Hoenig: QE2 May Lead to "future instability"

Brian Hicks

Updated November 5, 2010



Since it’s Friday and I have already spilled enough ink on the Fed and QE2, I’ll let Thomas Hoenig’s views on the whole matter speak for themselves.

From the Wall Street Journal by Sudeep Reddy entitled: Fed’s Hoenig on QE2 and Future Instability 

What do you think of the FOMC decision to launch QE2?

I really hope that this works out. I want the economy to improve as much as anyone. I want unemployment to come down as much as anyone. My advantage, I think, is that I have a lot of experience and that experience gives me, in a sense, a longer-term framework and a broader perspective on these issues and I think the consequences of actions. That’s what’s really causing me to take this stand….The consequences, and for some the unintended consequences, is that we can cause greater instability in the future — and I don’t mean in the immediate future. I mean years perhaps, quarters certainly, that can actually make matters more difficult to recover from. So that’s really weighing on me and has influenced my views from the start.

What kinds of bubbles and financial instability do you envision? Where do you see those develop and can’t the Fed deal with those through other tools?

In the period of the ’70s and then the ’80s, where we had negative interest rates for the decade of the ’70s about 40% of the time, we ended up having to take some really dramatic actions at the end. I was involved in the closing of about 350 banks in a region that had experienced the immediate upside — the boom — of energy, of agriculture, of residential real estate and commercial real estate. Those bubbles collapsed. Yes, we dealt with it.  But there are no shortcuts on those and there was a very dear price to pay. And again in the decade of the 2000s we had interest rates negative about 40% of the time, we kept them there lower even as the economy was recovering at first modestly, and we even lowered them as they were recovering. As a result we have a very serious real-estate crisis that we’re suffering from today. So yes, we deal with them but you don’t want to be dealing with them in a crisis mode. I think the mandate is for meeting our long-run potential in terms of production, and to meet our moderate long-term interest rates and to encourage maximum employment, but in the long term. And I think financial instability is counter to that.”

How did the committee get to the $600 billion figure for new asset purchases?

Other people’s estimates are maybe a 20, 25, maybe 30-basis point reduction in long-term interest rates. You get these relative price shifts and you get an increase perhaps in the stock market and these are all desirable goals. But I fear, given our experiences, given that this is forcing interest rates below their long-run equilibrium, it means there will be givebacks. When all these very important decisions were made in 2003 to bring interest rates to 1%, it was because unemployment was 6.5% and thought to be too high. As a consequence of that — not immediately but in time — we now have 9.6% unemployment.

The fact is that if I ask people, professionals, was the consumer in the United States overleveraged? I get almost 100% acknowledgment that the consumer was overleveraged and that they need to rebalance. The fact is, that takes time. … I wish it could be done immediately. But that takes time and the rebalancing takes time. But if we try and short-cut it, we sow the seeds for the next series of problems and we want to avoid that.

What’s the risk of this move looking like the Fed is monetizing the debt?

I think it’s a legitimate risk because we are monetizing the debt, call it whatever you will. It is buying long-term or intermediate-term Treasurys in substantial amounts, that is by any definition monetizing the debt. What the consequences of that are, we can agree on or disagree on. The position would be that it’s temporary and that we would reverse all this. My concern is that if my experience is a reasonable base, then we will be slow to reverse it. And that means leaving it in there longer than — in hindsight — we will think was appropriate, we will create the next series of problems, whatever those are.


Facing mandatory retirement next year, it’s too bad Hoenig won’t be around to help clean this mess up.

Maybe Richard Fisher will still be up to the job.

Have a great weekend.

Related Articles:

Hoenig: QE2 Won’t Work

Hoenig: Let Troubled Banks Fail

Jim Grant on the Fed’s “Mission Creep”

Jim Grant: “The Fed is out of its lane” 

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