The Breakdown - From Corrupt To Broken: An Insider’s Analysis Of The Fed, feat. Danielle DiMartino Booth

Episode Date: May 1, 2020

Danielle DiMartino Booth is the CEO and Chief Strategist of Quill Intelligence. Before that, however, after correctly predicting the mortgage meltdown, she was called upon to serve and spent 9 years as an advisor to the President of the Federal Reserve Bank of Dallas. That experience led her to write “Fed Up: An Insider's Take on Why the Federal Reserve is Bad for America.” In this episode, Danielle and NLW discuss: How the Fed went from simply corrupt to corrupt and broken Why we’ve been living through the largest experiment in monetary policy history Why interest rates are the lowest they’ve been in 5000 years Why COVID-19 was the pin, not the balloon  Why current Fed action compromises the Fed’s independence  Why the market structure incentivizes consumption and risk investment over savings Why risk investments have ceased to be risky because of Fed backstopping  Why a key concern going forward is a second wave of COVID-19 layoffs in industries beyond the obviously impacted

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond, with your host, NLW. The Breakdown is distributed by CoinDesk. Welcome back to The Breakdown. It is Thursday, April 30th. Yes, we have made it through a full lockdown month. And today we are talking about the Fed. My guest today is Danielle DiMartino Booth. Danielle is the CEO and chief strategist for Quill Intelligence, which is a market research and

analytics firm. She is the author of Fed Up, an insider's take on why the Federal Reserve is bad for America. Now, importantly, and one of the things that makes Danielle's perspective so unique on this front, is that she spent nine years at the Federal Reserve Bank of Dallas, where she served as an advisor to President Richard W. Fisher. This was through the financial crisis until March 21st. As you can imagine, Danielle's perspective on the Fed then is informed not just from hang out on Twitter and in-market analysis conversations, but through actually seeing the

inner workings of this institution, which has, as we've seen, such a dramatic impact on our lives. We talked today about why the monetary policy regime we've been living under for the last 10 years is the largest monetary policy experiment in history. We talk about why 2019 was setting up 2020 for some serious economic trouble in the context of declining world trade even before coronavirus hit. We talk about the mass expansion of facilities for the Fed in the context of the coronavirus and get into why many of those facilities are actually potentially broaches of the Federal Reserve Act and in fact threaten the fundamental independence of the Federal Reserve as an institution. We talk about the disconnect between market confidence and consumer confidence and what it's going to take to bring those into sync, if even possible. We talk about the long-lasting impacts on people's perception of savings versus consumption and what that might mean for the economy.

And finally, we talk about some reasons for optimism and a return to resilience that is starting locally with families and communities. This is a great conversation for understanding more about the federal resolution. this hugely important institution, and I hope you enjoy it as much as I did. As always, these conversations are edited only very briefly to keep the spirit of the conversation as close as possible. All right, we're here with Danielle. Danielle, thank you so much for joining. I'm so happy to be here. So for those who aren't familiar with you, I just gave a little bit of an intro to the episode, but I would love to have you share just more of your background and how What would you spend your time on now?

Well, my background is kind of, I mean, you almost need to take an anti-nausea pill for my background. After leaving business school in Austin, I decided that I was just, I had to work on Wall Street, which was a strange thing to decide to do if you're from Texas and not graduating from Wharton. But I ended up working at a very scrappy, beautiful investment bank called Donaldson-Lafkin and Genrette, DLJ and it was bought out by the Swiss at the very top of the internet bubble in kind of in that 2000-2001 area which is the first time as a as a young person as a young investor as a young follower of the markets that I sensed that there was this presence in the markets if you will a federal reserve I didn't know what a federal reserve was at the time when you when you are

on Wall Street in many ways they try and keep you in the dark But I knew that there was a presence that was elevating stocks that absolutely had no profitability and would later in life look back and say, gee, that was Allen Greenspan. In any event, after 9-11, I met the love of my life, ended up leaving Wall Street. I signed a non-disclosure, left the industry and wrote for the local paper for a few years outside of the shackles of compliance. It was great to be able to write whatever I wanted. And I ended up becoming kind of the world's preeminent expert on the housing bubble. I got lots of hate mail predicting that it was going to be a systemic and global calamity.

