FinRegRant Episode 2 with Tom Hoenig
Takeaways from the Jackson Hole Economic Symposium
Our very own Tom Hoenig recently attended the Jackson Hole Economic Symposium and gave us his thoughts and analysis about the event. He also has an amazing hat. Listen below.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to firstname.lastname@example.org
Brian: Welcome to the FinRegRant. My name's Brian Knight. I'm a senior research fellow at the Mercatus Center, joined by my co-host Jessica Paska. And today we have a very special guest, our colleague Tom Hoenig, fresh from a, you know, secretive meeting of the world's elite at Jackson Hole. Tom, how was it hanging with the Illuminati?
Tom: Well, it was a very good meeting. I might tell you, and if I can correct you a little bit, Brian is not secretive. We have about half the world's press there, so no one's, no one's hiding. But it was a good meeting. Lots of, lots of good topics and lots of informal discussions outside of the formal meetings. There's a lot of opportunity to get together and really talk about issues. So that was a good meeting.
Brian: So, you know, obviously Chair Powell and, and other luminaries delivered speeches. Those are, those have been pretty well covered in the press. As you mentioned, half the world's press are there, but can we trust them? Dun dun. Yes, we can. It's fine. Whatever. But point being, but let's talk about in your opinion, what, what did you see? What can you discuss that, that you think is perhaps underappreciated or, or really merits more attention? What, what, what are what, give us like a couple things that you, two or three things that you think really people need to be thinking about that, that, that came up in the discussion this year.
Tom: Well, I think first of all we had some, some pretty important luminaries as you like to call 'em. Jay Powell, Christine Lagarde, the new head of the Bank of Japan and, and representatives actually from the New York office of the People’s Bank of China. So there's a good mix there, but I would tell you that, so my sense of it is they're very serious. At least they say they are. And so far they've kind of given that impression about bringing inflation back down. They're willing to pay the price. They're willing to risk a recession and no one wants it, including them, but they are willing to risk it because they think if they don't do that now, they'll have a bigger problem later. And I think that came through loud and clear in both Jay Powell's remarks and in Christine Lagarde’s remarks at the luncheon.
Tom: So that's number one. Number two, there is, I think, a new appreciation, if you will, and maybe a better understanding of the liquidity risk around the US treasury market. Several times the formal speakers and informally people made note of the fact that the US treasury market is the deepest, most liquid market in the world. Most important market in that sense for central banks. And there are all these things except when they're not. And that becomes now a major concern. And by that I mean first of all, the, the banks who help fund the US debt, the largest banks, GSIBs, we call 'em, Global Systemically Important Banks, are up to their eyebrows. You if I can say that in terms of having to buy treasuries as we've increased the debt so substantially.
Tom: And they can do that, except as they like to say, the leverage ratio is the constraint because they have to have so much capital against their total assets. And if their assets are increasing, I should say, if their treasury assets are increasing as a proportion of their balance sheet that makes it more difficult for them to act as a primary dealer. And so there was actually recommendations by some in open session Jeremy Stein, for example, who really would like to see the the leverage ratio become less of a binding constraint on their ability to buy treasuries that has other kinds of consequences that was discussed I think, and importantly, so, so number one, the leverage ratio to, to, to, to let that become less important in the banking capital stack. Number two, though, there's concern that although it's such a large market today, there's not a real good clearing mechanism.
Tom: So there's proposals to begin to have a central clearing facility for US treasuries as you would have now for foreign exchange, and that that would provide greater transparency and therefore opportunity for greater liquidity in that market. The issue is, of course, moral hazard around that. What if this if this central clearing unit gets in trouble, will the central banks need to bail that out, number one. And thirdly with that in mind, there was a fair amount of discussion, again, in the formal session and informally about the concern for should there be a standing repo facility for treasuries, for not just banks, but for those holding treasuries, since they're credit risk free. This would provide a greater liquidity for ’em to under, if the economy becomes under pressure and you want to liquidate those, that you have a facility called the central bank to do that.
