Devin Leonard and Peter Coy talk to the former Fed chairman about Fed-speak, Ayn Rand, and why he quit playing the sax. And then there’s his legacy …
Before you were a professional monetary policy person, you were a professional saxophonist. What are the similarities between the two professions?
The only thing that was economic, I might say, about my music career, aside from the fact that I did everybody’s tax returns in the band, was the decision I made to leave the music business on economic grounds. I essentially concluded that having seen what some of the really good people could do, and fundamentally recognizing that it’s not an issue of studying and you’ll learn, there are certain inherent qualities that you’re born with, and if you don’t have them, you’ll never achieve certain levels. Mozart had it when he was 4. I never had it, period. I was a fairly good amateur musician, and I was an average professional. But the one thing I saw was that the big band business was fading. So I made an economic decision, and it turned out the best judgment I ever made in my life.
The Henry Jerome Orchestra was an early proponent of bebop. At the time, did you see yourself as part of a revolution that would affect the whole world musically?
Revolutions are something you see only in retrospect. I was aware we were doing things that were novel. The reed section sat in front of the trumpets and the trombones. I was acutely aware that I was hearing something different from the brass. That’s where the bebop was coming from. But we weren’t the only ones doing it. I mean, Dizzy Gillespie sat in with the band.
You met Ayn Rand almost by happenstance through your first wife. What would your life have been like if you hadn’t met her?
I would probably have stressed mathematical economics and model building more than trying, as I am today, to figure out how cultural issues affect economic policy and especially how fear, euphoria, and herd behavior significantly affect modern economies. Such issues I trace back to my relationship with Ayn Rand.
But there’s a question she asked you that you said changed your whole way of looking at everything.
That is a fact. It did. Before I met Ayn Rand, I was a logical positivist, and accordingly, I didn’t believe in absolutes, moral or otherwise. If I couldn’t prove a proposition with facts and figures, it was without merit. In the midst of a conversation, she said to me, “Do I understand the thrust of your position? You are not certain you exist?” I hesitated a moment, and I said, “I can’t be sure.” And she then said to me, “And who, by chance, is answering that question?” With that little exchange, she undermined the philosophical structure I had built for myself. The contradiction was too glaring and opened me up to listen to the rest of what she had to say. We remained close until she passed away in 1982.
Years later, when your present wife, Andrea Mitchell, first visited your apartment, you read her an article you wrote about monopolies for Ayn Rand. Why that article? And did it fuel your romance?
We had been discussing monopolies at dinner, and I was trying to keep her engaged. So I invited her back to my apartment to read an article I wrote in the mid-1960s. I was raising serious questions about the whole basis of the Sherman Antitrust Act of 1890, and I actually went through considerable detail as to what I thought was wrong about it. Nothing I’ve seen in reality has changed it. I’m not denying that monopolies are terrible things, but I am denying that it is readily easy to resolve them through legislation of that nature. But we were in conversation of some form or another which related to this. So I was terribly curious to see how she’d respond. I’ve frankly forgotten how she responded.
Couldn’t have been too bad.
No, I grant you that. It worked out extraordinarily well. We’ve had the most wonderful marriage. It gets better every year. We’re still very much together in love.
When you were Fed chairman, people talked about your inscrutability. You talk in your book about practicing the art of constructive ambiguity. What does that mean?
As Fed chairman, every time I expressed a view, I added or subtracted 10 basis points from the credit market. That was not helpful. But I nonetheless had to testify before Congress. On questions that were too market-sensitive to answer, “no comment” was indeed an answer. And so you construct what we used to call Fed-speak. I would hypothetically think of a little plate in front of my eyes, which was the Washington Post, the following morning’s headline, and I would catch myself in the middle of a sentence. Then, instead of just stopping, I would continue on resolving the sentence in some obscure way which made it incomprehensible. But nobody was quite sure I wasn’t saying something profound when I wasn’t. And that became the so-called Fed-speak which I became an expert on over the years. It’s a self-protection mechanism … when you’re in an environment where people are shooting questions at you, and you’ve got to be very careful about the nuances of what you’re going to say and what you don’t say.
