Buck: Welcome back to the show, everyone. Today, my guest on Wealth from your podcast are Alex Pollak and Howard Adler. And this is a they have a book called Surprised Again The COVID Crisis and the New Market Bubble. Both Alex and Howard are you know, they’re they’re guys who worked for the Treasury, which is, you know, pretty mainstream. And of course, the concepts that they talk about in their book are probably will be of surprise to a number of you.
Let me give you a little background on Alex Pollock first. He’s a senior fellow of the Mises Institute and the author of Finance and Philosophy Why We’re Always Surprised. Notably, its surprised again this time, right? And boom and bust financial cycles and human prosperity. He was a principal director of the Office of Financial Research U.S. Treasury from November 19th to February of 21.
There’s a lot more to say about him, but I want to get to Howard, who’s also an attorney and former government official, knew from May 20, 19 to January 21, served as the deputy assistant secretary of the Treasury for the Financial Stability Oversight Council, where he was responsible for monitoring the financial stability of the United States during the first year of the COVID 19 crisis. He’s very distinguished, been awarded the Treasury’s Distinguished Service Award for his efforts by the Secretary of Treasury as well. Long introduction for you guys. You know, you’re too accomplished for the show, unfortunately, and we don’t have time for anything else now.
Howard: Says former surgeon, current star investor.
Buck: Well, something like that. But welcome to the show, guys. This is this is fast is a fascinating topic. First of all, you know, speaking about this book and in the concepts, I think you talk about a U.S. experience in boom and bust financial cycles every ten years. How does that happen? I mean, do you want to talk a little bit about that?
Alex: Historically, it is just the case that more or less not exactly, but more or less, about every ten years we have some kind of financial crisis. Paul Volcker had a very witty comment on this. He said, Every ten years we have the greatest crisis in 15 years. And and that’s a comment that’s particularly insightful because memories are short and institutional memories are short.
New people come in, old ones. Memories get fuzzy. Yeah. For example, what of the decades that both Howard and I lived through? What was the 1980s? In the 1980s, 4000 savings and loans in this country failed and 1400 commercial banks fail. People just don’t remember this. Sure. These financial structures can be very fragile when faced with what they didn’t expect.
And there and often enough things that weren’t expected or even thought impossible to happen anyway. The the physicist Freeman Dyson said many things which were considered impossible, nevertheless came to pass. Sure. And it’s all right. And examples would include house prices falling on a national basis, which were thought to be impossible, where it was early 2000s. Oil prices dropping precipitously in the early 1980s, which was thought to be impossible. Big, important banks going bust. And more recently, interest rates rising rapidly after everybody had gotten used to the idea that interest rates would be lower for longer. So this is a.
Long history over history, different things at different times. But the great financial historian, Charles Kendall Berger, from whom I learned this ten year moralist cycle, he observed it over several centuries in the 19th century, when Walter Batchelor, who will speak later, was writing. He was observing a ten year cycle in England in financial crisis, and we still have it now. So we’ve had crises in the eighties, 1980s, 1980s, 2000, 20 tens and now 2020s, and here we are.
Buck: So is the idea there that it’s just the natural history of the economy or do you is, is there a God? Is there a sense that there is a you know, that sometimes the government actually creates these problems?
Alex: Oh, no question that the government contributes to creating these problems. We saw it well in the 1980s with the collapse of the savings and loan of savings and loans, which was from the same thing, the Silicon Valley Valley Bank collapsed. And then we have a short term deposits invested in very long term fixed rate assets. That structure of the savings and loan balance sheets was mandated by the government. They were forced to do that by the regulation in the in the great housing crisis. The government was leader in trying to create what they call innovative, but which meant low quality mortgages, which of course unraveled. And now we have a long period on the Federal Reserve. I say being the Pied piper for believing in very low interest rates.
Alex: And it was going to be safe to hold fixed rate assets against that. And now we see the opposite is the case. So the government is absolutely involved in helping to create these as well as trying to get out of the woods.
