Is the Federal Reserve Bad for America?: A Conversation with Danielle DiMartino Booth

Danielle DiMartino Booth is a global thought leader on monetary policy and economics. She is the author of FED UP: An Insider’s Take on Why the Federal Reserve is Bad for America (Portfolio, Feb 2017). FED UP, which rose to #22 on Amazon’s Best Seller List, is currently in its fifth production run.

DiMartino Booth founded Money Strong LLC in 2015. Through her economic consultancy, she has published a weekly newsletter for 132 consecutive weeks. Aside from her vast direct distribution network, over 100,000 readers enjoy her newsletter on a weekly basis via Linked In, Seeking Alpha, Nasdaq, Talk Markets and dozens of other websites.

DiMartino Booth is also a full-time columnist for Bloomberg View, a business speaker, and a commentator frequently featured on CNBC, Bloomberg, Bloomberg Radio, Fox News, Fox Business News and other major media outlets. DiMartino Booth recently accepted a position as Senior Economic Advisor for Commerce Street Capital.

Prior to Money Strong, DiMartino Booth spent nine years at the Federal Reserve Bank of Dallas where she served as Advisor to President Richard W. Fisher until his retirement in March 2015. She continues to research, write and speak on the financial markets, focusing recently on the ramifications of credit issuance and how it has driven global fixed income, equity and real estate market valuations. Sounding an early warning about the housing bubble in the 2000s, DiMartino Booth has earned a reputation for making bold predictions based on meticulous research and her unique perspective honed from years of experience in central banking and on Wall Street. DiMartino Booth began her career in New York at Credit Suisse and Donaldson, Lufkin & Jenrette where she worked in the fixed income, public equity and private equity markets. DiMartino Booth earned her BBA as a College of Business Scholar at the University of Texas at San Antonio. She holds an MBA in Finance and International Business from the University of Texas at Austin and an MS in Journalism from Columbia University.

In this interview, DiMartino Booth discusses her inside view of the Federal Reserve system as well as global distortions in today’s financial markets.

Danielle DiMartino Booth’s Bloomberg View Column:

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EW: Thank you so much for agreeing to speak to us. I really want to discuss your book Fed Up, but for those who aren’t too familiar with your background, you worked in investment banking for a period of time and were a financial journalist before joining the Federal Reserve in 2006. Correct?

DDB: Yes. It was while I worked on Wall Street that I earned my second Masters in journalism from Columbia. I was a night school student. It was always going to be my retirement plan, it just kicked in earlier than I anticipated.

EW: What convinced you to join the Federal Reserve rather than continue down the journalism path? Was it just a once in a lifetime opportunity?

DDB: Being a financial markets columnist was similar to a role I had previously at Credit Suisse, that of writing market commentary. So, it wasn’t pure play journalism, it was much more of my take on the markets and the message they were conveying to investors and policymakers. It was my column that put me on Richard Fisher’s radar screen, specifically the work I had done on subprime mortgages and mortgage equity withdrawal and cash out refinancing and what the implications would be for the global financial system.

As some of the forecasts that I had been making for years started coming to fruition, the Fed came calling. I thought what better way to combine my years of experience on Wall Street and my views on the economy. I knew what was coming in the housing market so I accepted the position offered and move on to my next battle station, so to speak – serving my country.

EW: What was the initial reaction you got when you joined the Federal Reserve? It wasn’t a very long period of time, but I think there was a small period of time after 2006 when a lot of people were still in denial about the housing market. What kind of reactions did you get from the other economists at the Fed?

DDB: This is probably what initially planted the seeds of the book – there was a lot of complacency inside the Fed. Most of the economists were in agreement with Ben Bernanke and they were in agreement with Alan Greenspan who preceded him concerning the housing market, simply because there had not been a nationwide decline in housing prices since the Great Depression. So, it was not in their models. Their methodologies were telling them that it was impossible for nationwide real estate prices to decline.

I refuted those beliefs by saying basically, “Do you not see the evidence staring you in the face, even if it may or may not be seasonally adjusted?”

I was not very popular. Let’s just put it that way.

EW: Did anyone tell you after the fact that they were wrong?

DDB: The most I would say on that count is that there was a recognition after the fact that the inflation metrics that the Fed were using were inadequate. They couldn’t capture inflation holistically. But they then proceeded to do approximately nothing about it, which is very frustrating.

EW: When you say ‘holistically,’ do you mean that the indexes used for the CPI are flawed or more broadly that asset prices aren’t being taken into account in these models?

DDB: Well, the core PCE is the inflation metric that the Fed currently favors. The CPI is a bit better because it captures residential housing inflation better than the PCE does. And yes, the third aspect would certainly be correct – asset price inflation doesn’t even register in either metric.