And these comments ended up having me go out to Omaha and be a guest of Warren Buffett and Charlie Munger. And shortly after that, I was called upon by the Federal Reserve and Richard Fisher. and I ended up going into public service where I served at the Fed for upwards of nine years with also somebody who was not a Ph.D. in economics. Also somebody with a background in finance covered every aspect of the financial markets for President Fisher when he was there. And when he retired, I left and wrote a scathing tell-all book about the Fed because I think it is a broken and corrupt institution. And now today I do in my day life at Quill Intelligence, what I did for President Fisher at the Dallas Fed, and that is I provide my insights on every aspect

of economic data and every functionality and event in the financial system, in the financial markets, whether they be bonds, private equity, or the stock market. Amazing. Well, so excited to have that wealth of experience joining the breakdown today. So what I want to do is, you know, the core of the meat of this conversation that I want to get to is your reaction to an analysis of Fed action over the course of the last few weeks, few months as the COVID crisis has come in and what you think the knock-on effects of that might be. But by way of setup, I'd love to kind of go back to comments you've made before where you've called the last 10 years or the last some number of years of monetary policy, the largest monetary policy experiment in history

that has had even failed attempts to unwind it in the past. let's set it up, I guess, for where the Fed was over the last decade coming into this coronavirus crisis. And maybe let's start by this notion of this being the largest monetary policy experiment in history. Well, if you like, the Merrill Lynch, interestingly enough, did some interesting math a few years back, and they actually revisited it recently and found that we are right now in the midst of the lowest, interest rates in 5,000 years. So I did not go back in fact-check them, but in order to, in order to generate the lowest interest rates in 5,000 years, it has to be something that is engineered inside of a central bank. It has to be something that pops out of a hypothetical

model. And in suppressing interest rates and in trying to synthetically create easier and easier monetary policy once interest rates hit the zero bound, at least in the case of the United States, obviously in Europe and in Japan, they have gone into negative interest rate territory. But in order to try and generate even easier monetary policy, the Fed resorted to buying securities, buying bonds, buying treasuries, buying mortgage-backed securities, and growing the size of its balance sheet in order to try and induce investors to speculate. in order to induce borrowers to borrow. And of course, these efforts have been sketchy at best in terms of their results,

and they've had many, many backfires and intended and unintended consequences as a result. So let's talk about the pre-COVID-19, right? This has obviously been a monumental event with a lot of implications, but going into this year, what were your... concerns with the state of monetary policy in the U.S. or globally, right? Had you been paying attention to repo markets last year? Had you been looking at the growth of negative yielding debt? Where were you before we got this tidal wave of economic shutdowns based on the virus? Well, I had been watching very closely the global economy. And if you look at the history of the world, if you will,

mild recessions in the United States, the recession that we had in 2001, the recession that we had, in 1990. These recessions did not include a contraction in world trade. And I bring up such a big subject because in 2019, we had a contraction in world trade. And if it had not been for some of the stimulus measures on the part of the Federal Reserve and had it not been for basically Chinese data being cooked in a book, then we would have seen a recession in 2000. as was evidenced by a contraction in global trade. At the same time, I was watching the debt levels grow, but the time 2019 ended, global debt had eclipsed a quarter quadrillion, $255 trillion of debt around the globe. You have to create extensive and more increasing amounts of debt in order

to maintain the facade of economic growth. And I was watching very close. Mostly, this explosive growth, the things that the Federal Reserve was doing, they were calling it not QE, but it was QE and the valuations that were rising in the stock market, in the bond market, and saying last year, well before any of us knew of COVID, I was saying this is a growing accident waiting to happen. So, okay, so perfect, perfect setup. Then COVID comes along. And, you know, we start to see, after a long period of kind of denial about it, we finally start to see action, right?