Tom: And I think that also has substantial implications for moral hazard. So that was a, I think, a very important topic, especially far as far as I'm concerned, in terms of fin reg and regulatory environment and financial stability. So that was, that carried a lot of the day. The third thing I think is, I think very important for fin reg in the future is a paper that was delivered by Barry Eichengreen, who really said, if you think of the US debt today, and it's growing at, at the, at the rate it's growing the ability to reduce that debt ever is now zero. And that if you think of the things that are gonna add to it and accelerate it in terms of the interest on the debt and the index of, of the basically the entitlements program within the budget, within the government spending budget you can see where they're concerned that this debt is gonna take over.
Tom: And it adds to the earlier problem of funding treasury debt and the liquidity of that market and what that means to the financial industry, the stability of the financial industry and the stability of the economy long term as that demands more of the economy's resources to fund that debt and more pressure on the central bank to buy that debt and to monetize that debt going forward. So those are, those are, I think, enormously important issues that are being brought out now as we enter a period where there may be another debt standoff as we begin to think about liquidity in the market more broadly, global market, more broadly. Now other topics include the issue of China and the movement of trade from China to other Asian countries. So it's a whole discussion of reshoring and friendshoring and what that means for economic growth and stability in the future. So a lot of, I think, important topics no solutions, but maybe a recognition that we have to start looking more systematically for solutions going forward.
Brian: So what, you know, okay. What do you think was, was there anything that was like, missed either a topic that you, you think needs to be discussed that wasn't, or in those things you just raised, do you think, where do you see, are there any potential blind spots or put differently, if you could sit everyone down and make them listen to you what would you say?
Tom: Well, the thing that was missing around these topics was solutions how, you know, what are the, what are, you know, other than eliminating the leverage ratio, which is, which is a symptom, not a cause there was not a good discussion of, you know, how do you contain the, the growing spending and the growing debt not only in the US but globally what, you know, there are no bounds now. There are no, there are no rules for controlling the, the monetization of debt globally in today's world, number one. Number two, there's no mechanism for constraining, spending other than political will, which there doesn't appear to be. And there was no suggestions on how you bring that together. There was on, on the sidelines, I might say, there was discussion of putting a new fiscal debt commission together that would be binding to where the, you, the solution would come to the Congress, and they either voted up or down one of those types of approaches. But it wasn't discussed formally. It was say, well, maybe this is what we can do. So, the absence is we have these problems, we recognize it, but what is the solution? None offered.
Brian: So was there any discussion of the interplay or trade offs between the costs direct and indirect of regulation and the debt concerns? Right, because you, you have sort of the fiscal cues, you have the as I understand it, and I don't understand it, you have the fiscal question, like government spending money, you have the monetary question of monetary policy, but then there's also sort of the regulatory question of how much growth is being foregone because of regulatory costs or impediments. And to be clear, you know, that might be justifiable, right? Like if, if we could get an extra percentage point of GDP, but everyone was gonna get cancer from polluted water, that, which, that might not be worth it. But on the, on the other hand, most of the questions are way less obvious than that. Is there any discussion there, any, any efforts to sort of wrestle with the, the headwinds of regulation on growth?
Tom: Well, that's a good question, Brian. There was a discussion on the issue of growth and what would what, what, what would affect growth in a positive way. And it was rather one of the, one of the, one of the papers that was delivered on the was on the fact that if you raise interest rate, well, that's slow growth, rather than what are the longer term issues around growth and how do we fix that? There was also, I think there was some discussion in, in in the meeting about the regulatory effects on growth. But it wasn't, it wasn't deep. It wasn't, it was more or less, yes, we have to be aware of that. Yes, growth is important, but what should we eliminate? Was not a topic. The only thing it was, was a topic was, well, should we somehow monetize more debt to make growth?
