The Fed Cannot Go Bankrupt; However, It Can Bankrupt the Country

Published by the Mises Institute.

07/13/2022 Patrick Barron

A recent essay on the Mises Wire triggered quite a bit of discussion among a group of Austrian school economists. Paul H. Kupiec and Alex J. Pollock's "Who Owns Federal Reserve Losses and How Will They Impact Monetary Policy?" became the focal point for a wide-ranging discussion of monetary issues that got to the heart of our monetary and overall economic future.

The Fed Cannot Go Bankrupt

The article itself is a fairly straightforward explanation of how the Fed works, and provides several options that the Fed might pursue in a rising interest rate environment. The authors contend that the Fed has intervened itself into a corner, where losses probably will increase as the Fed raises rates. David Howden opined that this might not happen, as the Fed will roll over its mostly short-term, low-yielding investments into higher-earning assets, which will tend to protect its net interest income and provide an operating profit. Furthermore, the Fed is not required to mark its low-yielding investments to market. Were it required to do so, the Fed's true financial weakness would be revealed.

The Fed Ignores the Rule of Law

But what can or will be done about it? Early in their essay, Kupiec and Pollock conclude that nothing will be done, despite the provisions of the law that created the Fed over one hundred years ago. The losses will not go away; they simply will be transferred to the unwitting public through loss of purchasing power. Per Kupiec and Pollock:

"Innovations" in accounting policies adopted by the Federal Reserve Board in 2011 suggest that the Board intends to ignore the law and monetize Federal Reserve losses, thereby transferring them indirectly through inflation to anyone holding Federal Reserve notes, dollar denominated cash balances and fixed-rate assets.

The "innovation" in accounting policies centers around the Fed's newly minted "deferred asset" account, to which underwater assets will be transferred. Per Kupiec and Pollock:

Today, the Federal Reserve Board's official position is that, should it face operating losses, it would not reduce its book capital surplus, but instead would just create the money needed to meet operating expenses and offset the newly printed money by creating an imaginary "deferred asset" (Section 11.96) on its balance sheet.

If the Fed were subject to the rule of law, either it would have stopped money printing years ago or its creditors would have forced it to close its doors. Yet the rule of law is completely ignored. Per Kupiec and Pollock:

The Federal Reserve Board's proposed treatment of system operating losses is wildly inconsistent with the treatment prescribed by the Federal Reserve Act.

The Keynesians running our economic life may be reassured that the Fed cannot fail in a technical sense, but the public should be appalled. The continual monetization of the federal budget threatens the complete loss of the dollar's purchasing power—to wit, a Weimar Republic–style catastrophe.

Unlawful Monetary Debasement Causes Capital Destruction

Today's monetary leaders fail to understand the true nature of money and, therefore, cannot conceive that there are real consequences to their outlandish irresponsibility in monetizing government debt and brazenly dismissing the rule of law. As the facilitator of monetary debasement, borne by the general public, the Fed fosters the destruction of societal capital.

The federal government does not have to answer to the law nor the public for its irresponsible and destructive spending. The purpose of insolvency is to force an institution, whether public or private, to stop destroying capital. Austrian school economists understand that capital must be created by hard work, innovation, frugality, and, most of all, savings. The market allocates scarce capital to those enterprises that create things worth more than those scarce inputs.

The Solution Is a "Return to Sound Money"

In 1953 Ludwig von Mises added a relatively short final chapter to his 1913 masterpiece The Theory of Money and Credit. Chapter 3 of part 4 is titled "The Return to Sound Money." It is as relevant today as it was almost seventy years ago. Mises explains how the US in particular could anchor the dollar to its gold reserves. The Fed would be eliminated and replaced by little more than a board that would monitor all dollars to make sure they are backed 100 percent by gold.

Mises was a master in presenting what self-serving Keynesian scholars try to hide in a fog of deception; i.e., that money can and should be subject to the rule of law, as are all other economic goods in society. I daresay that there is no single reform that comes closer to fostering peace, freedom, and prosperity than a "return to sound money."