There are current discussions at the Fed, again, that they’re having with regard to the same question. That they’re still conducting the exact same debate some seven or eight years later, that once again shows the Fed is not seeing the forest for the trees. They still use core PCE as their main gauge of inflation. Nothing’s changed over the years. They still don’t capture asset prices as a component of inflation.

EW: Do you have a preferred metric that you would use over the PCE?

DDB: Actually, yes I do. A friend of mine at UBS has recently come up with a new mousetrap, a new inflation metric that incorporates residential home price movements as well as prices of the NASDAQ and headline CPI. He adjusts all three of those metrics for volatility to make an apples-to-apples comparison. It shows that we have just crossed over the line historically from being in balance to over valuation.

US Consumer and Asset Price Inflation (CAPI) and the Federal Funds Rate (1988-2017) constructed by Brent Donnelly, Spot FX trader at HSBC.

EW: Anybody who picks up your book is not going to be in doubt about where you stand because the subtitle of your book is “An insider’s take on why the Federal Reserve is bad for America.” I think we already covered some of the details of why you feel that’s the case and at the risk of asking too broad a question, at a high level why is the Federal Reserve bad for America?

DDB: I think I just described the dynamic to you, which is an institution that refuses to accept its failures in order to improve its performance on a going forward basis. It’s hubris. It is pursuing the same type of policies over and over again since Alan Greenspan took office nearly thirty years ago. It is pursuing those same policies despite the fact that the Nasdaq bubble blew up and caused great harm. That was followed by the housing bubble erupting which also caused great harm.

What the Federal Reserve has done, as evidenced in a new report that shows global debt has increased to $217 trillion, is to try once again to solve a debt problem with the creation of yet more debt.

EW: Is it the institution itself that is the problem or just the people currently occupying it?

DDB: There is a very insightful study that was conducted inside the New York Fed in the aftermath of the crisis and the findings of the study were basically that dissent and pushing back against the consensus inside the Fed is frowned upon and heavily discouraged. That is something that I would say is institution wide and makes for this environment of group think.

Regardless of the type of institution, from public to private, having a bunch of yes men and yes women never ends well and that is what has happened at the Fed. It was certainly not the case in the Volcker years when dissent was rife, but since 1996 there have only been two dissents among Federal Reserve Board Members. Prior to 1996, when they started keeping transcripts of the meetings, there was definitely a more energetic and open-minded process. That has been squashed over the years, and it’s why the Fed is bad for America.

EW: What specific solutions should be sought? Do you think the solution is inviting broader viewpoints to the Board itself or should policy changes be sought? For example, targeting only inflation rather than also unemployment, or moving to a more rules based set of policies.

DDB: I absolutely think we need more intellectual diversity. In terms of the makeup of the Fed, I would advocate moving back to the individual mandate of minimizing inflation, I would also eliminate the inflation targeting. An ideal inflation metric would be dynamic over time to incorporate a changing economy.

We have become a much more services-oriented economy than we used to be, yet goods continue to have a much higher weighting than they would if they reflected how much the country and the environment has changed over the years.

So, there are many, many changes to be made at the Fed. But these changes would be very easy to implement. Politics, sadly, stands in the way.

EW: How much do the actions of foreign central banks influence what happens at the Fed? We’re in a period where every central bank in the world seemingly has very easy monetary policy. Does fear of an excessively strong dollar play significantly into the Fed’s thinking?

DDB: Things changed a lot about two years ago. You might recall that China devalued the yen preemptively in front of what they anticipated to be a September rate hike which ended up being postponed until December. That postponement may answer your question, because it put Yellen on the defensive.

The rules of engagement between the United States and foreign central banks changed because there was a de facto recognition that they could no longer make monetary policy just for the United States.

EW: What’s your general take on Janet Yellen? She certainly has tightened policy much more than Bernanke did. Is she still fairly dovish to you?

DDB: If I was Janet Yellen, I would have come in and implemented a rate hike cycle much faster.

She sat on the Board for a long time and had been very much against hiking rates in 2012 and 2013 when I was on the inside. I was certainly advocating for hiking then. She was one of the big deterrents against that at the time.

Since Yellen was at the San Francisco Fed, she and her staff’s dovishness have hampered the ability to normalize interest rates in an expeditious manner. The Fed was behind the proverbial curve for a long time and now they’re tightening into a weaker economy, which never ends well.

EW: I guess that gets back to the fundamental question and why I have some sympathy for Ben Bernanke, probably much more than I would for Alan Greenspan. The obvious solution to the financial crisis, preemptively, would have been to not have loosened monetary policy to the extent that it was, but once Chairman Bernanke found himself in the position that he did in 2007 and 2008, what options did he really have?