Tom: And, and especially came in, in the, in the context of innovation you know, to, to innovate, to have venture capital, to have the ability to scale. You have to have access to capital. And if you are constraining capital 'cause of higher interest rates, concern for inflation, what would be the effect on innovation and therefore future growth that was discussed, but not again, in the sense of, well, wait a minute, what are the long-term implications if we have, if we don't get inflation under control? And, and how do we deal with assuring that the economy is stable enough to allow capital to flow to innovative activities. So it was more of, again, we have to have capital, which we all agreed to. If we're going to facilitate growth, we have to have a, a market environment that is someone said appropriately regulated, but not overregulated. But that's not defined. And it's hard to get agreement among this group as any other. 'cause There was a cross section of what I'll call fairly progressive economists and fairly conservative economists. And so we still aren't in a point where they're talking to one another for common solutions, and that's a ways to go. But I think we, the conference did raise the awareness of this dilemma, and that may be the first step in the thousand mile journey.
Jessica: So despite the lack of solutions, you feel optimistic about coming away from the trip.
Tom: I feel, yes, I do feel optimistic in the sense that it was extremely good in terms of defining what the issues are. And I think incentivizing the next stage of say, all right, now we do need to look for solutions. In fact, one of the participants Maya MacGuineas who's very much on the issue of the government's debt challenge is saying, wait a minute. We can, we can bring a group together to begin to look at that. And then others in terms of, alright, we do have an issue with the treasury market, but what is a, what would be the better solution? Not just off the cuff, but we have this paper. What other opportunities might there be to solve this problem that doesn't increase the moral hazard problem that would accompany a greater role of the central banks intervening into the treasury market? So, yes, I'm optimistic. You have to raise the problem. You have to identify it before you can solve it. And they did a good job of that. And I'd say kicking off the idea for solutions.
Brian: Okay, so Tom, I really appreciate your optimism, but lemme see if I can ruin it. What is the, what issue do you think is, is not getting anywhere near enough attention? What's the blind spot that's gonna kill us all? And, and, and you know, what is the thing that you just wanna grab people if there is one, and say, you need to be paying attention to this and you're not.
Tom: Well, the one I'm most concerned about is the long-term debt problem. Because when even the CBO says under the most optimistic projections that the growth rate of the US economy is gonna fall below 2% and stay there when it has been above 2% for decades on average you're taking a lot of future wealth out of this economy. And I think that is that, that breeds social unrest and dissatisfaction. And when I hear a person say, you know, that's it, and no one's addressing it, I get worried. And we have to admit that Congress is not addressing it. And the Fed, that central bank has been enabling the Congress to avoid that problem for over a decade now. So that's where I'm discouraged, but I'm also going to be persistent in bringing that forward so that we do find people willing across the aisle. Okay. You cannot, the Congress has to find some middle ground, and I know that is wishful thinking at the moment, but they have to begin to address this long-term problem. And when I see the Congress talking about increasing spending already I get discouraged, yes, but I don't give up hope. No.
Brian: Well, that, that's good. So <laugh>, I know when we do events here at Mercatus afterwards, we'll send the attendees you know, like a thank you note, and they're like, oh, is there anything we could've done better? Do you have any recommendations for next time? I don't know if, if the Kansas City Fed does this or not, but let's assume you get in your mailbox. So like, thanks for coming. What could we do better next time? What's, what are you writing? What are you putting down to make Jackson Hole better next year?
Tom: Well, I, I, I think I, I don't know what Jackson Hole will be next year, but I assume it'll be given the way the, the, the economy and other things are leading, we'll have another set of problems or the same set of problems. So I would add a session, what are the best solutions going forward for problem A, B, and C and get some distinguished speakers to, to from around the world, not just from the US from around the world to address those. And I think you'll get some pretty good outcomes. In fact they, they, they did do a panel, but I would do a panel of if I could I do a panel of finance ministers and a panel of central banks, and I'd say, how would you solve this problem? And if they duck it as they would be inclined to do, I put more pressure on 'em because you have to submit your, your, your paper before now you're not gonna tell the secretary of the treasury what to do, I realize, but you can at least say is this, you think of this as a solution and you do that for them and for some central bankers.