Is there anything you learned during the recent financial crisis that shook you, like that question that Ayn Rand asked you years ago, and changed the way you looked at things?
Yes, of course. I was on George Stephanopoulos’s Sunday morning show on Sept. 14, 2008, and he asked me, “Six months ago you were saying that the probability of a recession was greater than 50/50. Do you still believe that?” My answer wasn’t that forthcoming. The fact that question would be asked tells you …
Tells you what?
That one day before Lehman Brothers crashes, conventional wisdom was not even certain that we would fall into a recession. In fact, we learned many months later that the downward trend had actually started. How could we have possibly got it so wrong? I mean, I actually was saying, “Yes, recession is coming, Not that we’re here yet.” We didn’t know that it had already hit.
It had actually begun in December 2007.
That’s what the National Bureau of Economic Research said. But they said it many months later. It wasn’t obvious at that time.
Is it humbling?
You’ve defended your record and explained your policies over and over again. Four years later, some still blame you for the financial crisis. Are you worried that’s what you’ll be remembered for?
I’m too busy. Let other people worry about that. It does, however, tell me something which I found disturbing. My basic purpose was not self-defense, although there was undoubtedly some of that involved. I was defending Federal Reserve policy. From my perspective, there were two strains of this criticism. One is that we left the federal funds rate too low in 2003, and secondly, on the regulatory side, we at the Fed did not respond appropriately and allowed underwriting standards on subprime mortgages to collapse. When I testified before the Financial Crisis Inquiry Commission, they brought up the Homeowners Protection Act [which gives the Federal Reserve broad powers] to prevent mortgage fraud. I laid out step by step what we had done to address the issues raised by members of Congress. But when the commission’s report came out, the evidence I presented was utterly disregarded. It’s sad. I had similar experiences when I tried to explain the Fed’s monetary policy from 2002 to 2005.
You did spend a lot of time making your case, though.
That’s basically because I seriously believed that I could make a difference. I was mistaken.
You also told the commission that you were right 70 percent of the time and wrong 30 percent of the time. What were you wrong on?
Forecasting the next week’s stock market change. I’ve been in the forecasting business for more than half a century. If I get it right 70 percent of the time, I consider that very successful. People don’t realize that we cannot forecast the future. What we can do is have probabilities of what causes what, but that’s as far as we go. And I’ve had a very successful career as a forecaster, starting in 1948 forward. The number of mistakes I have made are just awesome. There is no number large enough to account for that. But I’m right more than half the time.
Some people said you were giving yourself a C-minus, but maybe in the business of predictions, a C-minus is better than it sounds?
Forecasting our futures is built into our psyches because we will soon have to manage that future. We have no choice. No matter how often we fail, we can never stop trying. The ancient Greeks had the Oracle of Delphi, who allegedly had the capability of seeing into the future, and military leaders used to go to her. And then there’s Nostradamus, two millennia later, who had very much the same aura. Fortunetellers and stockpickers today make a reasonably good living. Physical scientists can forecast with some precession. But in economics, we are extraordinarily fortunate that we succeed a majority of the time.
What concerns you most about the economy in 2012?
So you still see Greece leaving the euro zone?
I just do not see how it can stay.
In the U.S., why hasn’t the recovery been stronger?
You have to ask what’s causing the problem. It turns out that almost all of the stagnation occurs as a consequence of declining investment in long-term assets like homes and factories.
You mean that they’re not being replaced?
The demand for buildings has gone down by almost half. We are essentially operating two different economies in the United States. One produces short-term assets like food, equipment, and software and typically accounts for about nine-tenths of the GDP. And that’s been doing tolerably well. Not great. By itself, that level of activity, if we could measure it, is operating at the equivalent of approximately a 6 percent rate of unemployment. The other tenth of the GDP is comprised of assets with a life expectancy of more than 20 years, mainly buildings. That segment of the economy has been cut almost in half. That’s a reduction of 4 percentage points in overall economic output and a comparable rise in the unemployment rate.
