This week’s Washington Post column is out, and its a look at what led the Fed to its current situation. Pretty much out of bullets, and out of options.

The online version is titled How the Federal Reserve boxed itself in, but I like the print version’s headline better: How the Fed boxed itself — and you

Here’s an excerpt:

“This unprecedented Fed intervention unleashed a series of unfortunate events: Bond managers scrambled for yield, ultimately finding AAA-rated mortgage-backed junk products. The dollar plummeted 41 percent over the next 7 years. Anything priced in dollars — oil, gold, foodstuffs — skyrocketed, sending inflation screaming higher. Housing took off, loan standards collapsed, credit quality suffered.

Of course, there were other factors: Radical deregulation, globalization, labor restructuring, flat income, the rise of Asia and more. But it’s hard to imagine the rest of the 2000s as the debacle it became without this initial Fed overreaction.

Indeed, we can only imagine what the 1990s and early 2000s would have been like had the FOMC been more Volcker and less Greenspan. Former Fed chair Paul A. Volcker was a no-nonsense central banker who believed that the Fed’s job was to fight inflation. Whatever happened in the stock market was none of his concern. If you bought Russian bonds and they defaulted, you were supposed to lose your money. Bought into a bad hedge fund that blew up? You took the hit! The dot-com collapse should have led to a flushing out recession and market crash that took a few years to recover from. Not, as was the case, an attempt to offer a salve to leveraged traders who were caught leaning the wrong way when the tide went out.

What we got instead was the Greenspan Fed. The ills caused by cheap money and excess liquidity were apparently to be solved by even cheaper money and more liquidity.

Many of the subsequent problems of the U.S. economy derive from those decisions from a decade or more ago. They have been compounded by a variety of other bad calls; it’s not all the Fed’s fault. But much of what ails us traces back to the Greenspan Fed.”

Regular readers of TBP or Bailout Nation will recognize many of the idea in the column…


click for ginormous dead tree print page image


How the Federal Reserve boxed itself in
Barry Ritholtz
Washington Post, August 14, 2011 page G6

Dead tree version PDF

click for ginormous page image

Category: Bailouts, Federal Reserve, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

22 Responses to “How the Fed boxed itself — and you — in”

  1. ilsm says:

    Thank You!

  2. eliz says:

    Nice concise summary.

    Unfortunately, it is still “news” to most people, while some of us have understood this for years. The morphing of the focus of The Fed and the Federal Government from the real economy to what David Korten labeled the phantom economy (the phantom financial economy) is at the heart of our situation, and you’ve nailed its origins to the Greenspan Fed.

    It is time to end the destructive and obsessive focus on the financial markets – a.k.a. Vegas East.

    It is time for us to find leaders who truly care about the real economy and “the small people.”

  3. dead hobo says:

    Your conclusion that the Fed will run out of bullets in two more years of low rates is incorrect.

    The Fed has gone Japanese and has morphed from a central bank, into creator of asset inflation, into a praying spinner of plates on sticks, and, after two more years, into sideshow that will, occasionally, prop up equities for trickle down purposes. You assume there no be another QE3. Pray tell, what patterns have you seen to date that would preclude such a thing? You are applying you common sense and anthropomorphizing it against a serial asset inflater. Why on Earth do you think the Fed will not mistake price recovery with deflation and go on another bout of asset purchases? What evidence do you have to support this? When have they not practiced asset inflation as their preferred method of curing all that ails?

    Personally, I’m waiting for another reverse head and shoulders pattern to appear. The only pattern I’ve seen to date is the Fed either hinting at or announcing an asset buying program just as the right neckline is being built. Why should this be different? Is price recovery, aka deflation, not going on as I write this? Cha ching, baby.

    BR, sometimes you are just too trusting in govt.

  4. zcwotun says:

    yes, thank you for educating the hoi-polloi “intelligensia” about Greenspan’s impact. Sadly he’ll never stop being the go-to “expert” for the Sunday morning talk show circuit.

    For all you history buffs…..archival footage/some backstory of Alan Greenspan c. 1960-1970 when he was an Ayn Rand groupie courtesy of Adam Curtis BBC’s documentary, “Machines of Love and Grace.”


  5. FS says:

    Your analysis is correct but I think Greenspan’s options were more limited than Volcker’s because so much more of America (through a variety of avenues) is more invested in the stock market. It’s not just the individual investor, but pensions, university endowments, 401k’s. The market has in some ways become more important now. In 1987, the market crashed and main street basically yawned, the market was able to come back.

