Aaron Klein on the US’s Real-Time Payments Problem and the Impact of Covid Era Quantitative Easing

Aaron Klein is a senior fellow in economic studies at the Brookings Institution. Aaron returns to the show to discuss his paper with George Selgin calling for real time payments, the inequality caused by the Fed’s current payment processes, the results of Covid time QE, recommendations for dealing with future crises, and much more. 

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Read the full episode transcript:

This episode was recorded on December 11th, 2025

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]. 

David Beckworth: Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow at the Mercatus Center at George Mason University, and I’m glad you decided to join us.

Our guest today is Aaron Klein. Aaron is a senior fellow in economic studies at the Brookings Institution, where he focuses on financial technology and regulation, payments, macroeconomics, and infrastructure for finance and policy. Prior to joining Brookings, he directed the Bipartisan Policy Center’s financial regulatory reform initiative. He has also previously worked in the US Treasury Department and the Senate Banking Committee.

Aaron is also a previous guest of the podcast, so welcome back, Aaron.

Aaron Klein: It’s great to be back, David.

Beckworth: It’s great to have you on. We’re going to talk about a paper called “Quantitative Easing and Housing Inflation Post-COVID.” That’s the motivation for bringing you back over here. 

Faster Payments

I also want to talk about previous discussions that we’ve had. The last time you came on, we talked about, among other things, the Fed’s payment system, the payment rails, the challenges it creates, particularly for inequality and people who live paycheck to paycheck. You’ve been on this issue for a long time.

It was interesting to see you and George Selgin, I believe in 2020, come together and write an article for the American Banker. Is that right? It dealt with this issue, the challenges of the payment system, and your shared frustrations. Maybe revisit, with us, that article. What did you guys argue in it? Then maybe we can see where we are now, five years later.

Klein: That paper came out February 28, 2020. It’s like something happened in March of 2020. Some virus started coming around that maybe upended the universe as we knew it. Somehow, that paper was lost in the transition. At the point, what George and I were arguing, was that the Fed was undertaking a four- to five-year process to build their new payment rails called FedNow, which happened much later than it should have.

I point out England took 18 months to build the same technological platform in 2008. The first iPhone came out while England was building a real-time payment system in 18 months. We were at about iPhone X while the Fed was taking four-plus years. If you listen to the Fed, they said, “Well, it’s much harder to network 5,000 banks than 500.” If you talk to any human being who’s ever done network engineering or a system, they’re like, “No, that’s totally irrelevant. The difference of 500, 5,000, you build the network, it works.” It was just the Fed was delaying it for reasons we’ll get into.

George and I said, “Well, look, we don’t have to wait until you’ve built your cathedral of payment rails to do a bunch of common-sense things to speed up the payment system to make it work better.” The Fed didn’t. Largely, it has done absolutely nothing. It has done a little bit of the changes. It has extended a few hours here or there. Frankly, I think some of those motivations were not about improving the payment system to help people, but were really about shortcomings found in the SVB crisis when Signature Bank was trying to fund itself and avoid a disorderly failure. The Fed had to hold a window open, one of these payment system windows that closed; they actually “did what they said they can’t do,” which is hold it open to get funding that night.

The way to think of the Fed’s existing payment rails or ACH networks is like your laundry machine. It’s a batch operating system. Everybody puts their clothes in a hamper. Hamper builds up, you throw all the clothes in the washing machine. They all come out clean together. That’s how our payment system has worked for a very long time. Real-time payments, where I pay you as I go, it’s like washing your clothes one by one as they get clean. It’s like what happens in Netflix. You queue up your Netflix, and it streams to you. Netflix doesn’t sit there and wait until 5,000 people have ordered Stranger Things and start playing it.

What we were saying was run the washing machine one more dime a day. The Fed was like, “Oh, well, we can’t do that, it’s not that easy,” or, “Hold the washing machine open a little bit later because when you close it at 6:00 p.m. in New York, that’s 3:00 p.m. in California, and that’s noon in Hawaii. This has real-world consequences.” The Fed has made some marginal improvements on that, but the underlying situation is they’re still using a washing machine when the rest of the world has gone to a streaming service.

Beckworth: Walk us through the argument for people who live paycheck to paycheck, people who get paid on a Friday, and their payment doesn’t clear until Monday. When I am sending cash to my kid through Venmo or the Cash App, I can do it immediately, it’s a fee. If I want to just go through the normal process, it takes several days. Tell us why that should not be the case.

