Fed Losses: The guest details a $243B cumulative operating loss and roughly $900B mark-to-market loss at the Federal Reserve, implying about $197B negative capital and taxpayer implications.
Mandates vs. Performance: He argues the Fed has eight mandates, excels only at elastic currency and financing government, and has failed on stable prices, moderate long-term rates, and financial stability.
Inflation Targeting: He critiques the shift from “stable prices” to perpetual 2% inflation, advocates long-run zero average inflation, and notes even past Fed chairs endorsed zero when properly measured.
Risk Management: The Fed’s 1980s S&L-style maturity mismatch—owning long fixed-rate assets funded short—creates structural losses; references to R-star highlight the uncertainty of guiding policy by unobservable variables.
Housing and MBS: Prolonged Fed purchases left it with over $2T in MBS, fueling a housing price bubble and unaffordability; he urges halting distortions and running the portfolio off rather than selling into the market.
Accounting and Oversight: He criticizes a 2011 accounting change that treats losses as assets/negative liabilities, calls for standard accounting, and emphasizes that inflation functions as a tax requiring Congressional oversight.
Policy Recommendations: Proposes a sound money mandate, Congressional approval of inflation targets, strict financial oversight, potential recapitalization, suspending dividends without profits, and permanent Fed-oversight subcommittees.
Market Implications: Notes risks to Treasury and mortgage market resilience, and underscores that productivity-driven “good deflation” can be beneficial, contrary to prevailing narratives.
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Dr. Pollock, welcome to Human Action Podcast. >> Thank you. It's really great to be with you this morning. >> Yeah. And I just we recently were in each other's company and saw presentations from the other at the Mises Supporter Summit down there in Delray Beach. So that was fun to see you there. And what came up, not from your self-promotion, but I think it was Jonathan Newman in his talk alluded to your testimony that was uh I think it was September 17th if I'm not mistaken uh on monetary policy to a a task force and that that wasn't on my radar. So I was like, geez. And I asked you, hey, you want to come on the podcast. So that's why you're here. >> So can you maybe just set the context a bit for folks before we dive into the you know the substantive point? you may just explain what the function of this uh this hearing was. >> Well, the banking committees of the Congress, which in the House of Representatives they call the financial ser committee uh has jurisdiction o among many other things over the Federal Reserve and monetary policy. uh those uh committees have subcommittees for various uh focus on things and in addition uh this year the House Financial Services Committee has set up a task force as they call it which is like a subcommittee but a task force like a temporary subcommittee uh which they call monetary policy treasury market resilience and economic prosperity but it's really a a task force to study the issue around the Federal Reserve uh hearing uh on September 17th and were nice enough to invite me uh to testify which I did and um testimony I think so. >> Well, great. And I think the specific title that they had um was less mandates more independence >> and uh so >> but that wasn't my title. >> Right. I know cuz I was going to say there was a grammatical problem. It should have been fewer mandates, more independence, and so I assumed that you were not the one who introduced that uh grammatical error. Uh so, and I had your testimony. I of course that's what I want to spend the bulk of this episode going through. But you said one thing in particular that I I would like to underline for folks. You said that the Fed has a $240 billion operating loss. Can you just explain what what that means? as of their most recent report, which is last week, it's now $243 billion. [snorts] Uh, and uh, I should say in advance that $243 billion in accumulated operating losses, that means expense in ex greater than income, spending money you don't have, uh, compares to their capital of 46 billion. meaning that in fact they have a negative capital of nearly 200 billion dollars. So 140 uh 243 billion minus 46 billion would get you 197 billion negative capital. Now the reason for this is that uh as I like to say the Federal Reserve made itself uh over the last decade into the biggest uh 1980s style savings at a loan uh that the world has ever seen. And that is to say they bought very longterm fixed rate assets and they funded them short. And this works fine as well as interest rates don't go up. But of course interest rates go up and down. So, and interest rates went up, the Federal Reserve is now in the position where basically it has a uh uh a huge investment uh of uh 4 billion four I'm sorry, 4 trillion four trillion with a T uh dollars or so uh of investments earning about 2% and they are financing them and it's costing them 4%. % and if you if you earn 2% and pay 4% it's very hard to make money. >> Yes. Even for the central bank. Yeah. So can you >> for the central bank as for everybody >> and and so again just for people understand you know earlier when you said like you know their capital was completely wiped out in terms of if they were to recognize this law that >> for a normal company that would mean like they were insolvent that the liabilities were more than the assets and they were >> completely they they are if if they were accounting for themselves in a standard or we could even say an honest way uh they would be reporting a large negative capital uh of 197 at the moment. 197 billion negative and that means they're technically insolvent and that means precisely as you said Bob liabilities are greater than assets. They can get the money to pay their bills because they just print up some more. >> Right. Right. So that's >> uh but their liabilities are much greater than their assets because they created a tremendously risky uh balance sheet and they have uh they have lost tons of money over the last uh three years now with the with the aggregate loss as we said $3 billion. Uh at the moment, an old banker taught me long ago, risk is the price you never thought you'd have to pay. And I'm quite certain that the Federal Reserve did not plan to lose 240ome billion dollars. They didn't do it on purpose, but they created a balance sheet that that had that result. Now, this loss is not only a loss for the Federal Reserve, it's a loss for the taxpayers because the Federal Reserve's profits or losses >> belong basically to the Treasury. And when they run a loss, it means the taxpayers are out that money. And it also means the national debt, which is we all know is reaching stratospheric uh levels, is that much bigger because of the Federal Reserve's losses. So what I tried to get the Congress to focus on among other things in this testimony was that the Federal Reserve finances are part of the overall government's finances. when they lose vast amounts of money, it's a cost to the taxpayers. And the costs are financed by increasing the national debt even further than it uh than it already is that it's uh 38 trillion or what whatever it is this morning. Unimaginable uh numbers, of course. >> Okay. And if if you'll forgive me here, Dr. Let me just walk through a couple points just before we move on to the the heart of your testimony because I think some listeners of this podcast might not realize the significance of what we've just been talking about because especially for fans of Murray Rothbard, there's a sense in which they think modern banking is inherently dubious and that there's a sense in which the bank, you know, they might throw around words like bankrupt or insolvent or things like that. But I want to be clear, we're not merely here saying, oh, they engage in maturity mismatch. And so in that sense what they're doing is is problematic the way any bank but you know like like City Bank right now on paper its assets are higher than its liabilities. They have positive shareholder equity. So what we're saying about the Fed is something qualitatively different. We're saying you know we're not making a moral judgment about how it behaves or things. We're just saying no the actual you know if you were to mark to market the the assets versus >> not mark to market. Wait a minute. Okay. Not to market. >> This is actual operating loss. Yeah, I misspoke cash. Yes, >> the cash they have paid out Yes. is greater than the cash they have taken in. >> Great. Yeah. >> Uh mark tomarket is another thing. They also have a gigantic mark tomarket loss on top >> right great >> of the of the operating. That's actually the next point I wanted to make and it's maybe I did a Freudian slip like in reverse because right that was the other point I want to make that I know a lot of people hear that and they think oh yeah I understand that um you know if you buy a bunch of fixed income assets particularly when interest rates were at rock bottom levels if you loaded up on a bunch of treasuries for example when you know the yield was really low and then all of a sudden interest rates rise >> two 2% on average for the Fed in round numbers. >> Yeah. So then yeah if interest rates you know the whole yield curve shifts up we understand that oh right that means the market value of those things now goes down and so if you had to if you were forced to res you know to sell them to raise money you you'd be taking a loss but some people think well yeah but if you held it to maturity you know okay and so what you're clarifying is would that 20 what in your testimony was 240 billion and now you're saying it's up to 243 something like that you're not talking about oh the the you know the asset value of what they're keeping on their books You're saying literally how much they've had to pay out versus how much they earn. So >> cash, this is cash that's gone forever. >> On top of that, there is a gigantic uh mark tomarket loss. And let me just pick up I've got it right here. Wow. >> Uh as of uh June 30th of this year, >> Mhm. >> in addition to the 243 billion now loss, there was a 900 billion mark tomarket loss. >> Right. Okay. >> So, in round numbers, they're they're down about a trillion dollars in market value terms. A trillion. >> Yes. Okay. Great. So that's uh that's what we're talking and and just the last point in case people are like well what are the Fed's expenses? It's things like paying interest on reserves, right? In other that's an example of like why the Fed has to pay money to people >> just to you know keep their operations going. It's not just like for the >> they have all the have all the normal expenses expenses of an operating company, employees, managers, rent, keep the lights on, uh run all your computers, and of course they also have literally hundreds of economists working for them, all all of whom have to be paid. They have examiners and all of that together uh is around $10 billion. But the big number is is paying interest on their deposits, which was uh a big change approved by the Congress in 2008 with no idea what it would lead to. >> Uh but that's where they now uh just like a bank have the income on your investments minus the interest that you pay uh for your deposits and that is now a vast negative number. Okay, great. So, or not great, but thank you for clarifying. I just want to make sure [laughter] because again, like I talked to some people when I try to explain