Brian: So I, I want you to do me a favor. If you do get the comment card in the mail, would you also write down, explore the discussion of the trade offs between regulation and economic growth? And my colleague Patrick McLaughlin didn't pay me to say that, but maybe he will after he hears me asked this question. But I do think that that just does strike me as just one of the areas that, one of the facets of the conversation that's underdeveloped and could be relevant, right? I mean, you know, it's all about, it's all about trade offs. I understand you, you can, you can more tightly or more loose control your monetary supply and their trade offs there, you can, the government can spend more or less, and there are trade offs there, the government can regulate more or less, and there are trade offs there too, but they all feed into each other, right?
Brian: Because, and I understand, I understand the idea that we're gonna just grow ourselves out of this problem is naive, but if we, if the economy, at least it seems to me that if the economy was sort of, its baseline level of growth was naturally higher because it didn't have as many regulatory headwinds, that gives you at least a little bit more room to play with and, and can ease some of the, the pain points in other places. That said, of course, you know, again, if you, if, there will be trade offs there, because to the extent that the regulations you end up cutting, yes, they have costs, but they also have benefits, then those benefits are not achieved. I'm not saying it's an easy answer, but that just strikes me as, as a, as a dimension to the debate that could be added in and perhaps profitably. So to have, to have that sort of conversation going across the different camps
Tom: That's a great suggestion. I'm, I would, and what I would do is I'd start, and I even recommend to you that there were two papers presented on growth and issues that affect growth going forward. I'd start with those and then I I would add, yeah, I would join your, your suggestion that is you have a depending on what the topic is and if it is towards economic of the future of, of our economy, and I would, I, I would start off with those papers, what affects growth, and then how does regulation in the excessive regulation adversely affect it, and what can we do about it? I think that's a great suggestion.
Jessica: Tom, I know you're not a housing policy guy, but I was just wondering with raising interest, rising interest rates, and it's, most people's probably large, largest financial responsibility is a mortgage and the most they interact with the banking system is through their mortgage. Is is that on anyone's radar or how the decision to move or not to move might affect the economy as well?
Tom: That's a great question. I, first of all, just tell you when I was at the Federal Reserve Bank, if we did a, we did a whole conference on housing and <laugh>, we selected the topic when housing was booming and saying, you know, where are the risks and so forth. And that was the year that the housing crisis occurred. So at the time, we picked the topic and everyone said, it's boring. At the time that the conference was, we had a major crisis. And, and so there, there was a great deal of discussion in terms of housing and what affects it and so forth. So now here we are today we have high interest rates again. Now it's different in some ways this time. We have a shortage of housing at the moment, which has cushioned the blow from the higher interest rates in the sense of housing.
Tom: Prices haven't fallen as much as they might have otherwise. But it is on their, on the policymaker's mind. But I will tell you this that in 1980, in the Volker period in the last great financial crisis, and now the fact that you allow the policymaker allowed the inflation to get as high as it did means that you sacrifice the economy in the sense of you, you'll risk a very serious recession. You'll risk a financial crisis like last March. And now there's even talk about, you know, future problems in the banking industry. You'll risk that because, you know, if you don't take care of the inflation, it will be a much worse problem later. So yes, they have it in mind, but they're putting that as a possible casualty to get inflation brought back down. And at the moment, at the moment the central bank, and I think the policymakers are willing to risk that downturn to get inflation down.
Tom: Now, at the same time, I've noted to others that should there be a serious banking crisis that affects the, the real estate market and other parts of the economy, there is a, a will be an enormous amount of pressure and a likelihood that the central bank of the United States, and I think others will reverse their policy, they will say on a temporary basis, but they will reverse it long enough to keep from the economy, from imploding what that means longer term in terms of inflation that will, that will be the unknown that they will then have to turn to and worry about again. So it's a, it's a very it's a very narrow tightrope they're walking at the moment.