Klein: It’s a very simple argument, and ‘tis the season. Christmas is Thursday, December 25. People have gifts under the tree. Now, if you get paid on a biweekly schedule and your paycheck happens to fall on Friday, December 26, it’s not that your business is paying you and sending you that money Friday. As you point out, the business will send you that money on Tuesday, usually, as their automated system, and then it sits in la-la land for three days. There’s no reason why you can’t have that money immediately.

What’s the real-world consequence? Well, the real-world consequence is I got to have a gift for my kid on the morning of the 25th, so I’m going to go and buy it, and that’s going to trigger me an overdraft fee. In addition, you don’t know when that money comes, so even if you want to say a world where it’s a financial literacy and you should understand and manage your money, and well, you’ve been profligate, why didn’t you put it in? If you want to be that hard.

I don’t know the exact moment my paycheck comes in. When I deposit something, it’s like the uncertainty principle of physics, where I can’t know the exact dollar amount and time my payment comes. There’s no reason for that. The rest of the world would tell you it’ll be there in 30 seconds, in two minutes. This uncertainty means I don’t know if my paycheck is going to come in on Monday or Tuesday. I don’t know if your paycheck is going to come in Friday, the 26th, or if it’s going to wait to the following Monday because Thursday, the 25th is a bank holiday, and sometimes those are distributed.

Thanksgiving is another example of a holiday that occurs on a Thursday. If you don’t know when you’re getting in, how do you possibly manage your money with that uncertainty principle? The real-world consequences—if you’re part of the half of America that always has $1,000 in the bank, it doesn’t really matter when your pay comes. If you’re trying to handle paycheck to paycheck, minute to minute, day to day, you need to have access to your money, and the idea that your money can’t be available for several days, and we can’t even tell you when that will occur, drives people into very high-cost workarounds.

My research showed, using the FDIC’s data, that 70% of people who go to check cashers have a bank account. Now, David, why would you go to a check casher if you had a bank account?

Beckworth: Because you don’t have enough money in your bank account.

Klein: Right, but I have the check. I have the money. Why wouldn’t you deposit in the bank for free? Why would you go around the corner to the check casher and pay $20?

Beckworth: Immediate purchasing power.

Klein: Exactly. If I get paid and I walk in on a Friday to my bank, I’m going to have access to that on Tuesday. Well, what am I going to do over the weekend?

Beckworth: Nothing.

Klein: Right, but if I go to the check casher, I’m going to have cash. Now I can go back to the bank and put the cash in. I first came aware of this when I was taking my kids for ice skating. Afterwards, we went to my local bank on a Saturday. I saw a woman with a check. She wasn’t going to have access to her money until Wednesday and said, “I have a problem. I didn’t know what to do.” Another woman walked up and said, “Go around the corner of the check casher.” I started to say, “Oh my gosh.” I had always been taught that check cashing was a problem of the unbanked. 30% of people who are check cashers don’t have bank accounts; 70% do. We can solve that problem. Check cashing is a multibillion-dollar-a-year business.

A different paper that came out of Brookings, Dan Murphy wrote it, showed that over $600 million of government stimulus checks during COVID were paid in check-cashing fees—

Beckworth: Wow.

Klein: —because you were waiting. You finally got the check, you needed the money, you couldn’t work, and you didn’t have another three days to wait for the check to clear. This is a problem that is only felt by people with immediate access to their money, living paycheck to paycheck. I don’t think a single employee at the Federal Reserve has ever worried about this, who has rule-writing authority in paper, but they would happily let them eat a financial literacy brochure over the weekend.

Beckworth: Another implication of this is that it opens the door for things like stablecoins to step in and fill in a service that’s not being provided immediately. Why this legacy? Why is it the case we’ve had such delayed payments?

Klein: Because the Federal Reserve is in the pocket of the banks and credit unions that charge overdraft, and because they don’t care. Payments is a backwater of the Fed, and because they just simply refuse to admit their mistake. I don’t think you need stablecoins for this. The rest of the world had real-time payments. England had it in 2008. Mexico had it in 2004. Japan had it in 1972. There’s nothing unique about a blockchain ledger or a tokenized asset to do this.

