Within the Federal Reserve, there is one very powerful voice of dissent
Thomas M. Hoenig, dressed in a gray suit, white shirt with French cuffs, and baby-blue tie, faces an edgy crowd of 150 people in a hotel meeting room in suburban Lenexa, Kan. A large "Kansas City Tea Party" banner covers a table at the door. Attendees wear anti-tax stickers on their lapels. This is not an after-dinner speech for which most central bankers would volunteer.
Hoenig heads the Federal Reserve Bank of Kansas City. This year he also serves as a voting member of the powerful Federal Open Market Committee in Washington, which controls interest rates and the money supply. Many of those just now finishing their chocolate-chip bread pudding dessert at Lenexa's Crowne Plaza Hotel would like to see Hoenig lose his job. Nothing personal: They just consider the Federal Reserve an affront to the Constitution and want to shut it down, lock, stock, and vault.
Hoenig smiles at his audience and begins: "This is a support-the-Fed rally, right?"
Then the room erupts in laughter. Disarmed, the Tea Partiers listen politely as Hoenig defends the Federal Reserve as an indispensible institution, even if at the moment, he says, it happens to be heading in the wrong direction.
And, by the way, if it were up to him (though it's not, really) he would break up the biggest Wall Street banks.
The applause starts tentatively, then builds to respectful appreciation. Afterwards, Steve Shute, a leader of the Hope for America Coalition, the Kansas group that sponsored the dinner, compliments Hoenig for impressing a tough crowd. "We believe the Federal Reserve should be abolished," he says. It "is helping to destroy the country." That said, Hoenig seems like an O.K. guy. "He is someone going toe-to-toe with Ben Bernanke and the Boston-New York-Washington-San Francisco elite axis at the Fed. He brought some Midwestern common sense to the Fed," says Shute. "We know he doesn't agree with us, but we're still proud of him."
This is Tom Hoenig's moment, and it's a strange one. In Washington, he is the burr in Fed Chairman Bernanke's saddle: the rogue heartland banker who keeps dissenting alone—for the sixth straight time on Sept. 21—to protest the Fed's rock-bottom interest-rate policy. Hoenig warns that the Bernanke majority is setting the country up for an as-yet-unknown asset bubble: the next dot-com or subprime craze. He can't tell yet where the boom-and-bust will materialize, but he can feel it coming, like a Missouri wheat farmer senses in his bones the storm that's just over the horizon.
Hoenig's outlying position seemed less eccentric earlier this year, when the recovery had more zip. "To continue to hold it through the kind of deterioration in the economy we've seen the past couple of months is, to me, quite puzzling," says Lyle Gramley, a Federal Reserve governor in the 1980s who works as a senior economic adviser with Potomac Research Group in Washington. Paul Krugman, the Princeton University Nobel laureate and New York Times columnist, has written that Hoenig and a couple of other Fed presidents from the provinces have intimidated Bernanke out of taking more aggressive steps to stimulate job growth.
"I think that's nonsense," Hoenig fires back. His irritation reveals how much he takes the disagreement to heart. Says Richard W. Fisher, president of the Dallas Fed and a Hoenig friend: "I know Tom anguishes over this. He and I have talked about it."
Hoenig's plainspoken rebellion has put him in the headlines, on cable television, and, in some cases, in the crosshairs for vituperative attacks. "In this environment, with 9.6 percent unemployment, Hoenig's position is just friggin' nuts," says Dirk Van Dijk, director of research at Zacks Investment Research in Chicago. "His idea for tightening monetary policy is roughly equivalent to a doctor giving anticoagulants to a patient suffering from severe internal bleeding." Part of Hoenig's pain comes from being typecast as a heartless inflation hawk, indifferent to the common man who can't find work. The son of an Iowa plumber, he argues that it's not primarily inflation he fears but the reckless borrowing and distortions engendered by sustained low interest rates. The hard truth, in his view, is that there just isn't much more the Fed can do to help, and we all ought to admit that.