Howard: And of course, of course when Ben Bernanke in 2008 began his so-called quantitative easing, which involved buying mortgage banks securities up to the tune of about ultimately $2.7 trillion worth, thus becoming, making the Fed the really the largest savings and loan in the country and and certainly providing a natural, if you will, artificial support to the housing market, creating a housing bubble that we’ve now got now that that quantitative easing is going to end is ending is winding down. You know, one can speculate what’s going to happen long term to the housing market without that that crutch. But it’s not only the government, it’s also human psychology. When when the markets are going well, people don’t want to miss out on a good thing and they keep buying. And people tend to have collective amnesia. They forget that things can go down and then they’re reminded there’s a crash and and then they miraculously forget again.
It’s sort of what I noticed as a young lawyer when I was doing sovereign debt deals. And in Latin America, everyone talked about the prospect, the prospects of Latin America, what a great place it would be for future growth. And then they default. And and then a couple of years later, we’d be talking about prospects again and people would forget about the defaults of the next default. Yeah, it’s also human psychology..
Alex: And remember, and Howard’s very accurate point that while the bubble is on, lots of people are making money.
Buck: Right. And that brings me to the next question, which is one of your arguments is that government agencies, the Fed, everyone involved in control, always tends to use these moments of shock, you know, in the boom and boom, boom and bust cycles to gain power. Is that is that right?
Howard: I think you’ve got it exactly right. For example, you know, the Silicon Valley bank failure and the signature bank failure just a few weeks ago is a perfect example of that. Now there are calls for tighter regulation and more regulators, more authority to the to the Fed and other bank regulators. And yet we Silicon Valley Bank failed because of the most basic thing in banking then managing your interest rate duration.
Howard: This is something that you’ll learn if you’re a, you know, a bank, a young banker and your first day of training. This is something you learn in the first week that you had that the safest thing to do is match the duration of your assets and liabilities. And if there’s a mismatch, then you’re going to be either vulnerable to an up to a rise or a decrease in interest rates, depending on which side the mismatches and that they fit this. The there are 15 pages in the Federal Reserve Bank examiners manual on this point. The authority, then examiners called it out. The authority was there to fix this, and yet the supervisors failed to do it. And now they’re going to impose new regulations which are needed at least to solve that problem.
Buck: Right. So basically, it’s, you know, I guess part of, you know, what this argument sort of reminds me, too, is I don’t know if you recall this book, there was 27 as Naomi Klein, The Shock Doctrine. Does that ring a bell? And anyway, similar concept where basically the idea was that, you know, every time there was a major, you know, economic problem or any kind of disaster, really, that created shock that the there was an opportunity to create further control, further regulation and usurp power because people weren’t paying attention to, you know, anything. But survival at that point is that that’s kind of crisis.
Alex: The crisis tends to centralize power, right? And then it tends not to never to go back to where it was before. There is a classic book on this, which you may know Crisis and Leviathan is the name of it by Robert Higgs, which makes exactly this argument, I think very brilliantly. There’s a constant ratcheting up of the of the power of the state with each crisis, and then it might back off a little bit, but it never goes back to that ratchets up again. And we we certainly see this in the financial system.
Buck: How did this you know I know you know, when you mentioned the bank crises, it sounds like there was a the current bank crises, these small banks that essentially these were oversight issues internally. Right.
Alex: Management, you can call it fundamental management mistakes.
Buck: Fundamental management mistakes. But then I guess the question is, you know, what is the role of government in that? And and is the government at fault in this? I guess, you know, to your point initially about how the you know, these cycles are are really almost planned out, so to speak.
Alex: So not planned out? I don’t think so. Yeah. But they do happen with some regularity, which is fascinating.
Buck: Yeah. Okay. Sounds good. Let me ask you this. So you mention political finance. You said all finance is political finance. You talk about that.