What do you think of this administration’s policies to address this?
Well, it’s not the present administration, it’s the current view of most policy-oriented economists. And here, regrettably, I am in the minority. The notion that if there is an economic problem, the government is obligated to address it, necessarily creates uncertainty about the future. And there’s hard research that shows such activism is responsible in part for the very heavy discounting of earnings on longer-lived business investments, and by households that had dramatically shifted from owner occupancy to short-lived rentals in the face of the uncertainty of the direction of home prices. We need to replace such activism with a policy that allows the markets to correct their own imbalances. Remember the Resolution Trust Corporation in the early ’90s? I was on the oversight board of the RTC. It got stuck with the job of liquidating more than 700 failed savings and loans. Some of the stuff that the RTC wound up with was perfectly liquid and saleable. But a big chunk was uncompleted eight-hole golf courses, half-built office towers, and vacant malls. Nobody wanted it. We all sat around and said, “This stuff is deteriorating very rapidly, and if we don’t get rid of it, the taxpayers are going to take a huge hit.” I mean, the numbers were very, very large. Somebody suggested, “Let’s package it and sell it.” And we did. Needless to say, the bids were less than 50 percent of the original cost. Congress was outraged. We were giving away taxpayer-owned assets to greedy vulture funds.
They wanted in on that action.
Indeed, that’s what happened. Hitting whatever bids were available in this stagnant market defined the low point on prices. Then something happened.
Real estate prices went up again?
Yes. Investors cleared out our illiquid inventory in a matter of months. The final cost to the taxpayers for the savings and loan crisis amounted to $87 billion, a fraction of the original estimate. Allowing the markets to liquidate worked.
You didn’t support the stimulus?
No, I did not. It was unnecessary. I argue in a book I am writing that the stock market recovery in early 2009 created an equity stimulus that, as best as I can remember, had a far larger impact on economic activity than [the stimulus act] without incurring increased public debt.
What concerns you more now, weak growth or inflation?
How do you see monetary policy evolving in the next year?
I’ve stayed away from discussing that issue since I left the Fed. It’s a very tough environment. The Fed’s a terrific institution, and I spent 18½ years of my life sitting around that place, and that and the Supreme Court are as close as you can get to what the ideal ought to be.
You talked about the uncertainty and the RTC model of liquidation. Super low interest rates can actually slow the process of liquidation, because the cost of carrying debt is so low. That was one of the things you were criticized for by some economists. What’s the difference between then and now, two different periods where we had exceptionally low interest rates?
Well, first of all, the reason why we moved the funds rate down in June 2003 to 1 percent was that we were seeing much of the same deflationary forces that we’re seeing today. Not that the probability of deflation was greater than 50/50. In fact, our forecast was that it wasn’t likely to happen.
Risk of deflation?
It was risk of deflation, which, though relatively small, was a major threat to the economy were it to occur. We were taking out some insurance. It turned out, as we expected, that it was paying fire insurance premiums, and the house didn’t burn down. But the more important issue is that the short-term 1 percent rate did not get reflected anywhere else. It didn’t affect long-term bonds. That’s why I have argued the low fed funds rate didn’t cause the financial crisis, which, as I have noted before, was the result of a global savings glut. Nobody lends money to develop an office building using the overnight federal funds rate.
It feels like we’ve been here before: back in an extremely low-rate environment. Circumstances are much more extreme, and the economy’s in arguably much worse condition than it was in your tenure. Would you agree that things are worse now?
Oh, yes. Of course.
Would you agree we’re in a liquidity trap now?
I can’t discuss that. I could, but I’m not.
I mean, there are limits to how far monetary policy can work in a case like this, right?
I’ll put it this way: Ben Bernanke has a far more difficult job than I had. He’s a very competent, experienced economist.
Do you ever talk to him?
Of course. We are both fluent in Fed-speak.