Danielle DiMartino Booth is the author of FED UP: An Insider’s Take on Why the Federal Reserve Is Bad for America. The book is the result of her work experience on Wall Street and the Dallas Federal Reserve. DiMartino Booth began her career on Wall Street. After that, she spent nine years advising the President of the Federal Reserve Bank of Dallas. She discusses her Fed reform insights with Steve.
Calling The Housing Bubble
Before DiMartino Booth left Wall Street, it had rolled out Collateralized Debt Obligations (CDOs). Mortgage lenders, such as banks, would sell mortgages to Wall Street. Wall Street created a pool of these mortgages and divided the pool based on the riskiness of individual mortgages. Investment banks then sold these high-risk tranches as AAA-rated bonds.
With Wall Street happily buying mortgages of all types, banks became aggressive and lowered their lending standards. As a result, even people with really bad credit had no problems getting a mortgage. This led to a rash of lending, which drove up home prices and built up the sub-prime mortgage sector.
Landing A Gig At The Fed
DiMartino Booth foresaw the mortgage and housing crisis and wrote about it as a columnist for a local newspaper in Dallas. Her views caught the attention of Richard Fisher, who was then President of the Dallas Fed, who hired her on as an advisor.
The Federal Reserve and ratings agencies completely missed out on the housing bubble and sub-prime crisis. DiMartino Booth attributes this to Fed employees lacking in-depth knowledge of the financial markets. For example, the Federal Reserve did not include home price and stock price increases into their inflation calculations.
In 1977, the Federal Reserve’s mandate was doubled from minimizing inflation to also maximizing employment. This second mandate gave them a lot more latitude in setting monetary policy.
To DiMartino Booth, this second mandate was a mistake. She believes job creation should rest with the private sector, not a central bank. This second mandate gave the U.S. central bank more powers than other central banks worldwide.
The Fed Under Alan Greenspan
When Alan Greenspan was appointed Chair of the Fed, he further revolutionized its culture. Greenspan was fascinated by the stock market. He signaled Fed policy so it would not spook the financial markets and promised liquidity in the event of a financial crisis.
Consequently, investors believed that the Fed had their backs.
Even though Greenspan spoke of irrational exuberance in the stock market, he did little to rein it in. This fueled the dot-com bubble and collapse under Greenspan’s watch. It also led to the housing bubble and banking crisis of 2005.
To stem the crisis, the Fed took interest rates down to the zero. They also launched unconventional monetary policy by buying up bonds and stocks through the TARP program.
Re-Sizing The Fed
In her book, FED UP: An Insider’s Take on Why the Federal Reserve Is Bad for America, DiMartino Booth does not talk about ending the Fed. She sees it as a necessary overseer of our financial system and a vital part of our national security.
Instead, she advocates three Fed reform steps.
DiMartino Booth recommends reducing the number of Federal Reserve districts from 12 to 10. She suggests reducing the Fed’s mid-west presence by three districts and adding a Federal Reserve district in the west.
She would like each district President to have a permanent vote on the Federal Open Market Committee (FOMC), which would replace the voting rotation that exists today. For instance, California and Texas are two of America’s largest economies. These districts should have permanent votes on the FOMC.
Her second Fed reform recommendation is to reduce the Fed’s mandate to stabilizing the dollar by controlling inflation.
Lastly, she would like to see more intellectual diversity and real-world experience in the Fed’s leadership ranks.
DiMartino Booth is heartened by Jerome Powell’s appointment as Chair of the Fed. Let’s hope he implements Fed reforms that make the institution more relevant to the real world.
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Steve Pomeranz: Danielle DiMartino Booth has an unusual background. She’s worked on Wall Street. Then she spent nine years at The Federal Reserve Bank in Dallas. And then she totally switched gears and earned an MBA at Colombia in journalism. So now, she’s a full-time columnist for Bloomberg View, and she’s frequently featured on CNBC, and Fox, and Fox Business, and all the other important outlets.
She’s written a book, and this book includes all of her skills that she has and the experience that she has when she worked for the Fed. And the book is called, or entitled, Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America, and it was published last year in 2017.
Hey, Danielle, welcome to the show.
Danielle DiMartino Booth: I’m so happy to be here today.