like, hey, the Fed's insolvent, >> you know, and they and they're like, oh yeah, yeah, banking is all screwy since, you know, they left the gold standard or fractures or I said, no, no, no. I mean, yes, I agree with you on all that stuff, but I'm saying no. In a very more specific technical sense, yes, what they've done. Yeah. >> Okay. So, one heading of your of your uh testimony is uh you say eight mandates and the Fed has only been good at at arguably like the first two or two of them, right? >> Do you want to and you know the answer you you could take this how you feel Dr. Pollock is appropriate for the listener. You know, I don't know if you want to go through all eight of them or if you want to just focus on some highlights or you you you take it away how how you think given the time we have the best way to communicate this. Well, maybe it wouldn't be bad uh to go through the mandates. In most uh public discussions, including presentations by the Federal Reserve itself, they always talk about their dual mandate, which would lead you to believe there are two things that they've been assigned. And those two things are stable prices, which they obviously haven't done very well at, and maximum employment. Uh but let's let's include all of their mandates. There there are uh there are actually eight uh and these are I'll just run through the list from my testimony. These [clears throat] are provide an elastic currency. They they're actually quite good at that [laughter] >> for better or for worse. An elastic currency means money that you can expand by printing it up. Mhm. >> Uh that is assigned to them as their first duty by the original and continuing Federal Reserve Act of 1913. A second mandate is to finance the government. Every central bank's real responsibility is importantly to finance the government of which they're a part. Uh if you're a government and uh you want to keep spending but your spending is more than your income, that is to say you're running a deficit uh and the uh market isn't too hot on buying your debt. What do you do? You go to the central bank and say, "Listen, you need to buy our bonds." And the central bank prints up some money and uses it to buy the government's bonds. and the and the debt of the government goes onto the balance sheet of another part of the government namely the central bank. Now this is this is essential uh to understanding central banks that that this is what they do uh among other things. Uh but but a key thing is to finance the government. So so far we've got an elastic currency and financing the government. Those are the two things that the Fed can definitely do >> and do well. Now the results not may not be that that good but those duties they can definitely perform. Uh uh and then on top of that uh we have a what was really a a triple assignment originally in and this came in in 1977 and the Federal Reserve Reform Act of 1977 said they have to promote stable prices, maximum employment and moderate long-term interest rates. So there are three more duties. Stable prices, maximum employment, moderate long-term interest rates. Their next duty is to regulate and create financial stability uh in the financial system. Uh they are set up to make money for the government. uh a a major business of every government is making money from issuing currency and that goes on through the Fed and the Fed should be making if it if it simply issued currency and then use those used that to in that funding that's funding when you issue money that costs you zero just the the minor the relatively minor expense of of printing up. We're here really talking about dollar bills and $100 bills and $5 bills. Um you in the market you automatically make a lot of money. Uh and that's that's another of their mandates. They have another assignment. This one from the DoddFrank Act of 2010 which is to pay for the Consumer Financial Protection Bureau uh out of their profit out of the Fed's profits. All right. So um I'll go through these quickly and then you can come back to any one you want. We talked about uh expand you know having a flexible currency uh that [clears throat] they can do and that is is actually quite handy in times of crisis and that was their real debt uh when they were set up in 1913 to be able to to finance a crisis. What's happened of course is they use the uh elastic currency all the time and the result is an endemic inflation uh to the point uh that the Fed has formally committed itself to perpetual inflation that is to say prices always rising never falling only going up. Uh so even when uh even when we say inflation is down >> Mhm. doesn't mean prices are down. It means the rate at which prices are rising is less than it was before, but the prices are still rising. So, I think we can safely say the Fed has failed its stable prices uh mandate. Maximum employment time, we have periods of rising and falling employment. I don't think the Fed actually has a lot to do with that in the long run. that's driven by innovation, productivity, uh, and having efficient uh, uh, enterprising markets, moderate long-term interest rates. Well, they've flunked that one. We have had both extremely high and manipulated uh, excessively low uh, long-term interest rates, including this most recent in the most recent decade uh, pushing uh, mortgage rates. The Fed also made itself into a huge investor in mortgages, which okay, >> in my view they never should be. Uh created a housing boom and by their long-term interest rate manipulation created the the unaffordability of houses uh which is now on everyone's tongue. A good bit of that is due to the Fed. So, uh, I think we can flunk them on moderate long-term interest rates, regulate for financial stability. Well, we have we have with the Fed, uh, regular financial crises and collapses. So, they they can't we can't really do that. Probably nobody can can do that. U, but the Fed certainly can't. and they're supposed to make money for the government, but as we said, they're currently losing vast amounts of money and they're supposed to pay for the Consumer Financial Protection Bureau out of their profits, but they have no profits. Of course, other things are going on, cutting the Consumer Financial Protection Bureau, but uh that was put into the DoddFrank Act as a scheme to prevent future Congresses from exercising the power of the purse. >> Oh. >> Over this over the this darling of the of the Democratic Strategy at that time, which was the Consumer Financial Protection Bureau. And in a in a quite uh unhealthy way, I would say they said, "Well, we'll finance it out of the Fed." So, the Congress doesn't get to appropriate their expenses. So, they won't be able to cut their expenses, but they got fooled because they assumed the Fed always would have profits anyway. So, we should just get rid of that. So that's the the eight mandates, two of which uh the Fed can comm uh demonstraably do and uh and six of which uh they either fail at or have a very questionable time about. So, just if we could circle back because you you gave great commentary on those, but the the stable price one I always found amusing about like the Orwellian nature and you when you elaborated on it, you know, you you hit the point I wanted to, but I don't know if this is on your radar, but people I've seen um people refer to, you know, Vixel and the the natural or the neutral rate of interest, you know, from, you know, historical economist and that, you know, he provides some fodder for, you know, modern people, including influence Louis Van Mises his theories, but I saw recent discuss like by recent I mean the last 5 to 10 years there was a renewed interest in him and people were talking about oh what's what's the neutral rate right now and so if you go and read his stuff he defined it as the rate that where prices neither rise nor fall because he was saying in other words if the if the rate of interest is too high then you're going to have deflation and if it's too low you're going to have inflation and so for he meant oh a neutral rate means consumer place prices stay the same year after year and then that's somehow the least the Fed economist you know citing him and talking about implications for today they somehow translated that into right so that means today if we if the Fed targets and hits the neutral rate you're going to have a stable you know like CPI rising at 2% a year >> and so it was like where are you getting no stable prices doesn't mean they rise predictably >> so they've like taken it to the first derivative like oh yeah it's stable as long as you can correctly predict pretty well how much inflation we're going to have as opposed to zero Oh, >> you are exactly right. The uh the Fed rhetorically did something very clever. They took stable prices, which is the phrase in the in the Federal Reserve Act, uh and said, "Well, we're going to talk about price stability, not stable. It's too too obvious what stable prices mean." >> Mhm. So we'll talk about price stability and then we'll define price stability as a constant inflation. >> It's a sort of a rhetorical trick, >> right? >> Uh so uh one of the things that uh >> I suggested in the testimony is what does stable prices in its natural sense mean? And as you just suggested in your comments, Bob, it probably means that an average rate of inflation of zero. Uh now that doesn't mean that prices never rise or never fall. Well, it means on average over time they're more or less flat which means sometimes getting uh in certain circumstances they'll rise but in other times uh particularly uh in uh in times of very high productivity and high inflation and high uh innovation prices will have a tendency natural tendency to fall. And if you read uh the Fed or its many media admirers, you'll say, "Well, isn't deflation terrible?" No, deflation would be going to the grocery and finding prices are lower and say, "What's wrong with that?" >> That's a good thing. Uh so over in in a stable price system and this by the way um I I I learned from my fellow my fellow fellow of the Mises Institute Brendan Brown uh who has a new book coming out on this and writes interestingly uh on the nature of money good money. The the new book is called Bad Money, contrasting what we've got, bad money, with what would be sound money, which would be uh stable on average over time. It's a that is a world that people can hardly imagine now thanks to the Fed and its inflationist tendencies. So, you know, uh, so what do you think the Congress meant when they wrote stable prices? I asked as I was doing this testimony. Well, if you look at the um 1978 act, which is the Humphrey Hawkins Act, which also had to do with the Fed, they say, well, we we have a goal in the long run in 10 years of getting inflation to zero. that's in the in the act that it's all hedged around, you know, subject to this and subject to that. >> But I think that's a good indicator that maybe they were thinking in their mind uh that they were really after truly stable prices. Uh and in this testimony in September, uh one of the Democratic members uh said in his his statement, "Well, stable prices, stable prices would mean zero inflation." So, if if it weren't for being able to try to to uh manage employment, we'd have to have zero inflation because it says stable prices. And uh I commented later in my remarks, well, my the congressman agrees that the natural meaning of stable prices is zero but inflation. But you have to have to think about it over over time because we know in economics uh everything is always changing and prices there are millions of prices >> right >> uh and some are going up and some are going down the one where there's a lot of innovation and productivity those prices go down the ones most controlled by the government those prices go up uh I mean you're looking for some kind of a an overall average or or tendency in in all of those uh prices. But if they're to be stable over time, sometimes they'll go up and sometimes they'll go down. Well, that's okay as long as it's good deflation. Good deflation is deflation which naturally arises from high productivity and innovation and growth and that's >> I think we've lost that point. Could I just add one more thing because you mentioned the natural rate of interest. The natural rate of interest is of course is an idea or a theory. Uh but it's a nonobservable entity. Nothing will tell you and you can't ever find or see or observe uh the natural rate of interest. And the natural rate of interest is is written in economics formulas as R followed by an asterisk. And they pronounce it R star. And R star is the the hypothesized natural rate of interest. And Chairman Powell much to his credit uh observed has observed in his speeches that this is a nonobservable. You're you're guessing about what you think this might be. And people have different guesses. And then he came out with this wonderful line talking about our star. He said, 'We navigating by the stars under a cloudy sky. I think that's that's wonderful. Yeah. And truthful and candid. And as I say, much to his credit for pointing this out to people. Well, to also credit two prior Fed shares in your testimony, you cite on this very issue of, you know, oh, is am I a crazy radical fringe guy for saying that stable prices should mean 0%, you know, CPI inflation over the long term? And you quote both Paul Vulkar saying something about, you know, people sometimes posit a little bit of inflation's good for employment. I don't think so. And then even Greenspan when he was the chair saying properly measured I think the optimal inflation rate is zero in the long run or something like that. So anyway that that's interesting too again just to show this isn't us trying to like expost rewrite history or something like no this is what people were saying we have in mind here. >> Yes. And it's very good to to think carefully about these things as as in all things and not not accept whatever the current uh the currentic uh uh commentary of the day may be saying but but as as we do at the Mises Institute try to think in in fundamentals about what what is really there and also what you really can't know. I mean you can know hey is fond of saying we we can know things in general how they work uh but you can't know the specifics of how economic and financial events will turn out and that's anybody who thinks the Fed can do that that's clearly just wrong and you only have to look at the dismal record of their forecasts to see that. >> Yeah. Exactly. Okay. So, you know, there you you sort of you listed what the Fed's existing mandates were, even though, as you say, a lot of people might have just thought there were two. And then your testimony, you you pivot and you say, "Okay, so what what what should they be doing?" And do you want to run through those? >> I do. Well, I I start off uh by saying, which we should mention, uh that there is a great deal of commentary about how the Fed should be quote independent. Uh some people uh have even said autonomous which is even more ridiculous. >> Uh you can't in a democratic republic uh under the constitution you can't have any part of the government which runs around as some kind of purely independent thing doing whatever it wants. That's the opposite uh of a constitutional system of checks and balances. Now the question is where does the Fed fit in to the appropriate system of checks and balances um and um it fits in as being accountable to the elected representatives of the people that is the Congress and it just it can't just go off by itself as we were talking about decide that what they want is 2% inflation forever and then just announce it and say this is it. Now, if you read the papers, they always talk about the Fed's inflation target. Yeah. But shouldn't be the Fed's target. It should be the country's target that somebody has appropriately approved. Uh and indeed, in the Fed's private uh private discussions going back into the 1990s when they were saying, "Well, we're going to have this target and so on. What should it be?" uh one of the members of the open market committee said well don't you think we ought to ask Congress what they think about this and he was right of course to say that and by the way on a different occasion chairman then chairman Greenspan made a similar comment you can't do this without Congress but they just ignored that and they they charged ahead acting as if they were some kind of autonomous power which they they cannot be uh under under our constitutional system. So there are two things that are here important I think on the on the constitutional part. The money power is given to the congress by the constitution to coin money. Well, those were the days. Uh, coining money. Uh, but to coin money and regulate the value thereof or regulate the value thereof is a constitutional uh responsibility, a power but also a responsibility of the Congress. >> The other u power that's relevant is the taxing power. This is really important and I think understood by the Mises Institute but maybe few other people that inflation is simply a tax. By inflating prices uh the Federal Reserve takes purchasing power away from the people and gives it to the government. That's a tax. Mhm. >> So, uh, Congress is also supposed to oversee, not only has the power to tax, but should be overseeing taxation and and the Fed is actually a taxing body through inflation. I think it's a really important uh fundamental concept. So, if you wanted as I we've talked about the name of this hearing, but the the name of my the title of my own testimony was how Congress should oversee the Federal Reserves mandates. Uh all eight of them. >> Mhm. Uh and I I did suggest in the end the a list uh of things I thought the Congress could do now uh to improve the accountability of the Fed uh and to improve the the functioning of the uh financial and economic system. Shall I just run through these? >> Yeah, sure. >> Okay, I will. These are one uh we call this a sound money mandate. I believe that the Congress should write into the Federal Reserve act. The following principle that the that the most fundamental responsibility of the Federal Reserve is to furnish a sound currency. a sound currency whose uh stability that people can and should rely on and do rely on because it actually is sound and stable and that I think it would be very good to write that in through the act which they they could do at least in theory they could do and they should do it. Uh secondly, the Congress ought to make it clear to the Fed that if you're setting a so-called inflation target that takes our approval. That's not something you go off and do by yourself and just announce to the world. We've decided well who are you? Uh you are uh you are a part of the government subject to checks and balances notably of the Congress. Uh and um and if you did have an inflation target, you know, it might uh might not have one. You might just have a commitment to sound money. You could say, well, that means uh inflation is between zero and 2%. As one example, not 2% between zero and two. That was the original. New Zealand, by the way, is the is the country that is the father of all inflation targeting. That was their original inflation target. between zero and two, you could have like the Swiss central bank does less than 2%. In other words, it could be zero less than 2%. And the the Swiss generate a pretty uh pretty sound currency uh relatively speaking relative to the dollar. You could have stable prices, a long run rate of zero. That would be what I recommend, which maybe varies over time between minus 1% and plus 2% but averages out to zero. Well, the Fed could come back and try to talk to Congress and do 2% forever, but whatever it should be, Congress ought to make it clear this takes approval of the elected representatives. Third, Congress should strictly oversee the Fed's finances. We talked about that. I have never seen now maybe it's happened but I am unaware of it if it did a serious oversight of the Fed's finances of their balance sheet and their profit and loss statement and their capital uh by the Congress and the Congress ought to be aware of this for all the reasons we talked about a minute ago. I think Congress ought to require the Fed to follow standard accounting. Um, the Fed believes it can make up its own accounting rules and they changed their accounting so that they could pretend that their losses were assets. >> Mhm. >> I mean, I hope your listeners get this idea. The Federal Reserve wants you to believe according to its financial statements that its losses are assets. That's bizarre. and therefore they publish statements that show that they have capital that they don't really have the leading central bank in the world. It's setting a terrible example in that way and I think if Congress ought to make them report uh according to standard accounting and then you get the reality and then you can decide what you want want to do about it. Um the the next point is I think the Fed should get out of mortgages to have the central bank uh owning uh mortgage securities which they did as part of the uh emergency reactions following 2008 and the crisis. Chairman Bernanki went up to the Congress, testified and promised this would be temporary. Well, now let's see. This is 2025. They started in 2008. So, it's been going on 17 years. Not too temp not too temporary. >> And they ought to get out of out of manipulating and distorting the mortgage market. It's not appropriate for a central bank in my judgment. Uh the next thing I suggested was the Congress should take up recapitalizing the Fed. Well, [clears throat] you might they might decide they're okay with the Fed running negative capital, but maybe they'd prefer [snorts] for their central bank, which is not only the lead the central bank of the United States, but leading central bank for the whole dollar using world, which is the whole world, uh should have positive capital and you could recapitalize the Fed to to offset its losses. that would uh and there are various ways you could do that which we could talk about. Um as as part of that you wouldn't let the Fed pay dividends to its stockholders when the Fed has zero retained or well has negative retained earnings [clears throat] and negative earnings. Nobody gets to pay dividends if you have no profit and no retained earnings. Uh that would be a point. Now, we ought to mention as we pass here, who owns the stock of the Federal Reserve? >> It's the member banks, right? >> The member banks, the private banks. The stock of the Federal Reserve uh is all owned by private banks who are the members, not by the government, not by the Treasury. So, when the Fed lost their capital, they lost all the all the money that the member banks had invested. and and you have to figure this out taking into account the Fed Federal Reserve banks are owned by private banks. And the last thing I suggested to the Congress is that the banking committees as the Senate Banking Committee and the House Financial Services Committee should in addition to this task force which I think was an excellent idea should set up formal subcommittees whose only responsibility is serious