    If the market crashes and stays down, the effects would be much broader.

  6. louis says:

    They really have been invaluable to our success the last decade.

  7. Chief Tomahawk says:

    Too bad Ron Paul didn’t win Iowa yesterday. He’s got a bit of a problem with the Fed.

  8. Winston Munn says:

    In re-reading Bernanke’s 2002 deflation speech, it became apparent that Bernanke considers economic actors as an unchanging numerical value who will respond to his machinations in equation-like fashion. I think this is a serious error in judgment.

    The insolvent and fearful-of-insolvency cannot be forced to borrow. Expansionary monetary policy in such a debt-adverse atomosphere only creates the potential for isolated inflation, not a general increase.

    If one hopes to encourage increased consumption, it only makes sense to expand the consumption ability of those who consume 100% of their wages. i.e,. the lower 50%. This is why Keynes recognized the need for a progressive tax structure that limited the burden on the poor and near-poor, as the wealthier do not increase their consumption with excess government lagesse but instead increase their savings. This excess savings of the wealthy will not represent job creation without an increase in demand.

    It is increased demand that then spurs capital to invest in expansion which then leads to higher employemnt and higher employment then leads to still higher demand. Demand is increased by increasing the income of those who save the least and consume the most – the lower and middle classes.

    Since 1980 or thereabouts, the U.S. has been trying without success to push the cart with the nose of the horse. There can be no sustained recovery without a structural reorganization of money flows.

  9. KJ Foehr says:

    IMO, the issue is much larger than just the Fed boxing itself in. Capitalism itself has boxed us in. Due to free-market, supply side economics becoming a religion beyond question in the USA over the past 3 decades, we have created a detrimental imbalance in our economy,

    1. excess domestic and global capacity,
    2. the propensity of our newly anointed, divine job creators to create jobs in China and India rather than at home,
    3. a concentration of wealth at the top that leaves more and more consumers unable to increase consumption,
    4. an unwillingness to make currently zombified banks face reality by writing-down debt and realizing losses that would free-up capacity for new lending,
    5. and voila, aggregate final demand is insufficient to fully utilize the economy’s current output capacity, and thus corporations have no reason to spend its hordes of cash to hire people or invest it to increase capacity / supply of good and services.

    The Fed will never run out of bullets / tools as long as it has the power to create money. The question is how effective can those tools be? QE3 in some form is almost a certainty and will probably be announced at Jackson Hole on Aug 26th.

    As for new bullets / tools, what is to prevent the Fed from buying corporate equities via diversified ETFs? Or State or municipal bonds to ameliorate the fiscal crisis some state and local governments will continue to face in the coming months? The number of tools available is limited only by the Fed’s creativity.

    The problem is the Fed can inject liquidity, but it cannot directly stimulate final demand, which is what is lacking due to the imbalance of the capitalist economic system described above. That is where fiscal stimulus needs to step in to help spur final demand by people directly. However, this appears highly unlikely going forward given the rise of ill-informed anti-government sentiment and the maniacal fear of government debt that has gripped those unable or unwilling to critically analyze and understand our current economic and fiscal situation.

    Bottom line? The Fed has tools, but they are geared to fix the wrong problem. The Fed’s primary tool, interest rates, works quite effectively to reduce inflation / cool an overheated economy by increasing borrowing costs, and then lowering rates again to re-stimulate already existing demand. But this tool is largely ineffective when that demand has been diminished by the reasons already cited above.

    As a result, I see dark days ahead unless and until free-market economics and libertarian, far right conservatism is implemented fully and found not only ineffective in helping us now, but understood to have been the cause our current economic problems. Only then we will able to move forward in a rebirth of wise, rational thinking.

  10. You gonna Fed Ex that box?

    I doubt it would clear customs. They have a thing about shipping hazardous goods. I suppose we could call them moral hazardous goods and ship them to China. That might be considered an act of war

  11. wally says:

    It seems to me that economic recovery (for the US) and high commodity prices are at a standoff. We can begin a recovery is commodities get cheap; we can’t if they don’t.
    It also seems obvious that the Fed’s QE programs have increased commodity prices, perhaps because they have increased liquidity for only certain a economic strata.
    If so, the Fed’s actions may have helped the financial industry… but may be prolonging the recession.