Howard: Well, you know, it’s it’s all political life. The secretary of the treasury is essentially a political figure. The the Chairman Powell, the Board of governors of the Federal Reserve System. Supposedly it’s the Fed is supposedly above politics. But nonetheless, I would submit that any senior official who gets appointed by an elected official is by his very or his or her very own nature. Political. Sure. And politics factors very heavily into this. One of the things we have to watch out for and you talk about government power, you want to tie those two things together for a minute, Is that now you’re starting to say, well, gee, if deposit are not safe, the deposits that are in federally insured in the banking system above $250,000, maybe we should go to a central central bank, digital currency. If a Fed money were in it set. In essence, your bank is is the government so since all of your money would be guaranteed by the government, then your deposits would be safe and you started to see a smart people make that argument. But that is a very dangerous situation because it would give enormous power to the central bank. If that were to happen, you might not have a private banking system. We think it’s.
Alex: The worst financial idea of current times to provide good little currency.
Howard: Just from starting from an economic point of view, the banking system employs about two and a half million, two and a half million people. If they were out of work, that would have a terrible impact on the economy. Banks are the main tenant of many commercial office buildings that would have a horrible impact on the real estate market. And if all of these deposits were on the books of the government, they would have to have assets. The balance is deposits, which would mean that the government would get to pick who gets money led to them and who doesn’t. And obviously you can see that in some administrations that would mean no oil and gas companies got money and you would have politics going into the private.
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What has up to now been a private credit allocation crisis and and not to mention the fact that the government look at every financial transaction that every individual in the country adds and we think it would have disaster has consequences for the economy and for people’s freedom.
Buck: And privacy is an interesting concept because there’s, you know, multiple problems with it. You mentioned privacy. You know, the the ability of the government to see all transactions, that kind of thing. But, you know, I, I get different stories on what the purpose of the central bank decentralized process would be all about. I mean, some people argue that, listen, all these dollars are all digital anyway. All they’re doing is turning it in, you know, using a different, more efficient software. But you see it as a more of a an elimination of the banks type situation.
Alex: We see it as a colossal centralization of power. Over people, individuals and over institutions in the country, in my in our in our judgment, extremely dangerous and a really, truly bad idea.
Buck: Do you think there’s a political I mean, first of all, you have a banking industry which is probably not going to be real happy about this. And they’ve got some fairly powerful lobbyists, I imagine, you know, big being big banks. I mean, how how realistic from a political standpoint, do you think that this kind of change would actually be?
Howard: Well, it depends on what happens if if two medium sized banks like SBB and and signature failed. No, but if there are massive bank failures and people start worrying about the the health of the banking system and people are at risk and the market crashes and you have a huge failure of confidence in banks, then I think, you know, a lot of bad policy is made as a result of crises. Then you may see a lot of people hailing this sort of thing as as a panacea and people maybe not prone to listen to the banks. That, after all, would be the ones who are perceived to have gotten us into all this trouble.
Buck: Is there anything that would make you concerned that the larger banks may have a similar, similar problems going forward?
Howard: I think the I think the larger banks are first of all, I think most of them are pretty well-run. They have embedded, they have embed. This is an easy problem to fix. I mean, there are interest rate hedges available that people could just do, bought insurance against this sort of problem, or you could have simply match the duration more closely of your assets and liabilities. And the Fed has made it easy now for people with this problem to get out of it by basically opening up a credit line that will lend 100% of your collateral, assuming it’s government, government and mortgage bonds, even though that the market value of that collateral may be far less, which is, you know, a great deal. So I, however.
Alex: Add to be noted. Can I just jump in there? Yeah, sure. You’ll be noted on that credit facility. The losses from such a facility will be taken by the Treasury. That is to say, the taxpayers. The Fed will lend you the money with the junior partner in the deal. Are the taxpayers.
Howard: Right the most. But but most importantly, what we learned from 2007 and 2008 are that these big banks are completely safe because the government will not allow them and not allowed them to bail out Jp morgan or Citi or Bank of America failed their counterparties. Who would be exposed that are so many tentacles in every aspect of our financial system and our economy that they’re failure could simply not be allowed to happen. Dodd-Frank was supposed to cure the too big to fail problem, but of course it didn’t. And that’s what you see now. You see a flight to safety, people taking their money out of the mid-sized regional and smaller banks and putting them in the in the so-called G sibs, the very largest banks.