DDB: You are going to think that I’m a broken record. If you go back to the transcripts you find that Bernanke was a huge proponent of Alan Greenspan’s policies. It’s likely that they all drink the same flavor Kool-Aid.

Of course, I’m talking about the years leading up to the housing crisis. I agree that he stepped into a bad situation where he couldn’t let the global financial system blow up. But, by the same token he was a ranking member of the Federal Reserve Board of Governors when Greenspan had the option to clamp down on subprime mortgage lending and chose not to. Bernanke himself had said that the subprime mortgage crisis would be contained – which showed how very blind he was to the potential for housing to inflict damage on the economy.

Beyond that, I think he’s a very brilliant man. He’s one of the great scholars on the Great Depression. But, he still introduced QE2 and QE3, which I believe have caused great distortions in the financial markets today. That’s all on Ben Bernanke.

EW: Ben Bernanke supported Alan Greenspan and then Janet Yellen supported Ben Bernanke. How much of that is the Chairs selecting like-minded people for the Board and how much is it the people on the Board understanding how to play politics?

DDB: There is a definite amount of political playing at this point. President Trump had some fairly combative things to say about the Fed being politicized and having held interest rates so low for so long that Barack Obama could claim to have slashed the deficit. Well, that’s very easy to do when you bring the country’s borrowing costs down to 1.8%.

Right after election day they knew that there was a potential threat to the institution and they changed their tune and started talking about dramatic tightening and aggressively reducing the balance sheet. These are sacred cows that they never dared touch before. When Obama was in office, their actions, or better said, inactions, smacked of politics. I’ve written extensively about that since the election.

EW: When you look at the fiscal side of the equation and the dysfunction of Congress, what effect has that had on the Federal Reserve? Has that put more pressure on the central bankers to feel as if they need to do more than they should really have to?

DDB: That is what the Federal Reserve has been saying for a very long time. They’ve been telling Congress to get off their duffs and recognize that we have a demographic storm building in the distance. If we don’t address these entitlement issues that are off balance sheet, then we are going to have huge issues going forward.

I think over time the Fed would serve the economy better by not acting as often in order to force Congress into action. I call it the great abdication and the Fed is facilitating what Richard Fisher used to call “congressional malfeasance.” They ended up facilitating and encouraging Congress to do less because they knew that the Fed would do more and more to bail out a very dysfunctional relationship.

EW: What do you do if you’re just an average person trying to navigate this boom and bust cycle? How do you protect yourself or is there a way to even do so?

DDB: I don’t know that there is a way. I’m Italian, so I always say that you need to “go to the mattresses.” I don’t know how, with a straight face, to tell investors how to protect themselves. The markets are in a strong up mode that is very reminiscent, not of 2007, but of 1999, where we’re seeing no revenue growth at companies. We are seeing higher cash flows and robust earnings, but again we’re not seeing the top line growth that would be indicative of positive momentum in the underlying real economy. That means that stock prices are going up of their own volition. I just have a hard time buying into that logic and suggesting to people that they just let the dice roll, but I’m not in the business of making investment suggestions and providing guidance anymore. I would just say that it’s better to be early than wrong.

EW: Sure. Without making a prediction about the future, just looking at the past, do you think the primary reason that stocks are going up of their own volition is because investors have no other options with such low-interest rates?

DDB: That’s the main driver of investment behavior. Without a doubt. We have seen record quantitative easing on the part of global central banks.

We just had retail sales come in under forecast in Japan and Kuroda has indicated that he is not in the same camp as Draghi, potentially looking at tapering the quantitative easing there.

Merrill Lynch put out a great report just a few weeks ago that said quantitative easing is still running at record levels. The world is awash in liquidity and I think investors perceive QE to be globally fungible. As long as someone is printing money, you have to stay exposed to risky assets.

If you look at the best performing asset class in this environment where there is this incredible reach for yield, it’s emerging market high yield debt. That’s the equivalent of sending grandma to Vegas.

EW: It’s not something that has ended well in the past.

DDB: No, it hasn’t and that is what drives me, because we’ve seen this before. What we haven’t seen is the ubiquity of the overvaluation. It was blatantly obvious in internet stocks that had no profits during the late 1990s. It was blatantly obvious in subprime mortgage backed securities that were trading at a premium even though they represented 125% loan to value ratios and buyers with no credit.

It’s much subtler and nuanced today because we have commercial real estate at record high valuations, every single bond market at record high valuations – from risk free treasuries all the way to emerging market debt. The average high yield bond in Europe is averaging a record low 275 bps premium to high quality debt. The value of the stock market to GDP is at a record high.

We have overvaluation everywhere. I think this has blinded investors because there’s no boogie man that they can point to and say, “As long as I avoid that asset class, I can be safely in others.”