I remember I walk off a United Airlines flight, and my frequent flyer miles for the flight are there as I’m debarking the gate. This real-time payment stuff is totally not needed from crypto. As you point out with Venmo—you gave that little story about you sending money to your kid—they can send you the money directly to your account. It’s a Visa direct debit. They use a Visa process. Visa’s hacked the rail system. They built this. They charge you 175 basis points. Visa doesn’t charge Venmo 175 basis points. Visa charges them a couple of cents. Why does Venmo charge you 175 basis points? Because it’s profit-maximizing for them. 

Other banks will give you immediate access to your check deposit, usually for 100 to 200 basis points. They figured out that’s profit-maximizing. It has nothing to do with their basis cost. Just like overdraft at $35 has nothing to do with the true lending risk of the bank. It’s profit-maximizing.

The Federal Reserve, who is supposed to regulate our payment system, has ignored the law, the Expedited Funds Availability Act, which requires them to move money as fast as technology allows, Section D, Expedited Funds Availability Act of 1987. The Fed thumbs its nose at this law like it’s thumbed its nose at the Homeownership Equity Protection Act of 1994, which required the Federal Reserve to issue regulations on subprime mortgages.

The Congress gave the Fed 180 days in 1994 to regulate subprime mortgages. Do you know when the Fed did it? 2007. Why? Alan Greenspan said, “I don’t think we need this regulation. I’m smarter than Congress. I’m independent. I don’t need to follow the law.” Ned Gramlich, governor of the Fed, tried to get him to do it, and Greenspan shot him down. How’d that work out for us? Right now, I’m trying to get the Fed to follow the Expedited Funds Availability Act, but they won’t do it. As a result, millions of people are going to pay billions of dollars in overdraft fees, check-cashing fees, and late fees.

Prior research I did that I submitted to the Fed in 2019 showed Americans would have saved over $100 billion if we’d done real-time payments when England did it in 2008. I think that number’s north of $200 billion. Don’t worry, the Fed gave a speech on income inequality and why that’s a problem. Everybody, you should feel sympathetic because they’ve intellectually agreed with you, while they’re giving you an overdraft fee as a lump of coal in your stocking because you needed to get your kid a Christmas present on Thursday. Your money could have been there on Wednesday, but the Fed let it sit there until Friday so that their banks could get overdraft fees and the bankers who sit on their boards could get holiday bonuses. Merry Christmas.

Beckworth: Merry Christmas. So many questions I could go down and explore. Let me start with this. The reason this occurs is because we have this gross settlement process for retail. You mentioned the ACH, which is the retail payment rails for you and me. Is it not the case, Fedwire, the wholesale, they already have real time, and they never had to deal with this issue? Again, why did wholesale come out ahead and retail fall behind?

Klein: I think you answered your question because, on the one hand, they’re trying to benefit the people that they care about, which are the big money banks, and the little people—retail people, normal people—they don’t care. They’re not on their board of directors. It’s just simply, “Screw you.” When I interviewed Federal Reserve governors, from my time on the Senate Banking Committee, all the way through my time at the Treasury Department, I did almost every single one for about 12 years. Only one of them ever told me they cared about payments.

“Why do you want to be a Federal Reserve governor?” “Monetary policy, bank regulation, it’s a cool job, it’ll help me sell some textbooks.” There are a lot of different answers, right?

Beckworth: Yes.

Klein: One of them cared about payments. Banker went on to be chair of the board of a major bank, and understood because slow payments are big money for the banking industry. Now, in terms of real time, Fedwire isn’t 24/7. They close Fedwire on the weekends. That was something George and I argued, that we could expand networks. Part of the reason was the big banks actually put in a real-time payment network called RTP way before the Fed, in part because they didn’t want to be the taxicab medallions in an Uber story of real-time payments, because these folks go all around the world and realize our system isn’t there. That required some of this back-office stuff.

Then the Fed said, “Oh, wait, I want to compete with you banking people because I don’t trust you running the rails. We need to run our own government system. We’re going to slow this down a little bit.” The consequence of them slowing down Fedwire, not opening it on the weekends, and other things, meant that the private system of real-time payments was going to be more expensive to operate. Thank you very much, government, for slowing down private sector innovation on this so that you could build your own train.

Beckworth: Okay. The Fed steps up and says, “We want to do our own real-time settlement, which will be useful for retail as well as other applications.” That’s the FedNow platform. Going back to your article, your argument is, “Hey, we’re going to have to wait five years to get this thing. We could have a quick fix by simply extending the hours of the existing payment rails.”