We start to see the markets react, even though they hadn't exactly when China was on lockdown. We got an emergency meeting in a rate cut, then a rate cut to zero, and then all these new facilities. And so tell me about your thinking as you watch this. Were there parts of it that you felt were necessary or prudent actions? What surprised you? I guess I'm interested in your take on. as you saw this unfold, and maybe some part of it just felt inevitable, even if surprising. Well, so things do feel inevitable. I kind of bristle at the characterization used by so many

on Wall Street that this is the corona recession and that absent this Black Swan event that the economy would not have been vulnerable at all and it would have continued to chug along. when you introduce the high degree of weakness into the markets that you do, the Black Swan event just is the needle that pricks the bubble, if you will. The response since then has been, it's been extraordinary. It's been gratifying to see in certain countries such as Germany, where they have really gotten the fiscal stimulus, the fiscal relief where it needs to be. It's certainly been less the case here in the United States.

And I would say that if I once viewed the Federal Reserve as being a corrupt institution, now I see it as being broken because of the relationship that has been established between the Treasury Department and the Federal Reserve, and my greatest concern remains that of the well-versive. being of small businesses in America that employ 47% of Americans are employed by small businesses. They account for 47% of our economic output. And the fiscal relief that has been extended to viable, solvent, strong businesses that need bridge financing to get past this crisis has absolutely been a failure compared to the sheer amount of money that has been extended

to speculators and hedge funds and private equity funds and the largest firms and stock market investors and bond market investors. So some countries have done it right. Some countries have not. And I would put the United States in the category of a country that has not done it right. Let's, I mean, go back a little bit. And this idea of moving from a corrupt institution to a broken institution. As it relates to this feeling the sentiment of the Fed as a corrupt institution, what is the root of that corruption? And I've talked with previous guests on the show about the way that the stock market has become increasingly a political utility, right, a political scoreboard. But I'm interested in when you say corrupt, what exactly do you mean?

Well, so the Federal Reserve Act, I'm going to get a little, I'm going to get a little bit in the weeds here, but it's necessary. Love it. Love it. The Federal Reserve Act explicitly precludes the Fed from taking on individual company risk and any kind of corporate risk, and it takes on, and it's not allowed to extend credit in any way to insolvent firms. So in turn, I don't know if anybody can remember the Enron saga, but Enron WorldCom,

a lot of companies had off-balance sheet vehicles that allowed them to really monkey with their accounting. And that is what the Fed has done. There are special purpose vehicles that have been set up at the Treasury Department, and it is through those vehicles that the Fed is able to provide financing and funding to the corporate bond market, to the high-yield bond market, potentially to the municipal bond market. there's been yet another facility set up to reach out to municipalities that are in need of a lifeline. And these are, again, an express violation of the Federal Reserve Act, but by the virtue of setting up entities at the Treasury Department, it's now an arm's length transaction, if you will. By the same token, the Treasury Department has control, if you will.

if you take it to the extreme over what the Federal Reserve funds going forward. So we have, and by extension, the Treasury Department is answerable, that they answer to the administration. And the Federal Reserve is supposed to be by its very, by the law, an independent and a political institution. And that violates this. The fact that the Fed is getting off on a technicality, because it's not technically. technically holding, let's say, a corporate bond on its balance sheet, but rather offloading it

onto the Treasury's balance sheet where any first losses are going to be absorbed by taxpayers is extremely problematic. And when you consider that the administration could potentially be in charge of allocating financing and funding to companies, you know, it's enough to make, at least in my case, it's enough to make my hair get set on fire. Yeah, I think that this is a really important point and why I'm glad you went into the weeds a little bit. But the encroaching closeness of elected officials to decisions that have such dramatic impact on markets creates, you know, it's not just moral hazard. It's a recipe for absolute disaster, right? And it creates this, you know, at best, a perverse incentive for what it looks like to actually take risk, right?

It replaces risk in the market with a need to have access to specific political actors, which, you know, is hugely problematic in so many ways. It is. And you're right. This goes one step beyond moral hazard. Moral hazard is simply the Fed saying, hey, we're going to buy the largest junk bond exchange traded fund in the country. And investors swarming into the stock market and saying, this is it. The Fed's going to bail us out no matter what we buy.