Brian: So you, you intimated that there might be a banking crisis brewing what's going on there? Like what are people worried about? What do people believe to be the mechanism that, that may, and what might that, what might happen?
Tom: Well, I I think it's more of what we saw in March. There is a great deal of concern about the amount of home to maturity assets that are well underwater, that are on these banks' books and are not being recognized in their capital count. And should there be a need for liquidity it won't be there as readily as people would like to assume. That's number one. Number two, we are seeing pressure in the economy, for example, on commercial real estate, and we focus on that. But if that's endemic in the regional banks, and to some extent even in the GSIBs with the, with the declining values, number one, from higher interest rates, that pushes the asset value down. And if it slows the economy to where those aren't cash flowing, then they'll, these banks will be under true and recognizable capital pressure.
Tom: They will be charging loans off and their capital will be under pressure, and that means they're going to tighten your credit standards even more so, and that eliminates other borrowers, and that makes, there's more pressure on the economy. So you get this snowball effect. And if you do that you will have a major banking crisis. And the worst part of that is, Brian, to your point, that usually leads to more regulation, not better monetary policy. So what happens is, what you're seeing now, it was after the March banking crisis that we got, lo and behold, a very quick version of Basel III endgame. You, if you, if you look at your, if you have an inbox from the regulatory agencies, you'll see more actions what I'll call corrective actions being required of the banks whether it's a written agreement or cease and desist or other types of actions to reign in the banks, you're seeing more of that.
Tom: So you have a tightening of, of regulation, not, it is not an agent. You have procyclical regulation, not countercyclical regulation as we go forward from here. So those are the things that I think we need to be mindful of in terms of my concern for a banking crisis in the future. The last thing I'll remind you of is with the Great Financial Crisis, the Federal Reserve stopped raising rates at five and a quarter percent. It took 'em two years to go from 1% to five and a quarter percent. 2006 Lehman's didn't happen for over two years later. So everyone's saying, oh, we got through this banking crisis in March. We're, we're home free. Well, that's strike one. I don't know if we're gonna have a strike two or not, but I'm betting that we're gonna see some downward pressure on the banking industry, and that means downward pressure on the economy. I'm an economist, so I'm a doom and gloomer by nature. But at the same time, there's a lot of data out there that even though they say economy's doing well, we're gonna have a 3% quarter this quarter. There's a lot of infrastructure problems underneath the surface. So I'm, I'm more cautious than most.
Brian: Okay. So we're, we're kind of heading towards wrap up. I have one question, one, one final question, but before that, I wanna just open up the floor to you. Is there anything else about Jackson Hole that you want, you wanna let our listeners know about? Is there any other thing that you just feel like needs to be mentioned?
Tom: No, I think, I, I, the one thing is I'm, I'm hoping that with the changing of the FOMC, this, this coming year with new members and changes, that they don't change their commitment to getting inflation under control. And that's, that was the chairman's message and now he has to deliver on that message. So let's pay attention.
Brian: Okay, so final question. Did you wear the hat?
Tom: I did wear the hat. I don't have a picture for you. And I didn't do an interview with that because the interviewer wouldn't wear a hat, so I felt, well, I can't do it either, so I'm sorry, but I did wear the hat and the boots and the buckle.
Brian: Well, okay. So we have a picture from last year that we can throw up just to let people get a sense of the grandeur of the hat. And with that, Tom, thank you very much for taking the time to talk with us and, you know, look forward to, you know, it is, it is our great privilege to work with you. So, you know, we'll get to talk again soon. But thank you for being on the FinRegRant.
Tom: Well, thank you for having me. And it's it's, you're great colleagues, so thank you both. All right,
Have a good one. You too.
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