Ex-St. Louis Fed Chief Criticizes Bank Bailouts, Sees Long-Term Inflation

(April 2009) Ex-St. Louis Federal Reserve Bank President William Poole criticized federal bank bailouts and forecast long-term inflation during three April 16 forums in Conway co-sponsored by Hendrix College and the Policy Foundation.

Morning Session: Apply 'Market Discipline' to Banks

Dr. Poole told undergraduate Hendrix students in a morning session that "market discipline" should be applied to large banks, forcing "them to shrink if they are inefficient." He likened recent actions by the U.S. government to central planning. "Centrally-planned economies fail because they prop up inefficient enterprises to the exclusion of new firms serving consumers," Poole told the class. He noted the process of "creative destruction," identified by the economist Joseph A. Schumpeter (1883-1950) is part of market-based systems like the U.S. economy, and should be allowed to proceed without government interference. "The political system has a very hard time closing the inefficient rural post office," Poole said.

Luncheon: Bailouts Will Not Help Economy

The subprime market was a cause of the current economic crisis, Dr. Poole told a luncheon crowd, as private and public policymakers reached an "inadequate understanding of the risk." He cited Collateralized Debt Obligations (CDOs), a type of financial derivative used to expand credit. Many of the loans in this market were poorly underwritten or understood, he said. Poole also cited Fannie Mae and Freddie Mac, which "grew and eroded the market position" of competitors, and money-center banks. "We have a terrible, terrible problem with all of the big banks on federal life support," Poole said. "Washington should not be propping up losing enterprises.

Associated Press reported Poole told the lunch that more authority for regulators of the financial industry won't ease the recession caused by the collapse of the housing market and subprime mortgage losses. The recession started in December 2007.

Afternoon Session: Fed Independence at Risk

Dr. Poole told a second Hendrix class in an afternoon session that recent Fed policies could put the central bank's independence at risk. "Monetary policy is being intermingled with fiscal policy," Poole said in the forum, which included a discussion of the Term Auction Facility and additional credit programs.

Inflation

Dr. Poole emphasized unprecedented Federal Reserve expansion of the monetary base during all three Hendrix forums. Poole earned his Ph.D in economics from the Univ. of Chicago where he studied under Nobel laureate Milton Friedman (1916-2006). He earned a reputation as an inflation hawk while leading the St. Louis Fed (1998-2008) and serving on the Federal Open Market Committee, which sets U.S. monetary policy.

Poole said the monetary base has expanded by more than 100 percent since September 2008, the largest expansion in the time series, which dates to 1918. He said his "best guess" was a return of long-term inflation in "the 4-to-6 percent range," not the 7 percent of the 1970s "because so many policy makers lived through it and are determined to prevent it." Poole cautioned that high unemployment and a weak housing market could present future impediments to the Fed reversing course, and removing liquidity from the system.

"Did you have a session on hyperinflation?" Poole asked students in the morning forum. "Where does inflation come from? The central bank creates too much money." Poole told the luncheon, "We're in the process of building up to Great Inflation Two."

Poole noted that monetary policy operates with a lag of between "6-to-9 months" under normal circumstances, and "up to two years" in an abnormal event. He identified September 2008 as the turning point, and added, "There's no ambiguity."

-- Greg Kaza

ADDITIONAL INFORMATION ON THE APRIL 16 FORUMS IS POSTED AT WWW.ARKANSASPOLICYFOUNDATION.ORG

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