That's moral hazard. Having the potential for having Treasury Secretary Manusian dictate companies that are going to be receiving funding, the Fed has put out details on its quote, unquote, quote, because it requires air quotes. The President had put out, excuse me, the Federal Reserve has put out details on its Main Street lending facility, but I would put Main Street in quotes because it has now been revised to include companies with revenues of up to $5 billion in 15,000 employees. That to me is not a Main Street small business in any way, shape, or form, but it could be a portfolio company owned by a private equity firm. And you start to see that you are

really crossing over into a deep enough conflict of interest that a future Congress, that a future Supreme Court, that a future administration could indeed question and go back and reverse what has been done, the damage that has been done in the name of there being a crisis on our hands. This is one of the things that I think is really difficult about having this conversation, in this climate is that it becomes instantly politicized on the basis of party affiliation when really these are, you know, these are structural challenges that, you know, you replace a, you replace a Republican in office with the Democrat in office, and we're still dealing with these same structural issues because they take on a force and await all their own.

And this is something you've talked about before, the difficulty of unwinding this, right? Once you set these sort of norms in motion, once you normalize this sort of behavior, becomes enormously difficult to walk back from, right? It takes a political will that's hard to imagine in our current political climate. It does, and that's not even, that's not even political in nature. That is the nature of the beast. I mean, as far as I'm concerned, it was under Democratic institutions, excuse me, Democratic administrations that we saw some of the worst corruptions of the Federal Reserve, because, you know, QE1, QE2, QE3, these were largely, these were largely employed by Congress, bypassed administrations in order to have the public spending purse opened wide up.

Because if you keep the, you know, the country's borrowing cost at such artificially low levels, well, they can just borrow a kingdom come and blow up our debt, which we know is now, you know, with the $3 trillion and counting of stimulus, we know that we could easily have a $30 trillion debt in no time at all. But again, with the Fed keeping interest rates at artificially low levels, politicians can say the country can easily enough service these debts because the cost to borrow is so low. Well, that is, that's, that's collusion by any other word. So let's bring this back up, I guess, to now and what people in the economy is dealing with now.

I wanted to bring in another factor, obviously, which is added to both the pinprick of COVID-19, as you put it, with the larger structural crisis. And then along comes an oil crisis. So how does oil and what's going on in the oil markets complicate this entire scenario? Well, so this is where politics comes back in and a sense of OPEC being. made redundant. I'll try and make this a short story. OPEC was effectively made redundant as a result of fracking in the United States. And I'm actually a huge advocate for fracking in the sense that if we take this out long enough, we are going to have energy independence, which I think is good for national security, to not be dependent on the kindness of any other country in order to have access to energy. But as a result, over the years, as the efficiencies of fracking have built up,

we have been able to extract a gallon, excuse me, a barrel of oil out of the ground for less and less money. And that has, that has been cataclysmic for oil exporting nations for OPEC, for Russia. and they have used the crisis of COVID-19 as an opportunity. Don't let a good crisis go to waste. But they've used this as an opportunity to start an oil war and flood the markets with supply and slam the price of oil down, where it sits south of $20 a barrel,

which is putting U.S. oil companies, oil and gas producers, out of business. Now, I would say that the inefficiencies in the energy patch in the United States, the consolidation of the industry, the insolvencies, these are some, these are things that we've been dealing with in 2018 and 2019, both because private equity swarmed into the industry and the consolidation was needed. And this oil crisis, this collapse, and in energy prices has expedited what had already started. But the upshot, unfortunately, especially for states such as Texas, is that it is making an unemployment crisis that much worse

because you're not just putting people in travel and tourism and restaurants on the unemployment rolls, but you're also having companies who are shutting down their oil wells and going bankrupt and putting entire workforces. on the unemployment roles as well. This is one of the, I think, most, well, it's discussed, but it's interesting to see how widely perspectives vary in some ways on how people interpret the economic damage from coronavirus from these shutdowns. And there's kind of the optimist point of view,

which is like, you know, everyone comes back as soon as we turn the lights back. That's kind of lights back on vision of the world, where somehow all of a sudden it just works. again and, you know, it's great and we're, you know, everyone's going back to the movies and go to restaurants again. There's this other point of view that thinks that there's starting to see the second order effects in different industries that are going to be structurally affected. And I think kind of part of what you're speaking to with oil is that it coincides with that in a way that there's even greater economic harm happening at the same time than just these