Klein: And mandating that the funds be available to people immediately who’ve had their account for more than six months and no more than $5,000. There’s a fraud issue. There’s a real fraud issue if somebody’s going to open up a fake account and put $10 million in it and take it out immediately. I get that. This is a retail thing. This law has been in place since 1987. Back then, people cared about the interest, the float. Right now, it’s about the overdraft and the fees. The Fed didn’t do it.

Beckworth: Here’s my question. Now we have the Federal Reserve. The FedNow is running to some extent already, right?

Klein: It’s running, but it’s a joke. It’s a Fed flop.

Beckworth: Fed flop, wow.

Klein: It’s a Fed flop by design.

Beckworth: Go on.

Klein: Look, they didn’t want this system to work because they don’t want to cannibalize the overdraft revenue, so they built a system that no customer can do. I can’t walk into my bank or credit union and say, “Hey, FedNow this to you. I want to send you some money, send it to FedNow.” They can’t because no consumer can do it. In addition to that, the Fed offers it at a pretty low price to the bank. The bank can set whatever price it wants to its customers, that is, the institutional money that says, “Hey, I want to pay my employees faster or FedNow this to them.” Do you know how much the banks are charging their customers?

Beckworth: No.

Klein: Neither do I because the Federal Reserve refuses to collect that information. There’s a very interesting letter sent from Senator John Fetterman, one of my favorite senators, who said to the Fed a year into FedNow, “How’s it going?” All the Fed would release is how many banks had signed up. By the way, they would release a Kafkaesque number because when you sign up for this system, you can sign up for send, receive, or both. The Fed would just say, “Sign up.” Then, you said, “Well, how many signed up to send money? How many signed up just to receive?” They wouldn’t tell you. My sources indicate over 90% were receive only.

David, I’m building a new technology called a telephone. I’m going to give you the first telephone. How much is that telephone worth to you?

Beckworth: Not much at all because I’m the only one using it.

Klein: Who are you going to call?

Beckworth: Myself, I guess. 

Klein: Right. Now I’m going to set up a network where you can call people, but no one can call you back. Then, Senator Fetterman asked the Fed, “Well, how much money has gone through FedNow?” You know what the Fed told him? “We’ll tell you when we want to.” An entity that says it’s responsible to refuse to answer any of these questions. Then, Senator Fetterman asked them, “How much are banks charging their customers?” The Fed responded, “We’re not going to find that information out. We believe in free markets.”

Anyways, I wrote another piece with a friend of mine, Gaurav, who’s the CEO of an insurance company, New York State Public Insurance Company, that does workers comp. You’re working on a job. You’re an electrician. You’re climbing a roof. You fall off your ladder. You can’t work. You’re out of work. You have workers’ comp insurance. That’s great, but it’s going to take you a while to file a claim. It’s going to take you a while for that claim to be approved. Then, they have to start sending you money.

Now, how long can you wait? Because you’re out of work. You’re not getting paid. You don’t have a cushy job at the Fed where you get a check every couple of weeks and paid sick leave. You’re waiting for your money. He said, “Look, I want to pay these guys fast.” Did a survey, some work. Read the article that we wrote where we talk about the delta, the markups that are being observed in the marketplace. Why would banks charge giant markups?

Now, if you’re an insurance company, you’re paying a lot of people. The difference between three cents and $3—three cents and $1.20. Look at the Fed markups, and then you could begin to understand why people aren’t using this. Now, why would you do a giant markup if you’re the bank? Well, wait a second, this guy stuck on workers’ comp is probably going to be starting to overdraft a bit. If I move that money faster, the overdrafts are going to go down.

Beckworth: They’re compensating with the higher markup.

Klein: I’m going to offer you a job that’s going to cut your income by a third. Do you want to take it?

Beckworth: You’re saying one of the problems with FedNow—you called Fed flop, that’s hilarious—is that they’re charging big markups to the retail person.

Klein: No, no, they’re charging big markups to the corporate people—

Beckworth: To the corporate people.

Klein: —who can customer. Retail people cannot use it.

Beckworth: Will we ever be able to?

Klein: I don’t think so. There are no plans to do that. The plan is, as I have parsed it, is to let the thing fail and then say there was no demand for it. America will be the only country you have to wait three days for your payment because somehow Americans want their money to move slower than the rest of the world.