Alex: Yeah, it is. It is the case, however, that very big banks can get into a lot of trouble. Big, big organizations have failed. Big, big banks have had to be bailed out. The the term too big to fail, I think was invented in 1984 for the bailout of Continental Boy, which seemed like a big, big, big failure at the time. It’s been since surpassed many times. But big organizations can get in trouble. They do have this implicit support, which is very real. Another good example of that would be Fannie Mae and Freddie Mac, both of which became and sold them and were bailed out at great taxpayer cost. However, I think we have to say among the risks we have, I mentioned a minute ago the Federal Reserve as Pied Piper, the banking system.
Among the risks is that in the banking system as a whole, there is a very large mismatch between long term fixed rate assets and the add on net short term floating rate deposits, which are financing a huge mismatch. The data is challenging here, but there have been two studies reasonably. One estimated that the mark to market unrealized loss on the whole banking system, and this counts both as both bonds and loans of an estimated $1.7 trillion large market loss for the banking system and the other estimated $2 trillion mark to market loss for the whole banking system. Now, the banking system as a whole has $2.2 trillion in capital. In equity of that 2.2 trillion, 400 billion, however, is goodwill and other intangibles. So the tangible equity is about 1.8 trillion. Now, what does that mean exactly? If you if you have a mark to market loss, it’s more or less equal to the market, to the mark to market capital. I’m sorry. To the to the tangible capital, which would, you know, to get to the mark to market capitalism. Correct. The loss of capital. Well, we’re going to find out. There is definitely a system wide theme here. The decisions made by managements, but very much induced by the long period of suppression of both short and long term rates by the Federal Reserve.
And that’s something we need to keep our eye on. And now we’ve been surprised yet again, as we said, by these couple of bank failures. And then we’ll we’ll see how the rest of this plays out. Depends a lot on how interest rates play out. In the eighties, interest rates were pushed into double digits with disastrous consequences for banks. Here we have short term interest rates around 5%, which people say is high, but it’s not high. Historically, 5% is an average kind of interest rate, but it’s already causing some certainly important strains.
Buck: What do you think from your perspective as a former Treasury people? How do you look at the way things are being managed by the Treasury Department, by the Fed right now?
Howard: We’ve both if you’ve read any of the stuff we’ve written lately, we’ve both been rather critical of that management. We talk about the COVID crisis, which in a crisis Alex alluded to Walter Badgett, who was a 19th century British banker and a great writer, really wrote the book on On What You Do when you have the financial crisis. And the book is You You lend freely to companies of good quality at high interest rates and on good collateral. And the COVID crisis was a different kind of crisis. It wasn’t due to the inflation of an asset bubble or a lack of capital. And in banking or housing, like the 2007 28 crisis was, it was basically the whole economy shut down.
We had a health crisis and that led to political decisions, forced the economy to shut down. Small businesses were closing, restaurants were closing. We had to get money out into the hands of people. And we’re facing an economic and a human catastrophe. And that’s what we did. We just led freely. A lot of these loans were forgiven. We adapted part of budgets plan, but but not all of it. The problem with with this is we are also followers. And in our book we call this Cincinnati. In principle, Cincinnatus was a Roman general who in Rome was invaded, was called out away from his farm to take even dictatorial powers and told to fix things. He defeated the enemy in 15 days, gave up his powers and went back to his farm. Cincinnati, in principle, says that when a crisis is over, you stop. But this administration didn’t stop. I mean, the crisis was really over at the end of 2020, but we had massive additional spending. The one point. In money printing.
And money printing, the 1.9 trillion American rescue plan, these proposals to forgive student loans, all of which cost massive amounts of money. And that’s inflationary. You know, there’s a recent Federal Reserve study that if you if you ran the numbers down, attributed roughly 40% of the of the inflation that we’ve seen to to government spending. And you can’t do that without having an inflationary effect.