  12. herewegoagain says:

    …and thank you zewotun.

    For more than a decade now, that Ayn Rand worshipping buffoon’s status as “the maestro” has been incomprehensible to me.

  13. “…the Fed’s actions may have helped the financial industry… but may be prolonging the recession…”

    may have? may be? wally, generously, that’s, overly, generous..

    “the Fed’s actions have helped the financial industry…and, is prolonging the recession.”

    again, wally, you haven’t been following the ‘bouncing ball’ — above, is, and, has been, the Goal, all along..

  14. @wally,

    I thought you were arguing for more borrowing? What exactly did you think more printing/borrowing was going to do to those who can’t qualify for those new loans and yet need to compete with those who can and spend the borrowed dollars they get?

  15. JB7456 says:

    The Fed doesn’t matter. If ya wanna goose the economy start a war…guns n butter. It’s academic. U.S. sabre rattling with Syria, Iran WILL get involved, and Mr. Netn Yahoo in Israel will want to send some big fireworks to Iran in what will be known as the Shah Shank Redemption. That way we’ll have pundits telling us how to think about the conflict instead of telling us why we should despise each other.

    Register Independent and for the next 2 elections vote every incumbent out. Our only weapon is the vote and they have figured out how to make us give it to them. Pass it on.

  16. wally says:

    “I thought you were arguing for more borrowing? ”

    Huge difference between monetary policy and fiscal stimulus policy. They differ in who they help and what they do.
    Without a growing economy we will never have the revenues to begin to pay down debt, no matter what you cut – you’ll face diminishing returns.
    However, Fed policy does not provide fiscal stimulus. In fact, as I said above, it does the reverse… it increases wealth disparity (moves money from the spending class over to a hoarding and speculating class). It does that by several means, but the increased commodity prices are an obvious one.

  17. machinehead says:

    ‘How the Common Man Sees It’ is onto something.

    The best way to quell the Chinese challenge is to send Greenspan to Beijing to ‘advise’ them. If that fails to crash the Chinese economy, send Bernanke to assist.

    Problem solved!

  18. Machiavelli999 says:

    It’s amazing. I don’t think there is a single institution more misunderstood than the Fed. What’s scary is not that common man doesn’t understand the Fed. I don’t expect him too. What’s amazing is that our so called financial elite (guys like Ritholz) have no understanding of the Fed either.

    It’s like we have taken 100 years of Irving Fischer, Friedman & Keyenes knowledge, wiped our ass with it, crumpled it up, spit on it and flushed it down the toilet. We have moved into an area we no longer rely on economic knowledge but instead where people like ‘wally’ above me come up with economic theories on the fly and are treated with just as much respect (if not more) than tested papers and theories in economic journals.

    It’s sad because this is the case on both the right & the left just don’t get it. And yet, it shouldn’t really be that hard to understand. The Fed is managing our monetary supply whether we like it or not. Since, it’s doing it we better hope it does a good job. Experience and history has proven that a low positive inflation target fosters economic growth. Yet, from TIPS spreads we can see that inflation expectations are far lower than what is necessary for recovery and to even meet the Fed’s mandate. And yet despite that, we worry that the Fed is doing too much while in fact it’s doing nothing.

  19. DeDude says:


    Yes they are managing our monetary supply but with a dual mandate of doing so to optimize both inflation and employment. It may have been that in the past, focusing and success on the first, would automatically take care of creating the economic growth that fixed the second mandate. But the current situation clearly do not allow the Fed to create more inflation without hurting employment and the economy. The main result of the last round of QE was to increase gas and food prices and hurt the consumer class and the economy. That is the problem with reading so many books that you have no time to look out the window. Every time is different and you have to figure out what the exact differences are, and how they may change some of the correlations and causations that previously could be counted on. That is the difference between knowledge and insight.

  20. grcvegas says:

    “sending inflation screaming higher….”

    Major fail right there Barry, I didn’t bother reading the rest of your post .

    inflation has trended downward since 1980, and actually went negative in 2009. That spot of deflation, coupled with continuing sluggish real monetary growth, is 80% the cause of our recent problems.

    You once wrote that only a handful of people in the world understand the implications of QE3. But I’m not surprised you count yourself among them….

  21. rahraw says:

    Barry, what is the relationship between Bernanke’s theory of a global savings glut and Fed monetary policy over the last ten years?

    Big fan-thanks!