oversight of the Federal Reserve. And if you in my judgment if you had such a committee the members of that subcommittee would actually become overtime expert in their subject which members of Congress do they if they serve a long time on specific committees uh and be able to have a a serious accountability of the Fed to the Congress and a serious carrying out of their monetary and taxation uh authorities and duties by the Congress. ress. So that that was my list of of things to do. >> Well, well, great. Just to touch on the the accounting chicannery that you mentioned there. I I mean I I read it on zero hedge or something, but I forget what year, but back when they made the the actual change like this was during like when they were doing the rounds of QE and I'm going to pat myself on the back. you know, some things I got wrong, but that one I got right. And I said, "This is a weird because what they for the folks at home, they they made some and it was a very innocuous thing like in the footnotes of some rel, you know, and it was like some some correct >> some random bloggers, you know, financial spotted it and then it just kept working up its way and then zero hedge broke, you know, and then I, you know, said it here in my for my perch at mises.org." You're >> right. It was 2011. >> Okay. 20. Great. And >> and they did. Yeah. It was, you know, put out, well, here's this little accounting change. >> And what it like the way I like in in layman's terms, it was like normally, you know, with a business if if they have a loss, then you know, they oh, when the Dustin, I was like, oh yeah, your assets are lower than you would thought. And then if you know, so then when you do, oh, geez, so that means like my assets minus my liabilities, which is the shareholders equity, that would go down and oops, if it's, you know, if it's negative, that means you're insolvent. But the way they were going to handle it is to say, "Oh, if we have a loss, because normally what they do, just for context for people like Dr. Pollock was saying is if they have earnings over and above their cost of operation and then the dividends they normally pass on to their, you know, member banks who own the stock, then any excess is remitted to the treasury. So in terms of their standard balance sheet, that would be listed as a liability. Like, oh, if we had an extra three billion that we owe the Treasury this year, they would show up as a liability to explain, yep, that three billion is not ours now. We got to give it to the Treasury." But then what happens if they have a three billion loss and they said, "Oh, well, we'll just list that as a negative liability." And so now that's just sitting there and then next year if we have a billion dollar profit that just whittleles down the thing we carried over. So now we have a negative two billion amount we owe the treasury. And then if we have another, you know, it's like they're digging out of the hole >> and I pretend that the capital is still there. >> But I [laughter] was pointing out like normal businesses can't you can't list a negative liability and put it there on the balance sheet. It doesn't make any sense, >> right? No. No. any I often point out that if any corporation including a bank uh which was a uh securities and exchange commission filer >> Mhm. >> did that did what the Fed does, its financial officers who signed those statements would probably be headed for jail. >> Yeah, >> think about that. It's a it's a fascinating situation and it was, as you say, a a change slipped into the Fed's accounting rules under the theory that they control their own accounting. That's a bad theory to let anybody just control their own accounting. >> Yeah, talk about independence. So, [laughter] it's like, why should we be bound by the rules of mathematics? This is [laughter] I think I even made that joke at the time. I said, "Yeah, and if they just if they just multiplied their loss by a negative one, then it's a it's a gain. So why don't we just do that? But it's [laughter] >> Yeah. So here we are. So you uh look how long this has been going on. >> Yeah. Um and I think you're right too just to focus on the mortgage back securities. I mean that's people are worried about home prices and gez things like that. And it's like well what do you I mean not that that's the the full explanation of course but >> yeah what do you think is going to happen if the Fed is is doing that? And what's funny too is at the time they even like if you had asked people like apologists for the policy why are you doing that among other things they would say you know to to rescue the the housing market you know to prop it up or something and so it's like okay so then now years later after that just mushroomed on the balance sheet and they own trillions in mortgage back securities and we're wondering why are home prices skyrocketing the thing that you guys admitted this will make home prices be higher than they otherwise would back when oh we don't want them to collapse so we'll prop them up. Okay. So, you know, it's [laughter] if you admit that buying mortgage >> they were still buying. They were buying all the way into early 2022. There had been a home price boom on house prices were in a bubble escalating uh at uh 15% a year or so, which is a you know, it's pretty tough if you're trying to buy a house and the prices are going up like that. And the here is the Fed still buying mortgage back securities and still feeding this house price bubble is in my mind completely unjustifiable with no possible argument in its favor in the as they kept it up over time. I mean uh so there you go. Now they could get out. They own the Fed still owns more than $2 trillion in mortgage back securities and these are primarily 30year fixed rate uh mortgages which is and they're all funded short uh with with money that prices on an overnight basis. This is uh [snorts] this is balance sheet management 101 that you're not supposed to do that. they would uh they would be furious with any regulatory charge. Although it's exactly what Silicon Valley Bank did, same thing. Yeah. >> Using more principally mortgage back back securities. >> Uh and uh I've often thought if they had gotten around to criticizing Silicon Valley before it collapsed, Silicon Valley could have applied. Well, it's the same thing you're doing. >> Right. Right. That's good. And and just to to kind of connect back to what we said at the start of this discussion, Dr. Pollock, that somebody might like they they're really painted into a corner that suppose they took your advice. Yeah, you're right. We should get out of this mortgage. They can't simply say, "Yeah, let's let's just sell off the 2.1 trillion that we're sitting on because of that interest rate, you know, change over time and that they have huge unrealized losses on that." So, if they did do that, then they would have to recognize, you know, the hundreds of billions. all the all those unrealized paper losses would become actual cash losses if they sold. They have another problem which is the position is so big and such a big part of the market that they really they couldn't sell without crashing the prices in the market. So the losses if they tried to get out of very much of that position uh they would drive down prices against themselves. So they're stuck, but but they could uh commit to they could get an order from the Congress. That's it. You just run these off now and and take as a principle going forward that you're not there to try to manipulate the housing market. >> Okay. Um, last point one question I had for you is you said in your testimony and then you have you said here too that you don't think that they thought they were going to end up in this position when they were like doing these things that at least expost looks like it was pretty reckless. And so I'm wondering though how could they like again not that I'm Nostradamus or something but I was going through this stuff like for years at mises.org you know, because I had a I think a weekly column back then and I was just going through or maybe it was month. I'm getting mixed up now. But anyway, and it was I was doing because a lot of the defenders were coming back and say, "Well no, if they got into a a tough spot, they could just raise the interest on reserves." And then I was saying, "Yeah, but if interest rates have moved and blah blah blah," and there's, you know, the dollars like and and price inflation becomes unacceptably high, that's just going to fuel the problem if they incur, you know what I mean? And it was like amazing to me that people weren't, you know, it wasn't that I was guaranteeing this was going to happen, but I'm saying now they're open to this. And so I'm just again, it's surprising to me that well, some guy writing for me is.org saw this possibility. Like they just literally didn't think of it or was like, h so what? We got to bail out our buddies. >> They they uh knew the chance was there. Uh, in my opinion, I I wasn't sitting in the room with them, but in my my opinion, they thought it was unlikely >> Mhm. >> that interest rates on the short end would go high enough to cause these losses. You know, sort of theoretically, well, yes, it's a possibility, but surely it's a remote case. It's back to my saying, risk is the price you never thought you'd pay. You knew you were taking the chance, but you didn't think it would ever hit you this bad. >> Yeah, >> I think that's the case. >> Okay. But I mean, again, I think you have to be right in terms of maybe they just convinced themselves, but also too, we're talking about a time when they were loading up on this stuff when the short-term rates were basically zero. It's like it didn't occur to them. >> They had made they had made the short, >> but it didn't occur to them that well, maybe the interest rates won't stay zero for the next 30 years. >> It did. [laughter] It did occur to them, but I don't think it occurred to them that they would move up. >> It's it's rapidly. Yeah. And >> if you look at the Fed's own interest rate forecast, they projected out a remember lower for longer. >> Yep. Yep. >> Uh they projected out continuing low interest rates. >> Yeah. >> So the gohead. So I just have one more. >> What looks like at one point the the remote case may turn into the reality that you are confronted with. Yes. So, I just have one more question for you, Dr. Pollock. You you were there in the room. You you you got the reaction. You could sense the body language. C can you give us a sense of what like were the the the congressional represent like were they soaking it in like yeah, this is kind of crazy or you know or was it like all just theater because yeah, we know the public's upset about egg prices, so we got to make it look like we're doing something. >> Well, of course, uh every member of Congress is an individual, but with uh different ideas and uh and goals and uh and and partisan commitments. So you really can't talk in general. I think was a a serious hearing about the ideas but uh as always a long way from having hearing to having something actually uh enacted and done and the you know and the uh fathers of the constitution set it up that way. should try to make it hard [clears throat] >> hard to do things and it is so I but I I feel like it's uh that was great that they had this hearing. It's great they've got this uh task force in the committee and it's our responsibility. I I think as fun Misesus himself would have said, you keep working on the ideas that are are right and uh and in the long run it's all about the ideas. >> Mhm. >> And which ideas prevail. So there we are doing our best. >> Yep. We're just going to keep plugging along and telling them the truth and hopefully some people listen and care about it. So well folks, my guest has been Dr. Alex Pollock, a senior fellow at the Mises Institute with a long career in uh banking and uh related matters and so he's an expert to be talking on these issues and he was here summarizing his September 17th testimony and speaking truth to power. So thanks so much Dr. Pollock for everything you've been doing. >> Thank you Bob for having me. I really enjoyed it. >> And thank you folks [music] for tuning in. We'll see you next time. >> Check [music] back next week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [music] [music]