Beckworth: This goes back to my stablecoin point. It’s not that stablecoin is the only solution, but it may be the only one left if we don’t end up—

Klein: What does that mean? You Venmo your kid instantly. It moves from your Venmo balance to theirs.

Beckworth: It’s just a fee associated with it.

Klein: No, no, no, it’s just moving it from their Venmo account to their bank account. That’s the time hold. I Venmo you, it goes from my Venmo account to yours. Now, do you leave the money in your Venmo account or do you empty it all into your bank account? It’s that moment in the transfer. Again, the same issue with stablecoins.

Beckworth: On-ramp, off-ramp.

Klein: I want to send you the money from my stablecoin wallet to your stablecoin wallet, that’ll occur instantly. But then how will I put that into your bank account?

Beckworth: There’s still the transaction cost of time, if nothing else. One last point on this, and we’ll move on to some other issues. This is the point that George Selgin raised in a previous podcast, is that in order to make a new network effective, there’s economies of scale. You want to get as many people involved, this telephone point. The Fed already kick-started the private sector to do this with the real RTP. RTP is out there trying to do their thing, and then all of a sudden Fed goes, “Oh, wait a minute, we want to be a player as well.” Now you have two big entities trying to build up a utility, effectively a utility with a natural monopoly, where you have economies of scale. You want to get the lowest part of the average cost curve, but you need one to bank as effectively as possible. Is this also a reason that they’re not going to work?

Klein: Yes. We’re old enough to remember there are two competing technologies, VHS and Beta. This is a classic story. This is when the original VCR came out. The listeners of this podcast, you’re just going to have to trust us that there was this new technology that let you watch things at home that you couldn’t before. You had to drive to a store and pick up a cassette, and there were two different technologies of this cassette. It was expensive for the stores to have two different versions of the movies, and they were just not compatible technologies.

I think most tech geeks would tell you Beta was a slightly better version. For reasons that would probably get you debanked according to the OCC’s latest thing, VHS was able to dominate the marketplace. They pushed the product better, and eventually, Beta fell away. This was somewhat repeated in the DVD era, maybe for some of our younger listeners with Blu-ray and DVD. You want one standard on some of these things. I think even a person more conservative than I would say, often the government’s role is to set the standard and then let everybody else fight out and the private sector to innovate on the technology, but sometimes you just need to decide this is the standard, the network, the rail on that.

When you step back like I have from the trenches of this, and you say, “What’s the outcome of a slow payment system?” The outcome of a slow payment system is the extraction of wealth from the bottom half of society moved to a group of people providing services to them to get around the myriad of problems. There is very limited cost to the top half of society. Then you ask yourself, “If income inequality is such a threat that the Fed PhD economists say it is, and they bemoan the structural consequences of a more unequal society, why are people at the Federal Reserve doing everything in their power, including ignoring this 1987 law?” 

I have gotten so blue in the face and so angry about this that I took matters into my own hands. I filed a petition. I don’t know if you know this, but the American Procedures Act allows any citizen to petition any regulator to implement a regulation that they have the authority to. The regulator is required by law to respond to the petitioner. They can agree and say, “We’ll do the regulation.” They can say, “We disagree, here’s why.” That’s it. The law says in a reasonable time. I wrote a petition. “Founding fathers, you want to go originalist in how you believe America?”

Beckworth: You go Aaron

Klein: I petitioned. The CFPB has a joint authority that was added when it was created in Dodd-Frank. It’s the Federal Reserve, jointly with the Bureau, that does this. I petitioned both regulators a year ago, October. You know what happened? The CFPB took my thing, took my petition. They sent me a note, received your petition. They put out a notice for public comment. There were many commenters who responded, some in favor, some opposed. They had a public dialogue over a couple of months. 

In January, three months later, the Bureau responded to my petition. They said, “We found that in 37 years since this law has been enacted, we’ve never once increased clearing time for checks. Technology has radically improved since 1987. We’re ready to do this.” That’s what the CFPB, one of the most accountable agencies in government did. You know what the Federal Reserve has done to my petition?

Beckworth: I’m guessing nothing.

Klein: Absolutely nothing. They barely acknowledged receipt of it after multiple emails to Ms. Misback. Those of us in the world of reg rules know that’s attention, Secretary Misback. That’s it. No notice, no public comment, no response. You can add to your list of laws that the Federal Reserve ignores, you can add the American Procedures Act along with the Expedited Funds Availability Act, the Homeownership Equity Protection Act, insider trading laws, et cetera, and so forth.

