the recession is usually when errors are most being realized, and productively dealt with. Worse is that governments usually fight recessions by arrogating to themselves greater control over the economy’s always limited resources through excessive spending. In their misguided zeal to fight recessions, politicians consume resources that would otherwise be utilized by businesses eager to stay afloat, expand, or both.
Some of this came up during a recent interview on Yahoo Finance. It was hardly adversarial. Yahoo had me on to discuss the Federal Reserve, at which point I argued that the Fed’s impact on the economy is well overstated. Readers familiar with me know my argument: the Fed projects its always overstated influence through banks that by virtue of being banks can’t lend in dynamic fashion. They must generally direct the funds entrusted to them toward sure things, which is a reminder that absent banks, the sure things could still easily find finance precisely because they generally pay monies borrowed back.
All of the above is well and good, but dynamic economies like the one in the U.S. are that way because so much of what’s not a sure thing attains funding. Silicon Valley is an easy example here. Most businesses there die, but the ones that survive have a remarkably positive impact on economic growth. Banks generally can’t finance Valley businesses that power so much progress, and it’s a simple reminder that they, along with the Fed that projects its influence through them, aren’t terribly important to growth.
The point about the Fed’s inconsequential nature was made to Yahoo Finance’s Adam Shapiro in the interview, and he politely responded that absent the Fed’s actions in 2008, neither one of us would have jobs. About Shapiro’s assertion, people can disagree. While it says here bailouts suffocate economic progress for the reasons previously discussed, Shapiro’s view is the majority view. Fair enough. People can once again disagree.
So if we separate opinion from the matter and just assume what yours truly thinks is false about the bailouts, that they saved jobs, was the Fed necessary in 2008? Getting more specific, would the financial institution bailouts that I think harmed the economy (it was the fifth bailout in less then 20 years for Citi, for instance) have not happened if the Fed didn’t exist?
The answer to previous question is a pretty easy one: of course the bailouts would have happened. With the federal government as large as it is, and with it having access to copious resources thanks to it being backed by the most productive people on earth, it’s not unreasonable to suggest that politicians armed with the money of others will (and did) regularly make incorrect, economy-sapping decisions to prop up ailing businesses.
Implicit in the notion that the Fed was necessary to save banks back in ’08 was that absent the central bank, Treasury or Congress or both wouldn’t have done the same thing. That’s not likely. Somehow economists and politicians convinced President Bush that certain financial institutions were “too big to fail” over eleven years ago, and the bailouts followed.
Similarly implicit in the idea that the Fed was necessary to do what it did is that the Fed, for being a “central bank,” has seemingly endless access to funds that it directed towards banks. Based on such a belief, the former Soviet Union only died because it didn’t have a central bank, plus Zimbabwe struggles today for similar reasons. Print money, and resource abundance will magically appear? No. That’s not serious.
The Fed is only a size player insofar as it, like Congress, is backed by the most productive people on earth. The Fed’s swagger is borrowed. It was able to play the false hero back then with the money of others, which is why the economy didn’t boom in the aftermath of Washington’s actions back in ’08. Rather than let markets work, Washington arrogated to itself the wealth created by others and re-allocated it. Central planning always fails, particularly when an economy is troubled. The resources available are precious.
Oh well, it’s just a reminder of what’s true: even if readers think the Fed’s 2008 actions essential, it’s unrealistic to assume the same wouldn’t have been done without the Fed. This should give pause to Fed supporters and critics alike: even if Congress does abolish the Fed, which it never will, little will change.