Biden’s Appointments Speak to an Extremist Agenda

Published in TownHall.

Perhaps the most outrageous example of the president’s extremist appointments was his nomination of Saule Omarova to head the Office of the Comptroller of the Currency. A graduate of Moscow State University on the Lenin Personal Academic Scholarship, Omarova tweeted in 2019, “Until I came to the US, I couldn’t imagine that things like gender pay gap still existed in today’s world. Say what you will about old USSR, there was no gender pay gap there. Market doesn’t always 'know best.'” In an academic paper Omarova’s advocated that “central bank accounts fully replace — rather than compete with — private bank accounts.” It’s disturbing that a person who spent much of her academic career deriding capitalist institutions and advocating for unprecedented government management of the economy, was nominated for such a critical economic position. At least the nation can be thankful that Omarova withdrew her nomination in December – as many moderate Democrats made clear they could not support her nomination.

Read the rest here.

Ukraine and the cost of war

Published in the Washington Examiner.

In an example unrelated to war, consider former President Richard Nixon’s 1971 decision to abandon the gold standard and impose wage and price controls and tariffs to calm inflationary forces. This was primarily a response to France’s effort to convert dollars to gold.

It's Another Housing Bubble And The Fed Is Holding The Pin

Published in Zero Hedge:

As economist Alex Pollock put it in an article published by the Mises Wire earlier this year, the Fed “continues to be the price-setting marginal buyer or Big Bid in the mortgage market, expanding its mortgage portfolio with one hand, and printing money with the other.”

In 2006, the Fed owned zero mortgages. Today, The central bank holds about $2.6 trillion in mortgage-backed securities on its balance sheet. According to Pollock, about 24% of all outstanding residential mortgages in the US reside in the central bank. That makes the Fed, by far, the largest savings and loan institution in the world.

William Isaac Announcements: February 15, 2022

February 15, 2022

My long-time friend and brilliant scholar, Alex Pollock, has written an essay on the probable impact of inflation currently gathering steam due to fiscal policies being pursued by Congress and the Administration and monetary policies being pursued by the Federal Reserve. I'm sure the article will resonate and bring back troubling memories of the 1970s and 1980s:

• 'Biden Inflation' made simple: Borrow from the Fed, take away from the rest of us by Alex J. Pollock published by The Hill.

The full article can be found at williamisaac.com. Be safe and be well.

All the best,

World’s biggest S&L

Published in Grant’s Interest Rate Observer.

Yes, agreed Alex J. Pollock, the Federal Reserve might well go broke, or, we should say, “broke.” The quotation marks acknowledge the Treasury’s standing guarantee of the central bank’s solvency. Then again, Pollock pointed out, where would the Treasury be without the Fed to buy its bonds?

So a relationship of codependency, as Dr. Phil might put it, is a foundational element of today’s federal finances. “It’s a paradoxical situation,” mused Pollock, author, think-tank scholar (currently at the Mises Institute) and, most relevantly for the purposes of this discussion, past president and CEO of both the Federal Home Loan Bank of Chicago and Community Federal Savings and Loan Association, St. Louis.

Your editor and Pollock were comparing notes on a Jan. 5 comment by J.P. Morgan Securities titled, “The case for an earlier start to QT.” In it, Morgan’s Fed watcher, Michael Feroli, speculates that so-called quantitative tightening might get a head start to spare the central bank the embarrassment of having to report an operating deficit. He reckoned that a funds rate higher than 2¼% could pitch the Bank of Powell into a loss.

…

Reviewing the Fed’s financials (including the Sept. 30, 2021 edition of the “Federal Reserve Banks Combined Quarterly Financial Report”), Pollock says that they only confirm his view that “the Federal Reserve has made itself into the world’s largest savings and loan, with all of the problems of being a savings and loan.”

Besides his 15 years spent at the head of the Chicago Federal Home Loan Bank, 1991–2014, Pollock led an unsuccessful attempt to rescue a failing S&L, Community Federal, St. Louis, in 1988– 1990. “We got the ball late in the fourth quarter on our own 1-yard line,” Pollock lightly told the St. Louis Post-Dispatch following the forced sale of Community in 1990. “We got it to the 20-yard line and time ran out, but it was one great drive.”