How Congress Should Reform the Fed
Summary
Transcript
[music] This is the Human Action podcast where we debunk the economic, political, and even cultural myths of the days. Here's [music] your host, Dr. Bob Murphy. Dr. Pollock, welcome to Human Action Podcast. >> Thank you. It's really great to be with you this morning. >> Yeah. And I just we recently were in each other's company and saw presentations from the other at the Mises Supporter Summit down there in Delray Beach. So that was fun to see you there. And what came up, not from your self-promotion, but I think it was Jonathan Newman in his talk alluded to your testimony that was uh I think it was September 17th if I'm not mistaken uh on monetary policy to a a task force and that that wasn't on my radar. So I was like, geez. And I asked you, hey, you want to come on the podcast. So that's why you're here. >> So can you maybe just set the context a bit for folks before we dive into the you know the substantive point? you may just explain what the function of this uh this hearing was. >> Well, the banking committees of the Congress, which in the House of Representatives they call the financial ser committee uh has jurisdiction o among many other things over the Federal Reserve and monetary policy. uh those uh committees have subcommittees for various uh focus on things and in addition uh this year the House Financial Services Committee has set up a task force as they call it which is like a subcommittee but a task force like a temporary subcommittee uh which they call monetary policy treasury market resilience and economic prosperity but it's really a a task force to study the issue around the Federal Reserve uh hearing uh on September 17th and were nice enough to invite me uh to testify which I did and um testimony I think so. >> Well, great. And I think the specific title that they had um was less mandates more independence >> and uh so >> but that wasn't my title. >> Right. I know cuz I was going to say there was a grammatical problem. It should have been fewer mandates, more independence, and so I assumed that you were not the one who introduced that uh grammatical error. Uh so, and I had your testimony. I of course that's what I want to spend the bulk of this episode going through. But you said one thing in particular that I I would like to underline for folks. You said that the Fed has a $240 billion operating loss. Can you just explain what what that means? as of their most recent report, which is last week, it's now $243 billion. [snorts] Uh, and uh, I should say in advance that $243 billion in accumulated operating losses, that means expense in ex greater than income, spending money you don't have, uh, compares to their capital of 46 billion. meaning that in fact they have a negative capital of nearly 200 billion dollars. So 140 uh 243 billion minus 46 billion would get you 197 billion negative capital. Now the reason for this is that uh as I like to say the Federal Reserve made itself uh over the last decade into the biggest uh 1980s style savings at a loan uh that the world has ever seen. And that is to say they bought very longterm fixed rate assets and they funded them short. And this works fine as well as interest rates don't go up. But of course interest rates go up and down. So, and interest rates went up, the Federal Reserve is now in the position where basically it has a uh uh a huge investment uh of uh 4 billion four I'm sorry, 4 trillion four trillion with a T uh dollars or so uh of investments earning about 2% and they are financing them and it's costing them 4%. % and if you if you earn 2% and pay 4% it's very hard to make money. >> Yes. Even for the central bank. Yeah. So can you >> for the central bank as for everybody >> and and so again just for people understand you know earlier when you said like you know their capital was completely wiped out in terms of if they were to recognize this law that >> for a normal company that would mean like they were insolvent that the liabilities were more than the assets and they were >> completely they they are if if they were accounting for themselves in a standard or we could even say an honest way uh they would be reporting a large negative capital uh of 197 at the moment. 197 billion negative and that means they're technically insolvent and that means precisely as you said Bob liabilities are greater than assets. They can get the money to pay their bills because they just print up some more. >> Right. Right. So that's >> uh but their liabilities are much greater than their assets because they created a tremendously risky uh balance sheet and they have uh they have lost tons of money over the last uh three years now with the with the aggregate loss as we said $3 billion. Uh at the moment, an old banker taught me long ago, risk is the price you never thought you'd have to pay. And I'm quite certain that the Federal Reserve did not plan to lose 240ome billion dollars. They didn't do it on purpose, but they created a balance sheet that that had that result. Now, this loss is not only a loss for the Federal Reserve, it's a loss for the taxpayers because the Federal Reserve's profits or losses >> belong basically to the Treasury. And when they run a loss, it means the taxpayers are out that money. And it also means the national debt, which is we all know is reaching stratospheric uh levels, is that much bigger because of the Federal Reserve's losses. So what I tried to get the Congress to focus on among other things in this testimony was that the Federal Reserve finances are part of the overall government's finances. when they lose vast amounts of money, it's a cost to the taxpayers. And the costs are financed by increasing the national debt even further than it uh than it already is that it's uh 38 trillion or what whatever it is this morning. Unimaginable uh numbers, of course. >> Okay. And if if you'll forgive me here, Dr. Let me just walk through a couple points just before we move on to the the heart of your testimony because I think some listeners of this podcast might not realize the significance of what we've just been talking about because especially for fans of Murray Rothbard, there's a sense in which they think modern banking is inherently dubious and that there's a sense in which the bank, you know, they might throw around words like bankrupt or insolvent or things like that. But I want to be clear, we're not merely here saying, oh, they engage in maturity mismatch. And so in that sense what they're doing is is problematic the way any bank but you know like like City Bank right now on paper its assets are higher than its liabilities. They have positive shareholder equity. So what we're saying about the Fed is something qualitatively different. We're saying you know we're not making a moral judgment about how it behaves or things. We're just saying no the actual you know if you were to mark to market the the assets versus >> not mark to market. Wait a minute. Okay. Not to market. >> This is actual operating loss. Yeah, I misspoke cash. Yes, >> the cash they have paid out Yes. is greater than the cash they have taken in. >> Great. Yeah. >> Uh mark tomarket is another thing. They also have a gigantic mark tomarket loss on top >> right great >> of the of the operating. That's actually the next point I wanted to make and it's maybe I did a Freudian slip like in reverse because right that was the other point I want to make that I know a lot of people hear that and they think oh yeah I understand that um you know if you buy a bunch of fixed income assets particularly when interest rates were at rock bottom levels if you loaded up on a bunch of treasuries for example when you know the yield was really low and then all of a sudden interest rates rise >> two 2% on average for the Fed in round numbers. >> Yeah. So then yeah if interest rates you know the whole yield curve shifts up we understand that oh right that means the market value of those things now goes down and so if you had to if you were forced to res you know to sell them to raise money you you'd be taking a loss but some people think well yeah but if you held it to maturity you know okay and so what you're clarifying is would that 20 what in your testimony was 240 billion and now you're saying it's up to 243 something like that you're not talking about oh the the you know the asset value of what they're keeping on their books You're saying literally how much they've had to pay out versus how much they earn. So >> cash, this is cash that's gone forever. >> On top of that, there is a gigantic uh mark tomarket loss. And let me just pick up I've got it right here. Wow. >> Uh as of uh June 30th of this year, >> Mhm. >> in addition to the 243 billion now loss, there was a 900 billion mark tomarket loss. >> Right. Okay. >> So, in round numbers, they're they're down about a trillion dollars in market value terms. A trillion. >> Yes. Okay. Great. So that's uh that's what we're talking and and just the last point in case people are like well what are the Fed's expenses? It's things like paying interest on reserves, right? In other that's an example of like why the Fed has to pay money to people >> just to you know keep their operations going. It's not just like for the >> they have all the have all the normal expenses expenses of an operating company, employees, managers, rent, keep the lights on, uh run all your computers, and of course they also have literally hundreds of economists working for them, all all of whom have to be paid. They have examiners and all of that together uh is around $10 billion. But the big number is is paying interest on their deposits, which was uh a big change approved by the Congress in 2008 with no idea what it would lead to. >> Uh but that's where they now uh just like a bank have the income on your investments minus the interest that you pay uh for your deposits and that is now a vast negative number. Okay, great. So, or not great, but thank you for clarifying. I just want to make sure [laughter] because again, like I talked to some people when I try to explain like, hey, the Fed's insolvent, >> you know, and they and they're like, oh yeah, yeah, banking is all screwy since, you know, they left the gold standard or fractures or I said, no, no, no. I mean, yes, I agree with you on all that stuff, but I'm saying no. In a very more specific technical sense, yes, what they've done. Yeah. >> Okay. So, one heading of your of your uh testimony is uh you say eight mandates and the Fed has only been good at at arguably like the first two or two of them, right? >> Do you want to and you know the answer you you could take this how you feel Dr. Pollock is appropriate for the listener. You know, I don't know if you want to go through all eight of them or if you want to just focus on some highlights or you you you take it away how how you think given the time we