Federal Reserve, I’m still waiting as a petitioner. I have a fundamental right that you’re abridging, considering my legal action to sue you, because fundamentally, you are not independent of the law. You may think you are, you may operate, but there are those of us in society that believe in rule of law.

Beckworth: Now, Aaron, there are a number of Fed officials who listen to the show and other Fed staffers. What would you want to leave with them? Who would you want them to start talking to, to make things happen?

Klein: Put my notice out for public comment, like the CFPB did, an agency that actually follows the law, and start talking to real people. Ask yourself, “Why do 70% of people at check-cashing stores have a bank account? Why are you slow-walking technology? Why has the rest of the world figured this out? Your colleagues at the European Central Bank created real-time payments across 19 countries in the eurozone in 2019 in less time than you were able to do it here. Go ask banks how much they’re charging for FedNow. Go ask the question. You are so afraid to find the facts because they will challenge the assumptions that you cling to, just like Alan Greenspan, whom some of you put up next to Ayn Rand as your great idols, and cause a subprime mortgage crisis in part by failure to issue these rules because you had this assumption.”

“You know what? I’m here to challenge your assumptions because they’re based on your world experience, which has very little to do with how the other half lives. While you open your Christmas gifts, think about the kid whose parents ended up spending hundreds of dollars in overdraft fees because they couldn’t wait, because you didn’t follow the law.”

Beckworth: All right. There is some change happening at the Fed. Maybe some of the new folks coming in, new roles, they will listen to this podcast, Aaron, and you will get maybe not a Christmas present this year, but maybe next year you’ll have Christmas come early with some changes.

Klein: I’m for Purim. That’s my Jewish holiday.

Beckworth: Okay, we’ll aim for that.

Klein: That’s around February, March. There’s no reason, if the CFPB can respond to my petition in four months, is it going to take the Fed four years?

Fed Governance

Beckworth: Now, Aaron, we’ve been talking about payment issues, and you’re making the case the Fed has not been responsive. This is really a Fed governance accountability issue at a bigger level. There’s been other things going on at the Fed that also speak to this. Lisa Cook, the Supreme Court, Adriana Kugler, you’ve written a lot about that issue. The Fed building renovation. We had Andy Levin on. That stoked the coals over there. We have advocated here the need for a true independent inspector general that would help. Just in general, what is your sense of what’s happening and what needs to be done to maybe change the direction of the Fed?

Klein: One, I agree, for a truly independent inspector general. I was pleased Senator Warren and Senator Scott of Florida’s bill was put up as amendment. I believe Senator Sanders, Senator Fetterman joined. Most of the Republicans. It was a fascinating vote. If you’re a political junkie, look up the roll call vote. 53 in favor. It was filibustered. Mostly, sadly, Democrats opposed it. I think that was a massive mistake. It was an odd coalition: Senator John Thune, Liz Warren, Bernie Sanders, John Fetterman. It was an odd but correct group. Ultimately, I think an independent IG is insufficient to solve the problem, in part because the Trump administration has whacked a bunch of independent IGs. That is the issue. I think you need something much more structurally reformed. 

Beckworth: Yes, that will be the challenge ahead, and it’ll be interesting to see what happens.

Quantitative Easing and Housing Inflation Post-COVID

Now, let’s switch gears here and go to the paper that you wrote that motivated the podcast in the first place. This is a paper that came out in 2025, titled “Quantitative Easing and Housing Inflation Post-COVID.” Maybe give us the executive summary, the bird’s eye view of the paper, and then we’ll jump into parts of it.

Klein: When COVID struck, a bunch of strange things happened, one of which was the American housing market skyrocketed. The median value of a home went up by about $100,000 over several years, but really somewhat quickly. At the same time, the Federal Reserve instituted massive quantitative easing of buying mortgages, which went on so long that the Fed was buying mortgages in the name of COVID relief in March of 2023. This thing went on longer than the stupid school closings, which was the greatest policy mistake of my lifetime, keeping our schools and my kids out of school.