Steve Pomeranz: So you have quite a unique background. You were on Wall Street, you’re a journalist. Why did you choose the Fed to speak out about?
Danielle DiMartino Booth: Well, I spent the better part of a decade inside of the Fed, so I really did have a fly on the wall viewpoint unlike a lot of my peers at the fed.
I did not have an active background. I had had real world experience which really provided me a good view of how out of touch this institution really was.
Steve Pomeranz: So how did you…who contacted you and how did you get to work for the Fed since you were not from an academic background?
Danielle DiMartino Booth: Well, when I had left Wall Street, I signed a non-compete and agreed to leave the industry for a little while. So I whipped out my handy-dandy journalism degree and offered to work for the local paper in Dallas, where I had just moved for free, which seemed to work very well with their budget.
So I was able to get good reaction very quickly with my column because it said things that were definitely unconventional at the time. Especially the comments I was making about the building housing bubble in the country and that gained the attention of one Richard Fisher, who had just started as the President of the Dallas Fed.
And it was actually Richard himself who called me.
Steve Pomeranz: Great, so you were kind of a unique position. Again you came from the street so to speak, you started writing columns about what you saw, on what you were thinking about the economy and, at that time, you mentioned the housing bubble and you could see kind of the things that were going on.
As a matter of fact, you left Wall Street before the big bust, but you saw some of the early signs of the mortgage situation. Tell us about that.
Danielle DiMartino Booth: Well, right before I left Wall Street, they had just started to roll out this kind of new product where if you took out a mortgage, the bank who had lend you the money to buy the home was going to sell that mortgage off to a big Wall Street firm, who would then park the mortgage in a warehouse of sorts until they had a sufficient number of mortgages, which they then put into a pool and created a whole new security of these pooled mortgages. And after at which point they would slice and dice them based on the riskiness of the individual mortgages inside of the pool and sell them off to investors.
And it seemed to me at the time, who would buy those riskiest tranches? I raised my hand, I asked the question, I got some steely-eyed, mean look from an investment banker at the front of the room. But that presentation really stayed with me in the years that followed as these sub-prime backed bonds became the mainstream and really exploded in size.
And allowed people who had never qualified to buy homes in this country and the wherewithal to gain access to mortgage lending. So we almost had a 70% home ownership [inaudible]collapsed back into the 64% area which is the long term. When I say long term I mean like long-term history to country average.
But allowing people to buy homes that really didn’t qualify as we now know, looking in the rear view mirror, became very problematic.
Steve Pomeranz: Well, it was this phenomenon and it actually was described very well in, so what was the movie about this?
Danielle DiMartino Booth: The Big Short.
Steve Pomeranz: The Big Short, thanks.
Where, it actually had Anthony Bourdain talking about, in the kitchen, saying we’re going to take Friday’s leftover fish, Saturday’s leftover fish. We’re going to make a fish stew out of it, we’re going to serve it as brand new on Monday. And so, it was all these bad mortgages, somehow they got into a pool.
And the rating agencies said, hey, these are now because of the diversification and so on the chances of these defaulting are much less. Therefore, we’ve got a brand new triple-A product. So you saw that really pretty early, but the Fed missed it totally. Why do you think they missed it?
Danielle DiMartino Booth: Yeah, that’s a good question and I think part of it came down to the makeup of the individuals inside the Fed. There were simply not enough people with in-depth knowledge of the financial market who could have explained it the way that Anthony Bourdain was. It was simply a lack of on the ground practical working experience that led to inability of most of the academics to see what was headed straight their way.
Steve Pomeranz: Also I think they were following some inflation measures. The way they measured inflation did not include the price of homes, right?
Danielle DiMartino Booth: No, they didn’t at all, nor did they reflect properly the fact that the stock market was going haywire. Because those types of asset prices if you will, the price of the asset of real estate, the price of the asset of a stock, of a share of the stock, these are assets that are not incorporated into the inflation measures that the Federal Reserve follows to this day.
Steve Pomeranz: It’s pretty amazing, let’s get some context. Let’s discuss a brief history of the Federal Reserve. When was it first chartered?