have the best way to communicate this. Well, maybe it wouldn't be bad uh to go through the mandates. In most uh public discussions, including presentations by the Federal Reserve itself, they always talk about their dual mandate, which would lead you to believe there are two things that they've been assigned. And those two things are stable prices, which they obviously haven't done very well at, and maximum employment. Uh but let's let's include all of their mandates. There there are uh there are actually eight uh and these are I'll just run through the list from my testimony. These [clears throat] are provide an elastic currency. They they're actually quite good at that [laughter] >> for better or for worse. An elastic currency means money that you can expand by printing it up. Mhm. >> Uh that is assigned to them as their first duty by the original and continuing Federal Reserve Act of 1913. A second mandate is to finance the government. Every central bank's real responsibility is importantly to finance the government of which they're a part. Uh if you're a government and uh you want to keep spending but your spending is more than your income, that is to say you're running a deficit uh and the uh market isn't too hot on buying your debt. What do you do? You go to the central bank and say, "Listen, you need to buy our bonds." And the central bank prints up some money and uses it to buy the government's bonds. and the and the debt of the government goes onto the balance sheet of another part of the government namely the central bank. Now this is this is essential uh to understanding central banks that that this is what they do uh among other things. Uh but but a key thing is to finance the government. So so far we've got an elastic currency and financing the government. Those are the two things that the Fed can definitely do >> and do well. Now the results not may not be that that good but those duties they can definitely perform. Uh uh and then on top of that uh we have a what was really a a triple assignment originally in and this came in in 1977 and the Federal Reserve Reform Act of 1977 said they have to promote stable prices, maximum employment and moderate long-term interest rates. So there are three more duties. Stable prices, maximum employment, moderate long-term interest rates. Their next duty is to regulate and create financial stability uh in the financial system. Uh they are set up to make money for the government. uh a a major business of every government is making money from issuing currency and that goes on through the Fed and the Fed should be making if it if it simply issued currency and then use those used that to in that funding that's funding when you issue money that costs you zero just the the minor the relatively minor expense of of printing up. We're here really talking about dollar bills and $100 bills and $5 bills. Um you in the market you automatically make a lot of money. Uh and that's that's another of their mandates. They have another assignment. This one from the DoddFrank Act of 2010 which is to pay for the Consumer Financial Protection Bureau uh out of their profit out of the Fed's profits. All right. So um I'll go through these quickly and then you can come back to any one you want. We talked about uh expand you know having a flexible currency uh that [clears throat] they can do and that is is actually quite handy in times of crisis and that was their real debt uh when they were set up in 1913 to be able to to finance a crisis. What's happened of course is they use the uh elastic currency all the time and the result is an endemic inflation uh to the point uh that the Fed has formally committed itself to perpetual inflation that is to say prices always rising never falling only going up. Uh so even when uh even when we say inflation is down >> Mhm. doesn't mean prices are down. It means the rate at which prices are rising is less than it was before, but the prices are still rising. So, I think we can safely say the Fed has failed its stable prices uh mandate. Maximum employment time, we have periods of rising and falling employment. I don't think the Fed actually has a lot to do with that in the long run. that's driven by innovation, productivity, uh, and having efficient uh, uh, enterprising markets, moderate long-term interest rates. Well, they've flunked that one. We have had both extremely high and manipulated uh, excessively low uh, long-term interest rates, including this most recent in the most recent decade uh, pushing uh, mortgage rates. The Fed also made itself into a huge investor in mortgages, which okay, >> in my view they never should be. Uh created a housing boom and by their long-term interest rate manipulation created the the unaffordability of houses uh which is now on everyone's tongue. A good bit of that is due to the Fed. So, uh, I think we can flunk them on moderate long-term interest rates, regulate for financial stability. Well, we have we have with the Fed, uh, regular financial crises and collapses. So, they they can't we can't really do that. Probably nobody can can do that. U, but the Fed certainly can't. and they're supposed to make money for the government, but as we said, they're currently losing vast amounts of money and they're supposed to pay for the Consumer Financial Protection Bureau out of their profits, but they have no profits. Of course, other things are going on, cutting the Consumer Financial Protection Bureau, but uh that was put into the DoddFrank Act as a scheme to prevent future Congresses from exercising the power of the purse. >> Oh. >> Over this over the this darling of the of the Democratic Strategy at that time, which was the Consumer Financial Protection Bureau. And in a in a quite uh unhealthy way, I would say they said, "Well, we'll finance it out of the Fed." So, the Congress doesn't get to appropriate their expenses. So, they won't be able to cut their expenses, but they got fooled because they assumed the Fed always would have profits anyway. So, we should just get rid of that. So that's the the eight mandates, two of which uh the Fed can comm uh demonstraably do and uh and six of which uh they either fail at or have a very questionable time about. So, just if we could circle back because you you gave great commentary on those, but the the stable price one I always found amusing about like the Orwellian nature and you when you elaborated on it, you know, you you hit the point I wanted to, but I don't know if this is on your radar, but people I've seen um people refer to, you know, Vixel and the the natural or the neutral rate of interest, you know, from, you know, historical economist and that, you know, he provides some fodder for, you know, modern people, including influence Louis Van Mises his theories, but I saw recent discuss like by recent I mean the last 5 to 10 years there was a renewed interest in him and people were talking about oh what's what's the neutral rate right now and so if you go and read his stuff he defined it as the rate that where prices neither rise nor fall because he was saying in other words if the if the rate of interest is too high then you're going to have deflation and if it's too low you're going to have inflation and so for he meant oh a neutral rate means consumer place prices stay the same year after year and then that's somehow the least the Fed economist you know citing him and talking about implications for today they somehow translated that into right so that means today if we if the Fed targets and hits the neutral rate you're going to have a stable you know like CPI rising at 2% a year >> and so it was like where are you getting no stable prices doesn't mean they rise predictably >> so they've like taken it to the first derivative like oh yeah it's stable as long as you can correctly predict pretty well how much inflation we're going to have as opposed to zero Oh, >> you are exactly right. The uh the Fed rhetorically did something very clever. They took stable prices, which is the phrase in the in the Federal Reserve Act, uh and said, "Well, we're going to talk about price stability, not stable. It's too too obvious what stable prices mean." >> Mhm. So we'll talk about price stability and then we'll define price stability as a constant inflation. >> It's a sort of a rhetorical trick, >> right? >> Uh so uh one of the things that uh >> I suggested in the testimony is what does stable prices in its natural sense mean? And as you just suggested in your comments, Bob, it probably means that an average rate of inflation of zero. Uh now that doesn't mean that prices never rise or never fall. Well, it means on average over time they're more or less flat which means sometimes getting uh in certain circumstances they'll rise but in other times uh particularly uh in uh in times of very high productivity and high inflation and high uh innovation prices will have a tendency natural tendency to fall. And if you read uh the Fed or its many media admirers, you'll say, "Well, isn't deflation terrible?" No, deflation would be going to the grocery and finding prices are lower and say, "What's wrong with that?" >> That's a good thing. Uh so over in in a stable price system and this by the way um I I I learned from my fellow my fellow fellow of the Mises Institute Brendan Brown uh who has a new book coming out on this and writes interestingly uh on the nature of money good money. The the new book is called Bad Money, contrasting what we've got, bad money, with what would be sound money, which would be uh stable on average over time. It's a that is a world that people can hardly imagine now thanks to the Fed and its inflationist tendencies. So, you know, uh, so what do you think the Congress meant when they wrote stable prices? I asked as I was doing this testimony. Well, if you look at the um 1978 act, which is the Humphrey Hawkins Act, which also had to do with the Fed, they say, well, we we have a goal in the long run in 10 years of getting inflation to zero. that's in the in the act that it's all hedged around, you know, subject to this and subject to that. >> But I think that's a good indicator that maybe they were thinking in their mind uh that they were really after truly stable prices. Uh and in this testimony in September, uh one of the Democratic members uh said in his his statement, "Well, stable prices, stable prices would mean zero inflation." So, if if it weren't for being able to try to to uh manage employment, we'd have to have zero inflation because it says stable prices. And uh I commented later in my remarks, well, my the congressman agrees that the natural meaning of stable prices is zero but inflation. But you have to have to think about it over over time because we know in economics uh everything is always changing and prices there are millions of prices >> right >> uh and some are going up and some are going down the one where there's a lot of innovation and productivity those prices go down the ones most controlled by the government those prices go up uh I mean you're looking for some kind of a an overall average or or tendency in in all of those uh prices. But if they're to be stable over time, sometimes they'll go up and sometimes they'll go down. Well, that's okay as long as it's good deflation. Good deflation is deflation which naturally arises from high productivity and innovation and growth and that's >> I think we've lost that point. Could I just add one more thing because you mentioned the natural rate of interest. The natural rate of interest is of course is an idea or a theory. Uh but it's a nonobservable entity. Nothing will