David Stockman Takes On the Fed's Easy-Money Policies—and the World
Roosevelt House, on East 65th Street on Manhattan’s Upper East Side, is hallowed ground for progressives. FDR and Eleanor Roosevelt lived in the six-story townhouse between 1908 and 1933, before moving to the White House. Roosevelt assembled his Cabinet at the residence, and many of the economic policies that became the New Deal were devised there. Considering that history, it was odd to find a crowd of 100 gathered at Roosevelt House in mid-May to hear a talk by David Stockman—a man who, as Ronald Reagan’s first budget director, embodied the supply-side economic philosophy that’s anathema to New Dealers. Stockman’s book, The Great Deformation: The Corruption of Capitalism in America, had been out for a month. He thanked his hostess for her introduction. “It’s the first time anybody has said anything nice,” he said. He proceeded to list those who’ve denounced his book: “The Republicans, the Democrats, and the Keynesians, and the monetarists, and the supply-siders, and Wall Street, and Bay Street, and the military-industrial complex, and also the neocons and the social-cons and the just-cons. And for those of you who haven’t heard of the just-cons, that’s everybody else in Washington that doesn’t fit the other categories.”
Despite all that scorn—or perhaps because of it—Stockman’s book is a hit. In April it made its debut at No. 4 on the New York Times Best Seller list, and it stayed on the list for a month. Not bad for a 768-page tome that spans eight decades of U.S. economic history. The 66-year-old Stockman appeared on Charlie Rose and The Daily Show With Jon Stewart, declaiming the need to save America’s economy from its addiction to what he calls “monetary heroin,” the U.S. Federal Reserve’s penchant for printing money, keeping interest rates artificially low, and encouraging asset bubbles.
In Stockman’s view, the Federal Reserve has entered unsafe and unknown territory. In nearly doubling its balance sheet to $3.2 trillion in assets since October 2008, the Fed has artificially propped up the prices of fixed-income assets and driven interest rates to absurdly low levels. The Fed’s actions have left investors with little choice but to seek higher yields by mispricing risk. Worse, he argues, all the new money that the Fed has pumped into Wall Street is not getting to Main Street, where theoretically it could be used to help the economy grow; instead, it’s just being pushed around by traders. While Wall Street cashes in, yet another new, dangerous financial bubble is being inflated—all of which has left the U.S. economy at risk of another 2008-style meltdown. Only this time, Stockman wrote in the New York Times on March 30, “there will be no new round of bailouts like the ones the banks got in 2008. Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.”
Stockman’s doomsdaying was ridiculed by Paul Krugman, who denounced his Times guest column as “sad” and “cranky old man stuff.” Jared Bernstein, a former top economic adviser in the Obama White House, condemned Stockman’s “dystopic, Hunger Games vision of America … it’s like hearing a crazy person on a street corner.” Stockman has also alienated his traditional allies on Wall Street, who love the Fed’s policies. And in a May interview with me at his apartment in Midtown Manhattan—Stockman and his wife, Jennifer, recently moved there from Greenwich, Conn.—he castigated several prominent Republicans, including members of George W. Bush’s administration, in bracingly candid terms.
Stockman’s odyssey from the face of the Reagan Revolution to scourge of the economic establishment involves, as he describes it, a “road to Damascus” conversion, brought on by a disastrous deal that caused his own Wall Street career to unravel. In proselytizing about the unforeseen dangers of too much risk and too much debt, he speaks from experience.
Stockman was raised in a brick farmhouse in western Michigan built by his grandfather, who was the county treasurer for more than 20 years. It was he who got Stockman interested in public service and entrepreneurial capitalism. “We had a little of everything,” Stockman told journalist William Greider more than 30 years ago, “an acre of strawberries, an acre of peaches, a field of corn, 15 cows. We did everything.” Stockman attended Harvard Divinity School before entering politics. He represented his home district in Congress for four years before Reagan plucked him from obscurity at age 34 to be his director of the Office of Management and Budget. Stockman’s mission was to somehow figure out how to raise the defense budget, cut income taxes, and balance the budget, all at the same time.