Danielle DiMartino Booth: Well, the root of the Federal Reserve basically started in 1907, I’ll give you a quick story. As was the custom of the day, a bunch of financiers met in JP Morgan’s parlor, and they figured out how to save the financial system. With the recognition that he was going to die one day, he recognized his mortality, the root of the Federal Reserve started to be planted.
In 1913, the Federal Reserve was established, with the individual mandate of ensuring that the buying power of the US dollar was stable. And in times of duress, as in the financial panic of 1907, being a lender of last resort. Look at that as just being somebody who shepherds the financial stability of the country’s economy and financial system.
Steve Pomeranz: Fine, so I know the lender of last resort pretty important function of the Fed to come in and reliquify the banks and to make sure that people who had their money in the banks could be reassured that their money was not going to be lost. But that changed over the years, and I want to skip way ahead, I want to get into the 90s during the period of Alan Greenspan.
Because something changed during those go-go years of the 90s, and especially changed because of Alan Greenspan, what were those?
Danielle DiMartino Booth: Well, there’s something that proceeded Alan Greenspan. And that was in 1977, the Federal Reserve, their mandate was doubled from minimizing inflation to maximizing employment. That second mandate gave them a lot more latitude in making monetary policy than I would argue that they should have.
I think that the job creation should be in the hands of the private sector, not in the hands of a central bank, it just makes no sense. We have very, very, very few peers internationally who have that second mandate. Minimizing inflation is pretty much an international standard. With that being said, Alan Greenspan, coming to the Fed, it revolutionized the culture of the institution in ways that are very difficult to describe over 30 years later.
His biography that was published over a year ago now, I want to say, revealed a fascination with the stock market. An outright fascination with the stock market. He had a stock market briefing prepared for him every single morning at 5:30 in the morning, before he got to the office in Washington DC.
Unfortunately, the fascination with the stock market turned into intimidation. And before Greenspan left office, we not only had the seeds of the housing bubble. We also had investors completely habituated to thinking that they would never lose money in the stock market, thanks to the Federal Reserve. The Fed would always have investors’ backs.
Steve Pomeranz: In 1987, we had that fairly significant crash on October ’87. Alan Greenspan was at the helm then, right?
Danielle DiMartino Booth: Yes, he was, and, in fact, he had, that was October 19th, he started on the job August the 11th. So I would like to say that he had the least amount of time on his hands to deal with a major disruption in the stock market but that victory goes to Jerome Powell, who of course, saw a four-digit decline in the Dow Jones Industrials on his first day in office this past February.
Steve Pomeranz: Yeah, but let’s get back to 87. So basically, the market went down, and then Greenspan came in, and basically assured the market that he would not kind of let it fall any further or collapse, and that became eventually known as the Greenspan put. Now a put is something, for those of you don’t know options, a put is really basically an instrument that ensures a price at a certain level, without getting into any of the weeds on this. So the fact that market participants could sense that they had a floor or they had the Federal Reserve at their back.
Can you take us forward on that?
Danielle DiMartino Booth: Well, it was interesting. Right after the crash of 1987, Alan Greenspan put out a statement that said the Federal Reserve in its capacity of the nation’s central bank stands ready to basically backstop the banking and financial systems. It was a big change, it was a huge change.
In the days and the weeks that followed Black Monday and the stock market crash in 1987, Alan Greenspan went so far as to dictate to the people on the market’s desk in New York, give them permission to tell bond traders, scattered across Wall Street, that give them inside information.
Information that the Fed was about to inject liquidity into the financial system prior that occurring. They were able to begin profiting off of leaked information. I’m not exaggerating, this is something that was documented, sanctioned by Alan Greenspan. He literally, this is a term that I’m sure you’ll be familiar with, but he started out the modern day plague of moral hazard as we know it.
And moral hazard is effectively, not being penalized for taking that incremental level of risk on as a speculator.
Steve Pomeranz: So the feeling is right now that if the market really takes a strong hit, the Federal Reserve is there. It’s watching the stock market, it’s going to inject the system with more liquidity.
And therefore, this lack of liquidity, this drying up of buying power is what can send a market into a tailspin. If you’ve got an entity like the Fed saying don’t worry about it, we’ll provide the liquidity, that eases it. But what happens when you take the risk out of the market, especially something as big as the stock market.
What can possibly happen, or what would be the ramifications of that in the future?