kind of short-term impacts. And so I guess this gets me to another kind of theme that I wanted to ask you about, which is how you reconcile market confidence versus consumer confidence, right? And the, you know, kind of the market's trying to rally for some sort of V-shaped recovery while consumers are just trying to figure out, you know, what happens next and how they're going to live, but also potentially have some seriously shifted behaviors, even when things, you know, quote-unquote, get better. So I think that there is, and I don't think that there's anything necessarily. wrong with having enthusiasm and having optimism that we're going to be able to have a better

tomorrow. But I would say that it's a bit naive. The confidence that you're seeing in the stock market is purely a reflection of investors saying that the Fed has our back, we can take undue risks, and there will be no consequences. That is what you're seeing in the stock market, because it's certainly not predicated in any way, shape, or form on earnings, which have completely collapsed. So there's nothing fundamental going on in the financial markets in the United States at the moment. As far as confidence in tomorrow and how we as individuals behave, I think that this is going to be, that there's going to be an extensive healing process involved. And it has more to do with simply being fearful for your health and the health of your loved ones and your family and your

friends, that's powerful. And it's going to be with us for some time. I can't tell you when I personally will be attending the next sporting event or concert. I would certainly never attend a political rally or stand in line at Disney. And I'm certain that I'm not alone in the way that people are going to be viewing certain types of activities that, by the way, Travel and tourism prior to COVID employed one in every 10 employees on planet Earth. One in 10 global employees were in travel and tourism. The sheer amount of wealth that's been created by central banks in recent years has made it to where the haves versus the have-nots, if you will, but the haves have been able to travel and enjoy life more than they ever have.

And that has resulted in a huge surge in employment in this industry that has been so affected. by COVID. But on a deeper level, beyond the health issue is the fact that 38% of Americans who made $100,000 or more had not one penny of savings set aside. And it's not just a matter of those who make the leave. Those who make 50,000 and under and who are collecting unemployment are going to make more money in the second quarter of 2020 than they would have had they kept their jobs. So this is not a statement about those who make the least, and it's not a statement about those who make the most, who will always be fine. But those in the middle who were not prepared for this, they're going to view money differently going forward. They're going to view consumption

differently going forward. They're going to say, you know, in a Scarlett O'Hara way, never again. Never again will my family suffer and have to eat ramen every night because I had to have to have a $70,000 SUV with a payment that I could barely afford. And I simply believe that there's going to be at least for some slice of the U.S. households return to an era of frugality that's not been seen since the aftermath of the Great Depression that is going to have a lasting impact on how quickly the economy can recover and whether or not it's going to be a matter of quarters or years. So I actually share that sense.

But one thing that's a countervailing force, which I think gets to these larger structural issues, is the disincentive to save, right, based on interest rates being so low, based on everyone effectively being forced into equities markets, right, and higher risk to get yield. And I worry, I guess, about the long-term implications of just the structural, incentives to save versus, you know, invest in markets? Yes. And this is where I get the most pushback on Twitter.

By far, it is when I suggest that Americans are not going to borrow as they once did. And the cynics out there or the cheerleaders out there say that I'm making a statement that is somehow un-American. It's actually quite the opposite. Our founding fathers did believe in the virtuosity of saving today to invest in tomorrow. But it's going to be interesting to see where the dust settles on this and whether or not we truly go back as a country, as a culture, to our profligate ways of living beyond our means, not by necessity. Again, I'm not speaking about those who earn the least and absolutely have to use. credit card debt in order to get them from one paycheck to another. I'm not speaking to that

cohort. I'm speaking to those who lived beyond their means as a matter of choice and felt that it was something that they would always be able to do because it was incentivized and it was asked of them by their leaders. They were told by Ben Bernanke. They were told by Bill Dudley when he ran the New York Fed, go take out a home equity loan, go do a cash out refinancing. It helps to support the economy. We're a consumption-driven economy. It will be interesting to see if there's backlash because there's been serious harm done to many families who did not have a rainy day fund. Yeah, I think it's interesting. I think a lot about narratives and one of them that I'm most interested to watch, which dovetails exactly with what you're describing, is whether we're going to