Now, then, Pollock observes, as of Sept. 30, 2021 the Fed showed $143.1 billion in cumulative unrealized gains on its portfolio holdings, down from $354 billion on Dec. 31, 2020. Probably, he speculates, four months of mainly rising interest rates have turned the positive September 2021 mark negative, and “maybe by a lot.”

Of course, the mark forces no action, the Fed being exempt from the regulatory rules governing regulated financial institutions. But if the central bank were not so privileged, and if you, Alex Pollock, were the CEO that had parachuted in to effect a miracle turnaround, what would you do?

William Isaac Announcements: December 23, 2021

From William Isaac’s email campaign and website:

December 23, 2021

Alex Pollock and Ed Pinto, two long-time friends of mine, who are THE leading experts on government housing programs, have written an important article on the past, present and future of government housing programs. I encourage you to read their new article on my website.

• Federal Housing Regulators Have Learned and Forgotten Everything by Alex J. Pollock and Edward J. Pinto

The full article can be found at williamisaac.com. Be safe and be well.

No, the United States Has Not Always Paid Its Debts

Published in Reason:

In 1934, Roosevelt officially devalued the dollar by increasing the price of gold from $20.67 to $35. Although contemporary press accounts characterized the government's actions as an abrogation (see the Wall Street Journal on May 4, 1933), Treasury securities issued in June and August 1933 were oversubscribed and a February 1935 Supreme Court decision upheld the government's actions. While these actions are generally portrayed today as an attempt to halt gold hoarding or end price deflation, they also appear to have had a fiscal motivation. In fiscal year 1933, the ratio of interest expense to federal revenues reached 33.15 percent, the only time this ratio has exceeded 30 percent since the post-Civil War era. The Roosevelt administration needed more funds to implement New Deal programs and wanted the flexibility to issue new Treasury securities unimpeded by gold convertibility.

Biden Pick for Bank Regulator Proposed Fed Take Over Banking, Manipulate Stock Prices

Published in the Epoch Times:

“If you have all of the deposits in the government bank, then all of the loans, or at least a very high percentage of the loans, are going to be there as well,” said Alex Pollock, former head of the Federal Home Loan Bank of Chicago and financial research executive at the Treasury who is currently a senior fellow at the classical liberal Mises Institute.

Controlling credit means the Fed—and de facto the federal government—would have a say in most major individual economic decisions, such as what factory or office tower gets built, who gets to build or buy a home, and even who gets to go to college or buy a car.
“If you’re politically correct, well, then you can get a loan; if you’re not, you can’t,” Pollock told The Epoch Times about the implications.

...

“She wants government to control the allocation of capital in the economy, which is a recipe for politicizing everything,” said David Burton, financial regulation expert at the conservative Heritage Foundation.

Pollock concurred: “It would become purely political.”

...

It isn’t clear what such price signals would be worth when the investors would be limited to options predetermined by the NIA, Pollock noted.

In fact, it isn’t clear how the Fed would determine what is or isn’t productive in a system in which credit flows are largely determined by the government. The ordinarily robust private credit to serve as a frame of reference would be largely absent and so the Fed would have to fall back on its own judgment.

“Nobody, especially a government bureaucracy, can know enough to do this,” Pollock commented in an email. “It is a totally naïve and, in fact, silly idea.”

At times, Omarova contrasted “productive” investment with speculative investment, which she called “misallocation of capital.”

But speculation “can be destabilizing or stabilizing,” Pollock said. Suppressing it by government mandate doesn’t necessarily heal the monetary woes. In fact, the current practice of the Fed buying up securities seen as safe, like government bonds and mortgage-backed securities, depresses yields on such instruments and pushes investors toward riskier assets, he said.

....

Pollock estimated that such an all-powerful Fed “would go on inflating the money supply by lending to the government itself (monetizing government debt) and to politically favored entities of all sorts.”

...