EW: That’s an interesting point. I think the Schiller P/E is about 30x now as well. I’m not sure if you follow that.

The correlations have definitely tightened among asset classes. Is it possible to theorize why? Why in the past has loose monetary policy led to flows into specific asset classes, but today so much more broadly?

DDB: I think part of what is at work is that we don’t have this massive financial innovation in the background that we had in the form of mortgage lending standards loosening up to the extent that they did. Remember, the mortgage market is appreciably larger than the treasury market – it’s the biggest debt market on the planet. So, you had the ability of one asset class to become systemic in nature and pose a risk to the global financial system.

That is not the case today. Money has flowed everywhere and it’s been so much more global in scope since the financial crisis because the balance sheets of every developed nation has been deployed. And last time, what we had was low interest rates, but we didn’t have this money printing gone wild.

EW: There was an interesting article in The Wall Street Journal about how correlations have increased substantially, not just in asset classes, but in underlying economic performance, while volatility has declined substantially.

DDB: I did see that article that you’re referencing. If you look at global GDP, no matter where you look, the volatility has been drawn down to nothing, which is consistent to past easing cycles. I don’t know if there’s a term, but it would be a great idea to coin one. I was just inspired to write that down. But, we’re looking at a global answer to the Great Moderation and it’s remarkable.

EW: Yes. A convergence in outcomes would suggest a convergence of policy I suppose.

DDB: Absolutely. Everybody is playing by the same playbook. You should be seeing identical outcomes, because the global business cycle has been snuffed out.

EW: If you look at the resumes of central bank leaders, there’s are very few who didn’t attend a narrow swath of elite schools. Janet Yellen went to Yale, Mark Carney to Oxford, Draghi to MIT, Stanley Fischer also MIT. It’s kind of similar with the Supreme Court, where practically everyone has attended Harvard Law or Yale. How much has a lack of diversity in background contributed to the group think that you’re seeing?

DDB: It has contributed immensely. There’s a group, not sure if you’re familiar with it, known as the G30. It’s everyone from Kuroda to Draghi and to your point, maybe with one or two exceptions, they were all schooled the same way.

Ken Rogoff, for example, is a member of the G30 and according to his philosophy, even though negative interest rates were a disaster in Japan, they could be deployed more efficiently and effectively here in the United States. This is actually a discussion that I had with him. Or, you could just recognize that they’re not efficacious. They don’t work. But, there’s not enough innovative thinking in a world where neo-classicism and Keynesianism has infected everyone.

EW: A little ironic that he co-wrote a book called This Time is Different.

DDB: What’s most ironic is that now he is the one saying that this time is different and he’s refuting his own book by saying that the risks posed by debt can now be eradicated.

EW: If someone is trying to track the economy on a shorter-term basis and look for inflection points, what are the metrics they should be looking towards? Do you look to the yield curve or other metrics more rooted in the real economy?

DDB: I do look to the yield curve. Recently, with Draghi’s threatening to taper ECB purchases, we’ve seen magnificent moves upwards in long-term sovereign bonds in Europe. That’s pulled up our 10-year treasury to the extent that we’ve seen a 10 bps increase in the spread between the two and ten year treasuries. I follow that extremely closely.

I also follow car sales because they’ve been such a massive driver of the current recovery. The two main drivers that were unique to the current recovery have been the shale boom and the bailed-out automakers and subsequent opening up of subprime auto lending. A third would be QE and its effect on Wall Street and the financialization of the economy.

EW: Is there any way out of the situation besides just allowing ourselves to experience the pain of a pretty severe recession?

DDB: Again, there were people who were very publicly advocating for the Fed to normalize interest rates when it was dithering over the size of the taper. Janet Yellen has a labor market conditions index that she created of nineteen metrics that provide a comprehensive view of the labor market. It showed that in 2012 and 2013 the labor market was very healthy and could have withstood tightening. The financial markets would have been vulnerable, but not the real economy. That’s the opposite of what we have today. We have a falling unemployment rate, which is the most lagging of indicators, but if you look at the six and three months of job creation, there’s been significant slowing.

EW: What can we look forward to in the future from you? Are you planning on writing any more books or are you focusing on your consulting?

DDB: For the time being I’m focused on my newsletter, speaking and consulting. Writing a book is a massive endeavor. There is another book in me, but it’s going to take some time to talk myself into writing it. I am also shifting to a subscription basis for my newsletter, which I promised myself I would do after the two-year anniversary of leaving the Fed had come and gone. And I’m also a Bloomberg View columnist. I think you’d agree my plate is pretty full.

EW: Terrific. I’ll have to check those out and I really appreciate you joining me today. Best of luck to you.