have this national conversation about what it looks like to build a resilience economy, right? And that from an individual level on down. And, you know, even the words that we use around saving are kind of forced into this fuddy-duddy old world kind of way of looking at things. And maybe part of it is, you know, needing these exogenous factors to shift mindsets. And part of it is rebranding and thinking about savings not as a thing you have to do to deny pleasure, but as something which creates optionality and opportunity in the future. But it's hard to imagine, I think, from where I said at least that that takes hold nationally as a whole and kind of totally shift sentiment. But I do think that you carve out some percentage of people who start to think like that and you do build a stronger economy and a stronger society,

even if it's just on the margins, right? So I guess, you know, my last question for you, which is potentially a set of questions, is what are the signals that you're watching now going forward? Where's your head at as you kind of think about what comes next? Are there particular second order effects that are important to watch? Are there certain market signals that you think are more relevant than others? What are you paying attention to? So I think what I'll be paying the closest attention to is whether really, really, And this is not, it's not a cop-out answer.

I don't want you to think that it is. But I'm going to be paying the closest attention to what happens with this virus. There is a second wave of layoffs that is building among corporations, business people, people who work in back offices. If we don't have sufficient demand, then there is going to be something of a crisis because we will have a second round of layoffs that are indirectly attached to the crisis. I've written just this last week about commercial real estate and what's going to happen to this sector if rents continue on the part of tenants, strip centers, malls, retail, lodging hotels, what's going to happen in the commercial real estate sector, which is a massive contributor to the U.S. economy? If there's a protracted slowdown in it, is there going to be a round of layoffs?

among construction workers who are some of the highest paid skilled workers in the economy, akin to oil field workers who don't have educations, but they make a good living in construction. So I'm looking at the second and third derivatives, potentially, of the economy being in recession for longer than what anybody's planning for, and that really is going to dictate how I view the ability of the economy to pull out of the contraction that we're in. and it's going to affect how consumers view the world as well, how long this recession lasts. Yeah, I couldn't agree more. And, you know, it's someone I think a lot about industries like the advertising industry

where you haven't seen mass layoffs at agencies yet, but as soon as, you know, these fees stay down. And, I mean, basically, you throw a dart at a dart board of industries and you can start to see where these second order effects hit. But listen, I really appreciate your insight. And maybe I'll just ask you one last thing. what's a cause for optimism? What's something that's causing or giving you optimism

even in these kind of turbulent times? Well, I'll tell you, I've been part of a fundraiser for personal protective equipment. And the hashtag for this is hashtag our finest hour been working with Ben Hunt at Epsilon Theory for front-home. And I'm gratified as an American to see the outpouring of charity to those who are in need. And I gave money to a charity in Belarus

where special needs children's with weak immune systems in an orphanage have been taken down by COVID. But there are things that I think are gratifying. If you look back at the Great Depression, there were some wonderful outgrowths economically. because of what people did out of the kindness of their hearts and because they were good human beings. And it is, it's gratifying to see the good in people come out in this very difficult time.

And, and I think that that is something that will also make a lasting impact on our hearts is that, you know, it shouldn't, we shouldn't be as me-centric as we are. We should be more aware of everybody in our society and what we can do to help, not just in times of crisis. So in a way, this is our darkest hour, but it is also our finest hour. And it's wonderful to be able to see day after day examples of that. Couldn't agree more. And it's a perfect note to end this conversation on. Danielle, thank you so much for hanging out and sharing your thoughts with us today. I know everyone who's listening appreciates it. I think one of the most interesting parts of that conversation to me is the idea that there is the potential for a permanent shift in consumer behavior, a permanent reconsideration of

trading short-term consumption for long-term resilience in the form of savings. I think that it is a challenge that those savings are de-incentivized by the market we live in, the society that we live in. It's both brand and structure tells us to consume or to invest in risky assets rather than actually preserve optionality in the form of safe savings for the future, but that will potentially see some amount of shift in this crisis. We've discussed before on this show the idea of resilience and the shift to a resilience economy, and it's a theme that I just want to keep hammering on, because I think that it takes manifesting to actually make it real. It takes investment. It takes narrative self-fulfilling prophecy to make it real. So my hope is that we will start to come out of

this with a broader sense of what a resilience economy might look like, even if it's just in the context of our individual lives or individual careers. But that's it for today. Tomorrow we have a very special, very cool episode, the beginning of a micro series on the future of money, money reimagined. Look out for that tomorrow at the normal time. And until then, guys, be safe and take care of each other. Peace.