According to Pollock and several other economists, there are a number of problems with this view.

Let Me Vote Those Shares for You

Published in the Federalist Society.

BlackRock’s idea to give institutional clients more control over how shares of stock are voted could be a good step. Some, such as Alex Pollock, say that it is still a ladder with the first rung above the head of most investors.

The fundamental idea of owning stock in a corporation is that shareholders acquire, along with their investment, ownership rights in the company, including the right to vote on company questions commensurate with their investment. These questions can include composition of the board of directors, compensation for company executives, company auditors, and company investment and disclosure policies, among others.

As Alex Pollock notes in an October 13 letter to the editor of the Financial Times, BlackRock acknowledges, “The money we manage is not our own, it belongs to our clients.” Hence, BlackRock’s new policy idea.

. . .

BlackRock hopes to relieve some of that pressure by passing it on to investment funds that place their clients’ money with BlackRock. As Alex Pollock explains in his Financial Times letter, however, “BlackRock is handing zero voting power to the real owners of the shares which it manages as agent.” It is making it easier for others—the fund managers of your investments—to vote your shares, but they do not own your shares. You do, and the BlackRock proposal does not reach to you to learn what you think.

Your broker-dealer cannot vote your shares. In many cases, though, the managers of funds through which you own stock can. They can use your investments to vote as if they were their investments. That can give them a lot of financial and, increasingly, political clout. With your money, they can pursue their agenda, not yours.

Alex Pollock recommends in his letter that “All investment agents, both broker-dealers and asset managers alike, should have the same requirements: no voting of shares by the agents without instructions from the principals.” “From the principals” means from you, the shareholder. That is the requirement for broker-dealers. Why should it not apply to the fund managers who, without your money, would have nothing but their own?

More on the Vision of Biden’s Pick to Regulate the Nation’s Banks

Published by the Cato Institute:

Now, Alex Pollock, the former deputy director of the U.S. Treasury’s Office of Financial Research, has taken a careful look at some of Omarova’s other writings. Some of the work will seem quite familiar, but most of it exposes ideas that are even more fundamentally opposed to a free enterprise system and the American system of government.

No More Debt Ceiling Increases: Let the Federal Government Default

Published in Real Clear Markets:

In the meantime, the Democratic Party and the media will predictably continue to scream, “The United States has never defaulted on its debt!” As ‘The Hill’ recently pointed out, this isn’t true, but nonetheless we’ll be told that if Congress doesn’t raise the debt ceiling the world will end.

At AEI, a Monetary Panel Expressed Pessimism About Inflation

Published in Real Clear Markets.

“While their conjectures are as speculative as any vulnerability identified in an official financial stability report, unlike official financial stability reports, they have the freedom to identify government policies and regulatory shortcomings as vulnerabilities,” Kupiec said.

The first panelist to speak was Alex Pollock, distinguished senior fellow at R Street Institute, a free market think tank in Washington, DC. Pollock mentioned several possible causes of the next financial crisis, including errors in judgment by the world’s central banks, a housing-market collapse, a future pandemic, or war. He cautioned that a crisis could be caused by a factor that “nobody sees coming,” which would inevitably hamper state response.

“If the next crisis is again triggered by what we don’t see, the government reaction will again be flying by the seat of their pants, making it up as they go along,” Pollock said.

Read the rest here.

A Public Letter of Concern about the Federal Reserve

Published in National Review.

This is not a partisan issue. Our objections would be equally strong if the Fed involved itself in industrial policy or national security. All Americans benefit from a central bank devoted to effective monetary and regulatory policy. The Fed should refocus on its core missions.

…

Alex J. Pollock — Former Principal Deputy Director, Office of Financial Research

United States Department of the Treasury; Distinguished Senior Fellow, R Street Institute

Read the rest here.

Inflation pain allegedly caused by Biden’s spending demands transparency, Republican says

Published in Fox Business.

But Alex Pollock, a distinguished senior fellow for finance, insurance and trade at the libertarian R Street Institute, told FOX Business that despite the other factors, he “certainly” thinks the president’s policies are playing a large role in the current inflation.