To pull it off, he converted to the then-trendy idea of supply-side economics. According to the theory, cutting income taxes would spur overall economic growth by encouraging individuals to spend the money they were no longer paying in taxes, which would in turn spur businesses to hire more people and build plants and invest in equipment to increase the supply of goods and services to meet demand for them. The virtuous circle of rising employment and income would send newfound revenue to the Treasury, allowing for budget deficits to be reduced while defense spending increased.
The theory failed in practice. The economy went into a recession that lasted from July 1981 to November 1982, and the deficit ballooned. Stockman spent much of 1981 sharing his frustrations with Greider. He knew that, “down the road,” Greider would turn his musings into a piece of journalism; he just didn’t realize it would happen so soon. Greider’s 17,000-word Atlantic article, “The Education of David Stockman,” appeared in December 1981 and revealed Stockman to be angst-ridden about the task Reagan had handed him. “None of us really understands what’s going on with all these numbers,” he told Greider. A few days after the article was published, Lesley Stahl, then the White House correspondent for CBS News, picked out a few of the more colorful passages and broadcast them on the evening news. “When CBS News turned it into a flaming repudiation of Reaganomics, everything changed,” Stockman recalls.
The article divided the White House. James Baker, chief of staff, and Richard Darman, an assistant to the president, defended Stockman. But, Stockman says, the “California Mafia” around Reagan—Michael Deaver, deputy chief of staff, and Edwin Meese, counselor to the president—wanted his head. Baker eventually called Stockman around 11 one morning and said, “You’re going to have lunch today with the president. Get your sorry ass over there at 12:30, and you better have a pretty good story.”
He and Reagan dined alone in the Oval Office. Stockman told the president the whole thing was a bit of a misunderstanding. “You know,” Reagan told him, “that reminds me of when I was president of the Actor’s Guild. I was having what I thought was an off-the-record meeting, and there was a journalist in the room, and the next day he betrayed me, and I had problems indefinitely, and it just shows you can never trust journalists.” After lunch, Stockman met with reporters and coined one of the most memorable phrases in recent political history: Reagan, he said, had taken him “to the woodshed.”
Stockman says his famous line deliberately created the false impression that Reagan had berated him. “I actually pulled that metaphor out of my upbringing, and it just had a powerful effect,” he recalls. “I went out and had a press conference and said I’d been taken to the woodshed, which was not exactly what happened. This metaphor is still in circulation, the woodshed metaphor, and it’s utter fabrication. But that’s how spin control works.”
Stockman continued to slog it out for the next four years as budget director. After Reagan won reelection, Stockman did what so many self-respecting high government officials do: He went to Wall Street to make money—and regain a measure of anonymity. In his words, he became the “highest-paid intern” at Salomon Brothers, where he learned firsthand how much money smart traders can make in the bond market betting on the Fed’s telegraphing of interest rates. He then learned how to give advice on mergers and acquisitions. He left Salomon in 1988 to join the Blackstone Group after his friend Peter Peterson invited him into the partnership.
He became a deal junkie, flying around the country constructing buyouts using the various tricks of modern finance to buy companies, load them up with debt, and then make a fortune with the help of a tax code that favors the use of debt over equity. “I was totally caught up in the bubble,” he says. In 2001 he left Blackstone to strike out on his own, with a few partners and more than $1 billion to spend. He created Heartland Industrial Partners and started buying manufacturing companies. He was more than content to leave policy to others. “I was totally disillusioned, and I thought it was pointless and that the Republican Party was a coalition of hypocrites,” he says. “As a young idealist, I was burned out and disillusioned, so I had no reason to involve myself.”