And we think that we think that had prudence and common sense reigned in 2021 and the spigots financial spigots were turned off, that we would not be in the kind of shape we are today with this massive rise in interest rates. We’ve had some inflation that is wouldn’t have been as bad as it is today. So we’ve been, I think, both critical of the economic policy that has been followed by the Biden the Biden administration.
Alex: If you believe that in a crisis, whatever the cause it takes crisis actions, then the Cincinnati doctrine we think is really important. You’ve got to turn off you turn off the interventions when the crisis is over. And it’s hard to do that. It’s hard to make it happen.
Buck: Or it’s hard to take things away once you give them.
Alex: That’s right. Everything you give creates a constituency. Yeah, or people who benefit from it. And our good a really searing example of this is the Fed’s purchases of mortgages, which lowered, I mentioned before, in the form of mortgage backed securities in the face of an unbelievable house price inflation in this country. The Fed went right on stoking the housing market all the way to March 2022 was amazing and we said at the time they have to just stop buying mortgages. But they didn’t. They went right on in the face of a of a giant house price inflation. Well, no, among the prices we’re paying is the correction of that mistake.
Buck: Going back to, you know, your your your comment, Howard, about money printing and excessive, you know, intervention, I wonder, you know, I think a lot of people wonder the same thing. I mean, we obviously had a significant intervention after 2008 as well. It didn’t lead to this kind of inflation. What’s the difference?
Howard: Well, I think the difference is degree what happened in 2008, 2007 and 2008 was what happens in every every crisis. The Treasury borrows money and the Fed and the Federal Reserve prints up the money to buy the Treasury’s debt. They work hand in hand. What you saw in 2007 and 2008 was an increase in the in the monetary supply and in the amount and the Fed this balance sheet from roughly eight or 900 billion prior to that crisis to roughly 4 billion, trillion, trillion, trillion. 4 trillion after that crisis. And a trillion is, you know, is an enormous amount of money. It’s a thousand billion. It’s hugely big bucks. Yeah. And and you can’t lose sight of that. And when you listen these government things, you say, oh, just another trillion. But there’s lots of things. So so so what happened was that when the Fed faced this crisis, its balance sheet had not come down very much. It was already dealing with about aa4 or $5 trillion balance sheet and the spending in this crisis and another 5 trillion to that, you got up to about 8.9 trillion. That’s a serious number and it’s a serious amount of increase in the monetary supply. So the problem with these crises is that you never really recover because the Fed doesn’t want to sell the stuff that it bought, the debt that it bought. It does If it sold $2 trillion above of of commercial mortgage obligations, it would destroy the housing market if it sold the five or so five and a half trillion of Treasury debt that it had. It would destroy the Treasury market.
Alex: So which markets were overpriced? Exactly because of the Fed buying. So these tremendous tops in the markets which were created by the Fed itself being the big bid to buy at the very high prices. Could I just add what Absolutely. Being in there too, and that is that this wasn’t only happening in the US. You had many other central banks all together. Yeah, we treat this actually in a chapter of the book we call Central Banking to the Max. And we we document how the European Central Bank, Bank of England, like Canada Bank, Japan, Federal Reserve, they’re all in this together. So you get an international multiplication with result of a first of all, a tremendous asset price inflation, which did already happen after the earlier interventions during the teens, during the 20 tens, a tremendous inflation, but inflation and asset prices that continue then in beginning in late 2020 and we talk about that in the book this the second surprise, the second gold surprise was the the big asset bubbles. And then, of course, the consumer price inflation. But it’s very interesting to see how this is. This isn’t just the Fed. It’s all the central banks getting together and all doing that same. And there there are some very striking graphs in the book to that effect.
Buck: What do you think? Where do you think this all ends or not? And but, you know, is there you know, it just seems like we’re on the brink of something again, something big. And in the question in my mind is always, you know, at some point, do we end up with some kind of reset? Do you ever see that? I mean, I know there’s people out there talking about I don’t even know if it’s a legitimate economic philosophy, but this modern, modern monetary theory, things like that, Where do you think this is? Where do you think the sense.