Pollock said the biggest contributor is massive government spending that’s financed by monetizing the debt. And the inflation, Pollock emphasized, is reducing Americans’ “real wages” and cutting the value of their savings.

Read the rest here.

Financial pain in the behemoth assets

Published in The Australian:

“Are banks too big to fail? Of course they are, as much as ever and probably even more so,” says Alex Pollock, who was deputy director of financial research at the US Treasury until February.

...

The US Federal Reserve banks have become the biggest player in the commercial banking system. “They are now huge home lenders; their $US2.2 trillion of mortgage loans is bigger on an inflation-adjusted basis than the entire savings and loans industry before its collapse in the 1980s,” Pollock says.

Governments and regulators quite like a big, concentrated financial system, which explains why little real reform was achieved in the wake of the financial crisis. What did happen was a huge increase in complexity that benefits large incumbents and regulators themselves. Regulators can “manage the system” more easily and treasurers can enjoy lower interest rates. And activist central banks can ensure governments enjoy much lower borrowing costs than otherwise.

“Banking everywhere has been, is and will be a deal between bankers and politicians,” Pollock says.

What Drove Five Decades of Big Changes in Banking?

Published by the Office of the Comptroller of the Currency.

A new post authored by Alex J. Pollock, Hashim Hamandi, and Ruth Leung (2021) on the Office of Financial Research (OFR) website helps answer that question, and it focuses specifically on the changes in U.S. banking that occurred from 1970 to 2020. The analysis includes chartered state and national banks, other depository institutions, and some specialized banking intermediaries, such as the 12 Federal Reserve Banks, and what the authors label the government mortgage complex, which consists of Fannie Mae, Freddie Mac, and Ginnie Mae. It also considers subgroups of banks—in particular, the ten largest commercial banking enterprises.

…

Much of this is well known. What is less understood is how the expansion in the generosity of deposit insurance has fueled real estate lending by deposit-financed intermediaries. A typical U.S. bank today has about three-quarters of its lending devoted to real estate loans of some kind. As observed by Pollock (2019), “We still use the term ‘commercial banks,’ but a more accurate title for their current business would be ‘real estate banks.’” This is a far cry from the prohibition on real estate lending for national banks prior to 1913. How does increased deposit insurance generosity affect banks’ mortgage lending?

…

Alex J. Pollock (2019), “Bigger, Fewer, Riskier: The Evolution of U.S. Banking since 1950,” The American Interest , February 25.

Alex J. Pollock. Hashim Hamandi, Ruth Leung (2021). “Fifty-Year Changes in the Banking Credit System, 1970-2020.” Post, Office of Financial Research.

In Memoriam: George Kaufman, PhD

Published in Loyola University Chicago.

At a retirement dinner held following the conference, banking leader Alex J. Pollock gave a speech about Kaufman and his contributions to the field entitled “57 Years of Banking Changes and Ideas.” He ended his remarks: “Let us raise our glasses to George Kaufman and 57 years of achievement, acute insights, scholarly contributions, policy guidance and professional leadership, all accompanied by a lively wit. To George!” Read Pollock’s entire speech→

Are Remote Workers More Productive? We Finally Have the Answer

Published in FOND.

Productivity is typically measured by an individual’s output vs. input over a period of time. One example of this is gross domestic product (GDP) per worker, which measures output by person over the course of a year. However, the ways in which we measure productivity today are much more complex.

The New Campus Housing Bubble

Published in Forbes, The Independent Institute, Ohio University College of Arts & Sciences Forum, and Catalyst.

My good friend, banker-scholar Alex Pollock of the R Street Institute, has shared with me some startling new data. High priced, comparatively luxury college student housing has been popular, and in this century lots of apartment complexes have been built with many amenities —granite or marble counter-tops, fancy swimming pools or saunas, etc. With unemployment rates below four percent and  low overall real estate delinquency since recovering from the traumas of a decade or more ago, this sector should be booming. But according to a story published by Wolf Street (Wolf Richter), delinquencies are rising dramatically.