tell you and you can't ever find or see or observe uh the natural rate of interest. And the natural rate of interest is is written in economics formulas as R followed by an asterisk. And they pronounce it R star. And R star is the the hypothesized natural rate of interest. And Chairman Powell much to his credit uh observed has observed in his speeches that this is a nonobservable. You're you're guessing about what you think this might be. And people have different guesses. And then he came out with this wonderful line talking about our star. He said, 'We navigating by the stars under a cloudy sky. I think that's that's wonderful. Yeah. And truthful and candid. And as I say, much to his credit for pointing this out to people. Well, to also credit two prior Fed shares in your testimony, you cite on this very issue of, you know, oh, is am I a crazy radical fringe guy for saying that stable prices should mean 0%, you know, CPI inflation over the long term? And you quote both Paul Vulkar saying something about, you know, people sometimes posit a little bit of inflation's good for employment. I don't think so. And then even Greenspan when he was the chair saying properly measured I think the optimal inflation rate is zero in the long run or something like that. So anyway that that's interesting too again just to show this isn't us trying to like expost rewrite history or something like no this is what people were saying we have in mind here. >> Yes. And it's very good to to think carefully about these things as as in all things and not not accept whatever the current uh the currentic uh uh commentary of the day may be saying but but as as we do at the Mises Institute try to think in in fundamentals about what what is really there and also what you really can't know. I mean you can know hey is fond of saying we we can know things in general how they work uh but you can't know the specifics of how economic and financial events will turn out and that's anybody who thinks the Fed can do that that's clearly just wrong and you only have to look at the dismal record of their forecasts to see that. >> Yeah. Exactly. Okay. So, you know, there you you sort of you listed what the Fed's existing mandates were, even though, as you say, a lot of people might have just thought there were two. And then your testimony, you you pivot and you say, "Okay, so what what what should they be doing?" And do you want to run through those? >> I do. Well, I I start off uh by saying, which we should mention, uh that there is a great deal of commentary about how the Fed should be quote independent. Uh some people uh have even said autonomous which is even more ridiculous. >> Uh you can't in a democratic republic uh under the constitution you can't have any part of the government which runs around as some kind of purely independent thing doing whatever it wants. That's the opposite uh of a constitutional system of checks and balances. Now the question is where does the Fed fit in to the appropriate system of checks and balances um and um it fits in as being accountable to the elected representatives of the people that is the Congress and it just it can't just go off by itself as we were talking about decide that what they want is 2% inflation forever and then just announce it and say this is it. Now, if you read the papers, they always talk about the Fed's inflation target. Yeah. But shouldn't be the Fed's target. It should be the country's target that somebody has appropriately approved. Uh and indeed, in the Fed's private uh private discussions going back into the 1990s when they were saying, "Well, we're going to have this target and so on. What should it be?" uh one of the members of the open market committee said well don't you think we ought to ask Congress what they think about this and he was right of course to say that and by the way on a different occasion chairman then chairman Greenspan made a similar comment you can't do this without Congress but they just ignored that and they they charged ahead acting as if they were some kind of autonomous power which they they cannot be uh under under our constitutional system. So there are two things that are here important I think on the on the constitutional part. The money power is given to the congress by the constitution to coin money. Well, those were the days. Uh, coining money. Uh, but to coin money and regulate the value thereof or regulate the value thereof is a constitutional uh responsibility, a power but also a responsibility of the Congress. >> The other u power that's relevant is the taxing power. This is really important and I think understood by the Mises Institute but maybe few other people that inflation is simply a tax. By inflating prices uh the Federal Reserve takes purchasing power away from the people and gives it to the government. That's a tax. Mhm. >> So, uh, Congress is also supposed to oversee, not only has the power to tax, but should be overseeing taxation and and the Fed is actually a taxing body through inflation. I think it's a really important uh fundamental concept. So, if you wanted as I we've talked about the name of this hearing, but the the name of my the title of my own testimony was how Congress should oversee the Federal Reserves mandates. Uh all eight of them. >> Mhm. Uh and I I did suggest in the end the a list uh of things I thought the Congress could do now uh to improve the accountability of the Fed uh and to improve the the functioning of the uh financial and economic system. Shall I just run through these? >> Yeah, sure. >> Okay, I will. These are one uh we call this a sound money mandate. I believe that the Congress should write into the Federal Reserve act. The following principle that the that the most fundamental responsibility of the Federal Reserve is to furnish a sound currency. a sound currency whose uh stability that people can and should rely on and do rely on because it actually is sound and stable and that I think it would be very good to write that in through the act which they they could do at least in theory they could do and they should do it. Uh secondly, the Congress ought to make it clear to the Fed that if you're setting a so-called inflation target that takes our approval. That's not something you go off and do by yourself and just announce to the world. We've decided well who are you? Uh you are uh you are a part of the government subject to checks and balances notably of the Congress. Uh and um and if you did have an inflation target, you know, it might uh might not have one. You might just have a commitment to sound money. You could say, well, that means uh inflation is between zero and 2%. As one example, not 2% between zero and two. That was the original. New Zealand, by the way, is the is the country that is the father of all inflation targeting. That was their original inflation target. between zero and two, you could have like the Swiss central bank does less than 2%. In other words, it could be zero less than 2%. And the the Swiss generate a pretty uh pretty sound currency uh relatively speaking relative to the dollar. You could have stable prices, a long run rate of zero. That would be what I recommend, which maybe varies over time between minus 1% and plus 2% but averages out to zero. Well, the Fed could come back and try to talk to Congress and do 2% forever, but whatever it should be, Congress ought to make it clear this takes approval of the elected representatives. Third, Congress should strictly oversee the Fed's finances. We talked about that. I have never seen now maybe it's happened but I am unaware of it if it did a serious oversight of the Fed's finances of their balance sheet and their profit and loss statement and their capital uh by the Congress and the Congress ought to be aware of this for all the reasons we talked about a minute ago. I think Congress ought to require the Fed to follow standard accounting. Um, the Fed believes it can make up its own accounting rules and they changed their accounting so that they could pretend that their losses were assets. >> Mhm. >> I mean, I hope your listeners get this idea. The Federal Reserve wants you to believe according to its financial statements that its losses are assets. That's bizarre. and therefore they publish statements that show that they have capital that they don't really have the leading central bank in the world. It's setting a terrible example in that way and I think if Congress ought to make them report uh according to standard accounting and then you get the reality and then you can decide what you want want to do about it. Um the the next point is I think the Fed should get out of mortgages to have the central bank uh owning uh mortgage securities which they did as part of the uh emergency reactions following 2008 and the crisis. Chairman Bernanki went up to the Congress, testified and promised this would be temporary. Well, now let's see. This is 2025. They started in 2008. So, it's been going on 17 years. Not too temp not too temporary. >> And they ought to get out of out of manipulating and distorting the mortgage market. It's not appropriate for a central bank in my judgment. Uh the next thing I suggested was the Congress should take up recapitalizing the Fed. Well, [clears throat] you might they might decide they're okay with the Fed running negative capital, but maybe they'd prefer [snorts] for their central bank, which is not only the lead the central bank of the United States, but leading central bank for the whole dollar using world, which is the whole world, uh should have positive capital and you could recapitalize the Fed to to offset its losses. that would uh and there are various ways you could do that which we could talk about. Um as as part of that you wouldn't let the Fed pay dividends to its stockholders when the Fed has zero retained or well has negative retained earnings [clears throat] and negative earnings. Nobody gets to pay dividends if you have no profit and no retained earnings. Uh that would be a point. Now, we ought to mention as we pass here, who owns the stock of the Federal Reserve? >> It's the member banks, right? >> The member banks, the private banks. The stock of the Federal Reserve uh is all owned by private banks who are the members, not by the government, not by the Treasury. So, when the Fed lost their capital, they lost all the all the money that the member banks had invested. and and you have to figure this out taking into account the Fed Federal Reserve banks are owned by private banks. And the last thing I suggested to the Congress is that the banking committees as the Senate Banking Committee and the House Financial Services Committee should in addition to this task force which I think was an excellent idea should set up formal subcommittees whose only responsibility is serious oversight of the Federal Reserve. And if you in my judgment if you had such a committee the members of that subcommittee would actually become overtime expert in their subject which members of Congress do they if they serve a long time on specific committees uh and be able to have a a serious accountability of the Fed to the Congress and a serious carrying out of their monetary and taxation uh authorities and duties by the Congress. ress. So that that was my list of of things to do. >> Well, well, great. Just to touch on the the accounting chicannery that you mentioned there. I I mean I I read it on zero hedge or something, but I forget what year, but back when they made the the actual change like this was during like when they were doing the rounds of QE and I'm going to pat myself on the