While persisting in this lonely campaign for the end to ultra-easy credit, Hoenig has also been a harsh critic of Wall Street excess (an issue on which he and Krugman mostly agree). In abundant speeches and articles, Hoenig has condemned the political influence of the financial elite. "We've had a Treasury Secretary from Goldman Sachs (GS) under a Democratic President and a Treasury Secretary from Goldman Sachs under a Republican President. The outcomes were not good," Hoenig says while being driven to a luncheon talk at an affordable housing conference in Topeka, Kan.
All of this—the prairie populism, foreboding about bubbles, and glass-half-full economic perspective—has made Hoenig a hero in the seven-state Kansas City Federal Reserve District (Kansas, Colorado, Nebraska, Oklahoma, Wyoming, the northern half of New Mexico, and the western third of Missouri). "Tom has seen the good, the bad, and the ugly, so people listen to him out here," says Terry Moore, the president of the Omaha Federation of Labor of the AFL-CIO and a member of Hoenig's board of directors at the Kansas City Fed. Moore acknowledges that unions generally have pushed for a degree of monetary stimulus that Hoenig resists. But the AFL-CIO leader trusts the banker: "We feel like Tom represents a heartland view of the economy you don't necessarily get from New York or Washington. He's an old farm boy from Iowa, and we like that."
Hoenig, 64, the grandson of corn and wheat farmers, doesn't affiliate with a political party, doesn't give campaign contributions, and definitely won't say who got his vote for President in 2008. A product of Catholic schools and Benedictine College in Atchison, Kan., he served in a combat artillery unit in Vietnam, and has spent his entire 38-year career at the Kansas City Fed. One reason he is speaking out now, he says, is that he has only 12 months before mandatory retirement will force him to leave, and he has decided he won't go quietly.
In the middle of the country, economic conditions are better than on the coasts. Lifted by exports, agriculture is booming. That helps explain Hoenig's instinct that it's time to get interest rates off zero.
As popular as he is in the region, there are plenty who disagree. "It seems odd to me that with 200 economists at the Federal Reserve in Washington, that Tom Hoenig has discovered some wisdom that escaped all of those people," says Lou Barnes, a veteran banker who tracks the Fed for Premier Mortgage Group in Boulder, Colo. "There's something undignified about all the dissenting and the questions it raises....It makes you wonder whether he's grandstanding."
FUNERALS FOR BANKS
Hoenig grew up in Fort Madison, Iowa. Locals called it Pen City because it was home to both the state penitentiary and the original Sheaffer Pen factory. Maximum-security inmates still reside in Fort Madison; the pen company is now owned by Société BIC. Hoenig carries only black Sheaffer fountain pens in his shirt pocket.
The second-oldest of seven siblings, he started taking inventory for his father's contracting business at the age of 9. "I don't know if it was legal or not," he says, reminiscing in the wood-paneled library off his office on the 14th floor of the grand limestone Fed building overlooking downtown Kansas City, Mo. A thousand people work for Hoenig here, ranging from PhD economists to the technicians who oversee the automatic forklifts moving pallets of $100 bills in and out of the spotless first-floor vault.
Economics was a natural part of Hoenig's childhood: "You basically kept expenses within revenues. That's what you were taught...and you saved."
He enjoyed economics more for the mechanics than as an ideological template. After Vietnam, he obtained a PhD at Iowa State. Asked for an intellectual influence, he offers Milton Friedman, but adds that it was the University of Chicago scholar's empirical history of U.S. monetary policy that he found inspiring, not Friedman's anti-regulatory passions. Hoenig joined the Fed staff in 1973 in Kansas City, hometown of his wife, Cynthia. They raised two sons, Michael, a lawyer, and Alex, who works in commercial real estate.