It was at Heartland, in January 2001, that Stockman decided to invest $260 million in Collins & Aikman, an auto parts manufacturer, in exchange for approximately a 60 percent stake in the company, a portion of which was bought from Blackstone, his former firm. In May 2005, Collins & Aikman went bankrupt. In March 2007, Stockman was indicted in federal court for essentially failing to prevent the company’s bankruptcy filing and for “defrauding” investors of more than $1 billion. “When you’re in the business of running a laundry, you’re cleaning shirts,” he explains of getting caught up in the leveraged buyout craze. “If you’re in the business of investing private equity, you create leveraged companies. And finally, when one of mine blew up, I realized it was like a wake-up call.”
Stockman fought hard to clear his name. “The prospect of the gallows concentrates the mind, and my mind got heavily concentrated,” he says now. He accused Helen Cantwell, the case’s lead prosecutor in the Southern District of New York, of not understanding bank covenants, accounting, and business operations. “It’s amateur hour,” he told the New York Times in April 2007. “How can you end up losing $13 million of your own money and $350 million of your fund’s and still end up with 30 years in jail?” He investigated what happened at the company, including during his two-year tenure as chief executive officer, and wrote a 200-page white paper, with some 800 footnotes and 43 volumes of supporting documents, laying out “chapter and verse of everything that happened at Collins & Aikman.” His thesis was persuasive. In January 2009, Lev Dassin, the acting U.S. Attorney in the Southern District, dropped the case against him. A year later, Stockman paid $7.2 million to settle a civil suit with the Securities and Exchange Commission.
The experience had taught him the danger of leverage. “Financial engineering is a hugely risky thing, and as long as the sky is blue and everything is moving forward, you can manage the debt, kick the can down the road, pay the interest, and refinance,” he explains. “But if unexpected shocks occur or cycles happen or industries change—you can pick all the things that happen in capitalism—if any of those adverse events come, it sets in motion a process of asset liquidation and company destruction.”
With his legal troubles behind him, Stockman turned his attention to trying to explain the 2008 financial crisis. He quickly concluded that Washington deserved much of the blame. The bailout of one financial company after another, he believes, eviscerated the principles of free-market capitalism. “I just saw the nonsense being spoken every day by Hank Paulson and the White House, and the excuse-making,” he says. He set out to write a simple “rejoinder” to the bailouts, just another of the occasional opinion pieces he’s published in the Times over the years. “I knew half of the stuff they were saying was just seat-of-the-pants, short-term talking points that hadn’t been researched, hadn’t been documented,” he says. “It was easily disputable, if not refutable.” But as he began his research, it dawned on him that the crisis “didn’t just happen out of the blue because a couple of people panicked. … It had been rooted in years and years, and incremental policy steps toward the brink.”
That bit of logic took him back to former Fed Chairman Alan Greenspan’s decision to organize a bailout of the hedge fund Long-Term Capital Management, in 1998, and to Greenspan’s move to dramatically lower short-term interest rates after the dot-com bubble exploded in March 2000. Stockman said George W. Bush’s presidency was “the fruition of the hypocritical Republican opposition that I had banged heads with time after time in the early 1980s: They didn’t really believe in markets when it was inconvenient. They really weren’t fiscal conservatives.”
Stockman says Paulson and Ben Bernanke overreacted to the collapse of Lehman Brothers. He calls it the “BlackBerry Panic.” He recalls “a helluva crisis in the bond markets” in the late 1970s and early ’80s when short-term interest rates were close to 17 percent. “There was a palpable danger in the markets then,” he says. As interest rates rose, investors who were long on fixed-income securities got hammered. “Nevertheless,” he continues, “there was not any focus in the White House on the equivalent of BlackBerrys in those days.” The policymakers in the Reagan White House, he insists, didn’t obsess about the vicissitudes of the markets and attempted instead to “make policy based on criteria that had some longer-term view to it, and some kind of national perspective.”
That discipline was lost during the weekly panics of 2008, he says. “The panic started on the third floor of the Treasury, with Paulson and all of these younger Goldmanites running around, who had no clue what public policy in America is about. They had been trained in the M&A world of Wall Street, which is a new deal, a new set of facts every day, and that’s what the world is about, and you grapple with it day by day.”