back. you know, some things I got wrong, but that one I got right. And I said, "This is a weird because what they for the folks at home, they they made some and it was a very innocuous thing like in the footnotes of some rel, you know, and it was like some some correct >> some random bloggers, you know, financial spotted it and then it just kept working up its way and then zero hedge broke, you know, and then I, you know, said it here in my for my perch at mises.org." You're >> right. It was 2011. >> Okay. 20. Great. And >> and they did. Yeah. It was, you know, put out, well, here's this little accounting change. >> And what it like the way I like in in layman's terms, it was like normally, you know, with a business if if they have a loss, then you know, they oh, when the Dustin, I was like, oh yeah, your assets are lower than you would thought. And then if you know, so then when you do, oh, geez, so that means like my assets minus my liabilities, which is the shareholders equity, that would go down and oops, if it's, you know, if it's negative, that means you're insolvent. But the way they were going to handle it is to say, "Oh, if we have a loss, because normally what they do, just for context for people like Dr. Pollock was saying is if they have earnings over and above their cost of operation and then the dividends they normally pass on to their, you know, member banks who own the stock, then any excess is remitted to the treasury. So in terms of their standard balance sheet, that would be listed as a liability. Like, oh, if we had an extra three billion that we owe the Treasury this year, they would show up as a liability to explain, yep, that three billion is not ours now. We got to give it to the Treasury." But then what happens if they have a three billion loss and they said, "Oh, well, we'll just list that as a negative liability." And so now that's just sitting there and then next year if we have a billion dollar profit that just whittleles down the thing we carried over. So now we have a negative two billion amount we owe the treasury. And then if we have another, you know, it's like they're digging out of the hole >> and I pretend that the capital is still there. >> But I [laughter] was pointing out like normal businesses can't you can't list a negative liability and put it there on the balance sheet. It doesn't make any sense, >> right? No. No. any I often point out that if any corporation including a bank uh which was a uh securities and exchange commission filer >> Mhm. >> did that did what the Fed does, its financial officers who signed those statements would probably be headed for jail. >> Yeah, >> think about that. It's a it's a fascinating situation and it was, as you say, a a change slipped into the Fed's accounting rules under the theory that they control their own accounting. That's a bad theory to let anybody just control their own accounting. >> Yeah, talk about independence. So, [laughter] it's like, why should we be bound by the rules of mathematics? This is [laughter] I think I even made that joke at the time. I said, "Yeah, and if they just if they just multiplied their loss by a negative one, then it's a it's a gain. So why don't we just do that? But it's [laughter] >> Yeah. So here we are. So you uh look how long this has been going on. >> Yeah. Um and I think you're right too just to focus on the mortgage back securities. I mean that's people are worried about home prices and gez things like that. And it's like well what do you I mean not that that's the the full explanation of course but >> yeah what do you think is going to happen if the Fed is is doing that? And what's funny too is at the time they even like if you had asked people like apologists for the policy why are you doing that among other things they would say you know to to rescue the the housing market you know to prop it up or something and so it's like okay so then now years later after that just mushroomed on the balance sheet and they own trillions in mortgage back securities and we're wondering why are home prices skyrocketing the thing that you guys admitted this will make home prices be higher than they otherwise would back when oh we don't want them to collapse so we'll prop them up. Okay. So, you know, it's [laughter] if you admit that buying mortgage >> they were still buying. They were buying all the way into early 2022. There had been a home price boom on house prices were in a bubble escalating uh at uh 15% a year or so, which is a you know, it's pretty tough if you're trying to buy a house and the prices are going up like that. And the here is the Fed still buying mortgage back securities and still feeding this house price bubble is in my mind completely unjustifiable with no possible argument in its favor in the as they kept it up over time. I mean uh so there you go. Now they could get out. They own the Fed still owns more than $2 trillion in mortgage back securities and these are primarily 30year fixed rate uh mortgages which is and they're all funded short uh with with money that prices on an overnight basis. This is uh [snorts] this is balance sheet management 101 that you're not supposed to do that. they would uh they would be furious with any regulatory charge. Although it's exactly what Silicon Valley Bank did, same thing. Yeah. >> Using more principally mortgage back back securities. >> Uh and uh I've often thought if they had gotten around to criticizing Silicon Valley before it collapsed, Silicon Valley could have applied. Well, it's the same thing you're doing. >> Right. Right. That's good. And and just to to kind of connect back to what we said at the start of this discussion, Dr. Pollock, that somebody might like they they're really painted into a corner that suppose they took your advice. Yeah, you're right. We should get out of this mortgage. They can't simply say, "Yeah, let's let's just sell off the 2.1 trillion that we're sitting on because of that interest rate, you know, change over time and that they have huge unrealized losses on that." So, if they did do that, then they would have to recognize, you know, the hundreds of billions. all the all those unrealized paper losses would become actual cash losses if they sold. They have another problem which is the position is so big and such a big part of the market that they really they couldn't sell without crashing the prices in the market. So the losses if they tried to get out of very much of that position uh they would drive down prices against themselves. So they're stuck, but but they could uh commit to they could get an order from the Congress. That's it. You just run these off now and and take as a principle going forward that you're not there to try to manipulate the housing market. >> Okay. Um, last point one question I had for you is you said in your testimony and then you have you said here too that you don't think that they thought they were going to end up in this position when they were like doing these things that at least expost looks like it was pretty reckless. And so I'm wondering though how could they like again not that I'm Nostradamus or something but I was going through this stuff like for years at mises.org you know, because I had a I think a weekly column back then and I was just going through or maybe it was month. I'm getting mixed up now. But anyway, and it was I was doing because a lot of the defenders were coming back and say, "Well no, if they got into a a tough spot, they could just raise the interest on reserves." And then I was saying, "Yeah, but if interest rates have moved and blah blah blah," and there's, you know, the dollars like and and price inflation becomes unacceptably high, that's just going to fuel the problem if they incur, you know what I mean? And it was like amazing to me that people weren't, you know, it wasn't that I was guaranteeing this was going to happen, but I'm saying now they're open to this. And so I'm just again, it's surprising to me that well, some guy writing for me is.org saw this possibility. Like they just literally didn't think of it or was like, h so what? We got to bail out our buddies. >> They they uh knew the chance was there. Uh, in my opinion, I I wasn't sitting in the room with them, but in my my opinion, they thought it was unlikely >> Mhm. >> that interest rates on the short end would go high enough to cause these losses. You know, sort of theoretically, well, yes, it's a possibility, but surely it's a remote case. It's back to my saying, risk is the price you never thought you'd pay. You knew you were taking the chance, but you didn't think it would ever hit you this bad. >> Yeah, >> I think that's the case. >> Okay. But I mean, again, I think you have to be right in terms of maybe they just convinced themselves, but also too, we're talking about a time when they were loading up on this stuff when the short-term rates were basically zero. It's like it didn't occur to them. >> They had made they had made the short, >> but it didn't occur to them that well, maybe the interest rates won't stay zero for the next 30 years. >> It did. [laughter] It did occur to them, but I don't think it occurred to them that they would move up. >> It's it's rapidly. Yeah. And >> if you look at the Fed's own interest rate forecast, they projected out a remember lower for longer. >> Yep. Yep. >> Uh they projected out continuing low interest rates. >> Yeah. >> So the gohead. So I just have one more. >> What looks like at one point the the remote case may turn into the reality that you are confronted with. Yes. So, I just have one more question for you, Dr. Pollock. You you were there in the room. You you you got the reaction. You could sense the body language. C can you give us a sense of what like were the the the congressional represent like were they soaking it in like yeah, this is kind of crazy or you know or was it like all just theater because yeah, we know the public's upset about egg prices, so we got to make it look like we're doing something. >> Well, of course, uh every member of Congress is an individual, but with uh different ideas and uh and goals and uh and and partisan commitments. So you really can't talk in general. I think was a a serious hearing about the ideas but uh as always a long way from having hearing to having something actually uh enacted and done and the you know and the uh fathers of the constitution set it up that way. should try to make it hard [clears throat] >> hard to do things and it is so I but I I feel like it's uh that was great that they had this hearing. It's great they've got this uh task force in the committee and it's our responsibility. I I think as fun Misesus himself would have said, you keep working on the ideas that are are right and uh and in the long run it's all about the ideas. >> Mhm. >> And which ideas prevail. So there we are doing our best. >> Yep. We're just going to keep plugging along and telling them the truth and hopefully some people listen and care about it. So well folks, my guest has been Dr. Alex Pollock, a senior fellow at the Mises Institute with a long career in uh banking and uh related matters and so he's an expert to be talking on these issues and he was here summarizing his September 17th testimony and speaking truth to power. So thanks so much Dr. Pollock for everything you've been doing. >> Thank you Bob for having me. I really enjoyed it. >> And thank you folks [music] for tuning in. We'll see you next time. >> Check [music] back next week for a new episode of the Human Action podcast. In the meantime, you can find more content like this on mises.org. [music] [music]