Danielle DiMartino Booth: Well, we saw 1996, Alan Greenspan recognized that there was rational exuberance and that the stock market was overvalued. At the time the Fed could have imposed higher margin requirements, and that really would have put the fire out.
We would have had a milder correction. But we certainly wouldn’t have ever seen anything like the overvaluation that we saw three years later in 1999 with the dot-com implosion, which, of course, the Fed rode to the rescue of that, once again placing a floor under investor losses, placing a floor under bank losses and that then subsequently turned into the housing bubble. And then they had to do it all over again but this time, bigger. They didn’t just take interest rates down to the zero bound, so to speak. They launched unconventional monetary policy and began purchasing up bonds in the open market to try and synthetically produce even lower interest rates to encourage people to borrow and then spend.
Steve Pomeranz: My guest is Danielle DiMartino Booth and we’re talking about her book Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America. You’re not suggesting that we do away with the Fed, are you?
Danielle DiMartino Booth: I’m not, I’m not an advocate of ending the Fed. I consider it to be, I have a very outside view on this, I consider having a strong and independent and apolitical central bank a matter of National Security. I don’t even want to think what the Chinese would do in terms of attacking our financial system if they thought that no one was watching over it.
So I’m a huge advocate of maintaining a central bank. But that being said, I think we need to take it down to the studs and completely reinvent it from where it has been, historically. One of the most encouraging developments recently, again, has been Jerome Powell. The first non-PhD in Economics to run the Federal Reserve since Paul Volcker, who preceded Greenspan.
Steve Pomeranz: And he has started to raise interest rates back to what could be considered normal levels. He has also started to reduce the huge balance of the Fed’s balance sheet from four and a half trillion to about 4.3 trillion, it’s a start, right? I mean when you wrote the-
Danielle DiMartino Booth: Baby steps, yeah.
Steve Pomeranz: Yeah, when you wrote the book a year and a half ago, you are bemoaning the fact that they weren’t doing either of those, but that looks like they’ve started that. So you are feeling a little bit better about the direction of the Fed, and what would you do to fix it?
What would be two or three of the main points that you would make in order to fix the Fed in your view?
Danielle DiMartino Booth: Well, first and foremost, we are no longer an economy that reflects where we were as a country in 1913. So I would reduce the number of Federal Reserve districts in the Mid-West by about three, and I would add another Federal Reserve district out west. Clearly, we saw under Janet Yellen’s stewardship that the subprime crisis blew up in her backyard when she was President of the San Francisco Fed. It’s too big of a financial area to just have one Federal Reserve district.
So once you had all 10 instead of the 12 you have today, get rid of 3, add 1. I would give all of the Federal Reserve district presidents permanent votes on the Federal Open Market Committee. This is very important to me, and because California doesn’t cease to be the largest economy in the country every three years.
So it’s never made sense to me that the presidents roll off of voting rotation once every three years. The same situation with Texas, the second largest economy in the country, you get my point.
Steve Pomeranz: Yeah.
Danielle DiMartino Booth: The second thing that I would do would be to reduce the Feds mandate back down to being singular.
It would just be maximizing the buying power of the dollar, minimizing inflation. And in times of duress, financially stability, again, I said it earlier, leave job creation in the hands of the private sector. And then, I would ensure also that we didn’t need 800 PhDS. I would introduce intellectual diversity and people who had more knowledge and experience in the real world into making monetary policies.
Such that, the leaders of the Fed had actually had experience with being on the receiving end of the policies they make. It didn’t harm Ben Bernanke to take interest rates to zero because he had a pension and healthcare for life.
Steve Pomeranz: There’s a guaranteed pension from the U.S. Government, not a private pension that has to worry about things like interest rates and the return of their assets.
Danielle DiMartino Booth: Absolutely.
Steve Pomeranz: Unfortunately, we are out of time. My guest is Danielle DiMartino Booth, the book is Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America. If you have a question about what we’ve discussed or you have a comment please go to stevepomeranz.com.
Ask us anything you’d like, stevepomeranz.com. And while you’re there sign up for our weekly update, where we will send you weekly commentaries and interviews straight to your inbox. Danielle, thanks for taking the time to join us.
Danielle DiMartino Booth: I appreciate your time as well, thank you.