Paulson, Stockman says, was “temperamentally unqualified” to be Treasury Secretary. Through a spokesperson, Paulson declined to comment for this article. “The guy was an emotional train wreck,” Stockman says, aided and abetted by Bernanke, whom Stockman calls “a totally fake scholar of the Great Depression. I’ll just say that flat out. He didn’t do any original work. He just Xeroxed Milton Friedman’s theory.” Stockman is no fan of the Fed chairman, to say the least. He believes the main tenet of Bernanke’s philosophy—that the Fed exacerbated the Great Depression by starving the system of capital—is bunk. “The Fed had nothing to do with causing the collapse in ’30, ’31, and ’32,” he says. “Nothing. But that’s what he believed, and so all of a sudden you have this, in my judgment, coincidence of a phony scholar of the Great Depression being accepted as one because he said he was one. I mean, what do these Washington people know? Has anybody ever read his work? … What I’m saying is, no other Fed chairman would have said ‘Great Depression 2.0 is around the corner,’ and when Bernanke said that, it just panicked the whole Washington system. The panic that led to these kinds of meetings, like that Thursday night meeting with all the congressional leadership, where they basically scared the living daylights out of them.” The Federal Reserve did not respond to a request for comment.
The fear quickly spread to traders and to the 24-hour cable networks, which couldn’t get enough of the story. Stockman says, “Paulson and Bernanke need to be held responsible for grotesque exaggeration of the consequences” had Congress failed to approve the $700 billion Troubled Asset Relief Program after voting it down the first time and watching the Dow Jones industrial average fall around 700 points in response. “That was the black day in American history, as far as I’m concerned,” he says, “because once they were panicked into writing this $700 billion check, I think that was the end of any kind of hope for fiscal discipline.”
That the financial system survived and the economy has recovered, albeit slowly, hasn’t altered Stockman’s disdain for Washington policymakers. He says Bernanke’s program of “Quantitative Easing” has forced interest rates to rock-bottom levels and encouraged investors to seek higher yields by taking more and more risk, placing the global economy on the precipice of a new financial calamity. He’s astounded that not even five years after the financial crisis, Bernanke has doubled down on Greenspan’s policy of flooding the market with cheap money and that once again traders and investors have forgotten how to measure the cost of risk. “It’s herded the buffalo right toward the cliff,” he says.
Krugman, for one, says Stockman’s analysis and history couldn’t be further off base. A few weeks after their initial squabble, Krugman struck again in the New York Review of Books, where he reviewed three books about the economy, including Stockman’s. Krugman dismissed The Great Deformation in a single paragraph. “It’s an immensely long rant against excesses of various kinds, all of which, in Stockman’s vision, have culminated in our present crisis,” he wrote. “History, to Stockman’s eyes, is a series of ‘sprees’: a ‘spree of unsustainable borrowing,’ a ‘spree of interest rate repression,’ a ‘spree of destructive financial engineering,’ and, again and again, a ‘money-printing spree.’ ” In Stockman’s dyspeptic worldview, “any policies aimed at alleviating the current slump will just make things worse.”
Yet it’s Stockman, not Krugman, who seems to have made the right call that the Fed’s creative monetary policies have led to an unsustainable bubble. In the weeks after our conversation, bond and stock markets the world over started to crack, with bond prices falling precipitously and the Dow Jones industrial average falling below 15,000 for the first time in two months. On June 19, after Bernanke suggested publicly the possibility that Quantitative Easing might end next year, the stock market fell nearly 550 points during the next nine hours of trading.
Stockman says it’s too soon to tell if 2008 will repeat itself. “We don’t know because this is uncharted territory,” he says. “Just draw a line on 100 years of history and show zero money-market rates for six years. You will find nothing remotely similar, not even during the Great Depression, actually. And then you have to ask, ‘Where is this leading?’ The answer is, ‘Who knows?’ Because it is so unorthodox, it is in such complete repudiation of what mankind has learned through many decades and centuries.” Stockman doesn’t know how the era of cheap money will end. But he’s betting it won’t end well.