The D.C.-based governors of the Federal Reserve—seven at full strength—are Presidential appointees, subject to Senate confirmation. They serve 14-year terms and direct monetary policy through the Federal Open Market Committee. The presidents of the 12 regional Fed banks, by contrast, are chosen and employed by the banks' private-sector directors. The regional banks are public-private hybrids: They both regulate and provide services to for-profit banks. The quasi-private-sector regional presidents have lower profiles than the politically appointed Fed governors, but the presidents are much better paid. Hoenig, who has held his current post since 1991, making him the longest-serving president, earned $374,400 in 2009. Bernanke earned $196,700.
Hoenig relishes the memory of his early years at the Kansas City Fed in the 1970s. For a bookish young economist, writing reports on competitive conditions for agricultural finance was as good as it gets. Later in the decade, he moved up to hands-on bank supervision, around the time that low rates ignited aggressive bank lending in the Midwest and sharp runups in the prices of agricultural land and domestic oil and gas operations. Those real estate and energy bubbles burst with a vengeance in the early 1980s, forcing thousands of farms into foreclosure, pushing small towns to the brink of depression, and bringing down 347 banks in the Kansas City Fed's district from 1982 to 1992. Working with colleagues at the Federal Deposit Insurance Corp., Hoenig personally helped administer more than 100 funerals for failed community banks. He recalls a memorable July 4 weekend in 1982 in his office at the Kansas City Fed, poring over the books of Penn Square Bank, an especially reckless Oklahoma City energy lender. Its executives pleaded for a bailout. "It's not salvageable," Hoenig, then an assistant vice-president, recalls telling his bosses. They let Penn Square go under. The Oklahoma City contagion spread to numerous larger banks that had purchased Penn Square's loans. The debacle contributed to the collapse two years later of giant Continental Illinois in Chicago, the largest bank failure in U.S. history until the crisis of 2008.
"What I took from that," says Hoenig, "was that it followed a period of very easy credit. It followed a period when people felt prices could only go up." Feel-good rates, in other words, led to excessive leverage and crisis. "I find it very interesting today," Hoenig continues, "how many people don't remember the late 1970s-early 1980s."
Under the leadership of then-Chairman Alan Greenspan, the Fed drove rates down in response to the dot-com crash of 2000 and the recession that followed. Hoenig had a turn as a voting member of the FOMC in 2001 and dissented twice that year from rate-lowering moves, even after the September 11 terrorist attacks exacerbated the economic slowdown. Greenspan and Bernanke, who assumed the Fed chairmanship in 2006, have insisted that easy-credit policies during the early 2000s didn't contribute to the housing bubble and Wall Street crisis. Hoenig disagrees. "The low rates in that era accommodated too much borrowing, too much leverage, too much risk-taking," he says.
Hoenig harbors powerful misgivings over not dissenting more often and more forcefully during the Greenspan years. "He regrets going along with the votes when Alan Greenspan was chairman to get rates so low and keeping them so low so long," says his friend Fisher. In an interview, Greenspan says: "He's a person with an independent point of view." He declined to comment on Hoenig's regret about his votes. Bernanke declined to comment for this article.
The crisis of 2008 required extraordinary actions from the Fed to head off a global depression, Hoenig acknowledges. These included bank bailouts, huge asset purchases to boost liquidity, and severe interest-rate cuts meant to stimulate hiring and growth. Beginning in the third quarter of 2009, however, he started urging his Fed colleagues at their periodic meetings in Washington to send a signal that they would "renormalize" by slowly moving rates up. In 2010, Hoenig was empowered with his once-every-three-years turn to vote—and decided to use it.
His argument, in brief: Despite continuing high unemployment, a modest recovery is actually under way. Personal income and expenditures are up in 2010, if only slightly. Businesses are slowly adding back jobs, more than 700,000 so far this year. But the Fed has consistently maintained that near-zero interest rates are here indefinitely. "In trying to use policy as a cure-all," he said in a speech to the Chamber of Commerce in Lincoln, Neb., on Aug. 13, "we will repeat the cycle of severe recession and unemployment in a few short years by keeping rates too low for too long."
