Fed President Hoenig: Still Need To Address The Debt Issue

Courtesy of Tom Lindmark at But Then What

Throughout the recession one of the more outspoken members of the Fed has been Thomas Hoenig, the President of the Kansas City Fed. Refreshingly, he continues to speak his mind and not shy from the harder issues that most in government prefer not to address.

In a speech that was given to the Kansas Association of Bankers a month ago but just released today, he had this to say:

The U.S. economy appears to be reviving from a nasty recession, but too little has been done to resolve the underlying problem of too much debt, a Federal Reserve official says.

In a speech given a month ago, but released to the public on Saturday, Kansas City Fed President Thomas Hoenig said massive amounts of public and private debt are putting tremendous pressure on the Fed to keep interest rates low, potentially sowing the seeds of inflation or further economic imbalances.

Hoenig, considered one of the Fed’s leading advocates for low-inflation policies, said the Fed has tried too hard to boost growth in the past by keeping rates low. But low rates only encouraged more debt, and fueled an increase in the money supply that has eroded purchasing power.

Sustainable growth can’t be achieved that way, he said.

The federal government has taken on much more debt in an effort to stimulate the economy, he said. Consumer debt remains bloated. And the biggest banks are still overleveraged by about $5 trillion, he said.

The way out of the swamp will be tricky, he said.

“As we become more confident that we are at the bottom of the recession and are moving into recovery, we must become more resolute in systematically reducing our balance sheet and raising interest rates,” Hoenig told the annual meeting of the Kansas Bankers Association on Aug. 6.

Well, it remains to be seen if there is any resolve to move away from a debt fueled economy towards one that is more grounded in fundamentals. It all sounds good, however, there is no magic wand that can be waved over the economy to cause that to happen. The adjustments he calls for require years to put into place and it’s problematic at best as to whether the public has the patience and will to go through the suffering that would be required.

I think it more likely that we are going to have to evolve towards that model. That probably means a reversion to something like we had before the crash with some of the rough edges smoothed and perhaps a dose or regulation that keeps the pot from reaching a boiling point. Then, assuming you have willing and able politicians, the ship can be turned gently. Lots of ifs in that proposition, aren’t there?

Hoenig also observed that the biggest banks have increased their market share of banking assets from 35% to 70% since 1990. He characterized the big banks as public utilities that were no longer driven by the market and felt that this development threatened the dynamism of the financial sector.

Kind of a curious observation, in my opinion. I have trouble squaring it with his call for a move away from a debt driven economy. Frankly, if we want to move towards an economy that is less reliant on leverage and, therefore, less reliant on financial engineering in general then I should think we would want to see the banks become more tightly controlled utilities. This part of his speech isn’t my cup of tea but it might be that he has a significantly more complex view than he expressed here, so I’ll reserve any criticism.