Howard: Of modern monetary theory? I think this inflation, if nothing else, demonstrates what absolute nonsense modern monetary theory was. The idea that the government can borrow forever with no impact on on interest rates and no adverse consequences. Oh, look at the inflation that we’re dealing with now. That wasn’t the case. What I tell you what I worry about, and I wrote about it in a piece in the Bulletin in your piece for The Wall Street Journal in December.
Howard: As I said, you just never you never go back to zero. Whenever you go back to a Fed balance sheet of eight or 900 billion, because each crisis is cumulative, you borrow more, you spend more and the levels get higher. And what I worry about is we’re very lucky because we live in a great country and everyone wants United States Treasury debt because the dollar is the world’s reserve currency. Foreign central banks keep their foreign read the bulk of their foreign reserves in dollars accrete in the form of Treasury debt. That creates tremendous demand for Treasury debt. But it isn’t. It isn’t infinite. Nothing’s infinite in the world. There are only 8 billion, 8 billion people in the world and, you know, ultimately we may borrow to a point where we can’t borrow anymore. And that concerns me.
Alex: All right. We have a two part second half of the the nothing is infinite is our export. And my part is and nothing is free, right? Whatever you do, you pay a price for.
Howard: And that’s what monetary theory gets completely wrong. There is a cost every time.
Buck: Again, the book is surprised again The COVID crisis and the new market bubble. Are we missing any major themes here that we haven’t addressed on this that might be worthwhile bringing up?
Alex: We’ll just stress one or one of the things that surprised again and surprised again there is is a kind of meta meditation on the nature of uncertainty, particularly in financial markets, and how if you have a dream that there’s going to be some master with a central bank or a government or anybody sitting aside and taking care of you and making sure that nothing goes wrong, that’s a dream and you’ll wake up from because we think and we discuss it in in the book and use the 2020 panic as an example. But they’re the examples come along, as we said, every ten years or so of the of the fundamental uncertainty, that is to say unknowability of the financial future.
Howard: And the book goes on to take number one, examines what happened during the COVID crisis, the tremendous shock to the financial system, the massive government intervention that led to a re inflation of all assets and to the average so-called everything bubble and the inflation we have now. And it talks about, as Alex said, the nature of financial uncertainty in particular, but also takes a look about certain sectors of the of the financial system, the economy, if you will, that are likely to create trouble in the future. And those are those areas are that we look at include money market funds, cryptocurrency, student loan debacle, public pension plans, which are another huge problem. And so we try to do that. We try to look at weaknesses from.
Alex: Those going to mention real estate and housing.
Howard: Real Estate and housing. And finally, just the role of central banks in general. So we think that it not only looks at the past, but it is a good view into the future. And some of the stuff that we said almost, you know, we wrote the book, really finished it almost about a ago, a little more than a year ago. And some of the stuff when I read the editorial pages and I just read one in the journal the other day about will the federal government be bailing out blue states and their underwater public pension plans? And no, you know, we we asked the same question a year ago. So I think we were a little bit prescient. And I think there are plenty of things to worry about.
But the good news is that we have an incredibly strong economy. We live in the greatest country in the world thus far, and it has managed to survive every shock that has been presented to it. And we believe it is likely to continue to do so, although there are grounds to worry about.
Buck: Good stuff and it sounds like you have enough material for the next three books as well, they’re ready. Go. So Alex Pollock and Howard Adler in the book again is surprised again the COVID crisis and the new market bubble available pretty much. Have you guys done an audible book?
Alex: We have not.
Howard: We have not no.
Buck: Got it. So not available on Audible, but you can read the old fashioned way. So. Okay, guys, thanks so much for joining us and we’d love to have you back again in the near future.
Howard: And thank you very much for having us. We really enjoyed the conversation.
Alex: Great to be with you.
Buck: We’ll be right back.