This is a minority view within the economics fraternity. Most experts are fixated on persistently high unemployment and the danger of the country slipping back into recession. In a column in The New York Times on Aug. 12 entitled "Paralysis at the Fed," Krugman asserted that Bernanke "is being political, unwilling to engage in open confrontation with other Fed officials—especially those regional Fed presidents who fear inflation, even with deflation the clear and present danger."
Hoenig counters that Krugman simply wants Bernanke to "agree with Paul and then make everyone else agree with Paul." Hoenig says he cannot push around anyone in Washington. If anything, he seems frustrated that other voting FOMC members who have expressed sympathy for his views are still backing Bernanke when it comes time to vote. "I'm a human being. I think I'm right, or I wouldn't vote that way," he says. "If they agree with me, I wish they would join me."
The Fed's internal deliberations take place in a decorous atmosphere. Visiting regional presidents stay in the same West End hotel, the Fairmont, and eat breakfast together at the white marble Fed building on Constitution Avenue, Northwest. Conversation is friendly, arm-twisting nonexistent, Hoenig says. "No one has ever lobbied me, and I have never lobbied anyone."
The Fed governors and regional presidents each have an opportunity to present their view of the economy and, after a break for lunch, their prescription for monetary policy. Under rules established by Bernanke, participants raise one hand to get on a list to speak and two hands if they wish to interrupt a colleague for clarification or to dispute a point. "I've done it on occasion," Hoenig says.
Some former colleagues wonder aloud what is driving Hoenig to register repeated objections to Bernanke's leadership. "He's a very practical, cautious person, I would say not given to dissenting easily," says Robert McTeer, who served as Dallas Fed president from 1991 through 2004. Hoenig's position made more sense earlier in the year, when the economy looked stronger, McTeer adds. "I think he's hung up on this issue now in ways that make it difficult for him to back off," says Gramley, the former Fed governor.
Hoenig's actions become more comprehensible if one attends a breakfast gathering of community bankers at the Kansas City Fed. He hosted such an affair in early September. While attendees sip coffee, Bruce A. Schriefer, president of Bankers' Bank of Kansas in Wichita, rises to ask, only half-jokingly, whether one day soon he and his fellow executives "will all be working for Goldman Sachs or Wal-Mart (WMT)?"
"I understand," Hoenig murmurs. Throughout the morning, the sense of regional pride, even defiance, is palpable. Hoenig, sounding like an old-time football coach, tells his guests that the more than 1,000 small banks they represent have a "fundamentally sound" business model and serve the noble cause of nurturing Main Street. The little guys need to stick together.
Another reason Hoenig wants to end super-low interest rates is that Wall Street banks and large corporations are currently able to borrow for almost nothing and either hoard cash, make acquisitions, or invest in long-term Treasuries for a guaranteed profit. Retirees and other bank depositors effectively subsidize this borrowing and earn almost nothing on their savings. "It's a distortion, and it favors the large institutions over the smaller ones and Wall Street over the saver," Hoenig says in an interview. "I just don't like it. It's not fair."
When community banks stumble, he adds, they are allowed to fail. When Wall Street collapsed, it got a heroic rescue. "I would break them up," Hoenig says of Citigroup (C), JPMorgan Chase (JPM), and Bank of America (BAC). "They're too big. They have too much political influence. When they get in trouble again, the temptation to rescue them because they are 'too big to fail' will be very strong." The financial reform legislation enacted in July wasn't tough enough; he would have liked to see the Glass-Steagall Act's separation of commercial and investment banking revived, along with the imposition of strict capital requirements on the banks by Congress.
Despite his dissent on monetary policy, Hoenig argues that a strong central bank is vital. At the Tea Party dinner in Lenexa, he says: "I know many of you believe in 'End the Fed.' " That's your prerogative, he continues. But "you better have something else in mind" as a replacement. He gives a quick and chilling history lesson of U.S. financial panics before the Fed system was created in 1913.
Some in the audience are not convinced. A bearded man approaches Hoenig after the talk and suggests that the Fed is part o