Under the name of COVID relief, the Fed bought what would be the equivalent of 90% of mortgages made in the country over several years. At the same time the Fed is buying every mortgage, mortgage-backed security—through Fannie and Freddie, not the private label—at the same time the Fed is buying all of these mortgages, home prices are rising. Then the Fed stops buying mortgages, and home prices plateau at their new permanent level. My estimate is 75% of that $100,000 increase was due to this asset purchase, because the last time I checked, if you try to buy every part of an asset, you increase its price. Housing is the number one determinant of inflation. Now, the way that we calculate inflation is a little confusing if you own your own house. You say, “Wait a second, my mortgage is fixed. How can housing be part of my inflation?”

This is where you have to go behind, and understand how the numbers are created. Well, your rents aren’t fixed, and so people who rent were paying more because values of homes correlate with values of rentals. For homeowners, what we do is, we say, “Well, what would it cost you to rent your house?” It’s based on an imputed rent calculation, which then is like, “Well, how much does it cost to rent this property?” Well, it costs more to rent a $300,000 house than it does to rent a $200,000 house. When a $200,000 house becomes a $300,000 house, your cost of the house, your imputed rent has risen. If you took housing out of inflation, we were back at 2% pretty quickly. When you add it in, because housing is such a large part of what we pay in life, in your basket of consumed goods, inflation was closer to 3%.

When you look at the rest of the world, that was not there. The housing inflation wasn’t there. It was uniquely American, just like QE. When I went back in the paper to research it, I see here’s Kristin Forbes, came to Jackson Hole, and said a very similar thing in her Jackson Hole address, I think in 2021, like, “Why are you guys still buying housing? The price of housing has gone up. Why are you doing this? You should stop.” The Fed ignored her.

Why did they ignore her? Well, the original theory of quantitative easing, is that it doesn’t matter the purchase of assets that you do because, jujitsu logic, the central bank injecting, it’s just a thing of spreads or this or that. The markets are very large. We don’t affect the underlying asset. My view of the most dangerous word in economics, “assume.”

When you look at what other countries, central banks did in Europe did quantitative easing, well, they bought corporate bonds. They bought a wide basket of things where they could put in a much broader—so they weren’t dominating any market. Why did the Federal Reserve buy so much housing?

Well, the Federal Reserve did this under Section 14 of the Federal Reserve Act, not 13(3), which is the emergency process. Section 14 of the Federal Reserve Act restricts the Federal Reserve to only buy Treasuries and mortgage-backed securities from Fannie and Freddie. It’s one of the ways that the government-sponsored enterprises are special, unique, get benefit, implicit guarantees, et cetera, and so forth.

They wanted to do so much quantitative easing, there are only so many Treasuries you can buy, so they bought all the mortgages. In Aaron Klein’s view, this assumption that buying a bunch of assets doesn’t change their price, breaks down when you’re buying 90% of the market. I have the data and the receipts in this paper to show the massive increase in house price appreciation, to which if it wasn’t this, what was it?

Other parts of the paper go through and say, “Well, was it preferences? Did people want to live in a different place in COVID? Did they want bigger housing, because we’re all working from home, and we need an extra room?” I think somewhat persuasively, it shows that it doesn’t, and that really what happened was this massive quantitative easing jacked up home prices, which created housing inflation, which then caused the Fed to say, “Well, wait a second, inflation is running hot.” It was ironically, in a way, a self-defeating exercise.

Beckworth: The Fed was the price maker in the housing market during those few years. Your argument is that the Fed’s view that its mortgage-backed securities purchases only affect the spreads is incomplete, or maybe even wrong; it’s the price itself, just because you said 90% of the market. Let’s contrast that to say previous QEs where you did that. Why such a difference? Was it just the bigger percent of the market, or what?

Klein: That’s a very good question. The answer has to be, we’re talking about one good housing. You’re talking about one prior QE, which was after the great housing disaster. What I would say is, if you buy 90% of housing, you’re going to create a distortion in the housing market. When COVID happened, the housing market was at some sort of natural equilibria. Now, there were small, short disruptions of COVID about—I have a paper by Laurie Goodman about appraisals, and all these things during the beginning of the shutdown. We’re talking about ’21, ’22 when things were back open, everything except schools in Montgomery County, Maryland, which was horrible. 

What we’re saying here is, in 2008 and 2009, the housing market was not at equilibrium. We had built way too many houses. We were in a deep disaster housing effect. Doing all of this in housing was a different world, because you were pulling on a string that was loose all over the floor, because the housing market was in a disastrous concept. 

One of the reasons I wanted to write this paper is, I think we have to think about quantitative easing, if it’s being limited by Section 14 of the Federal Reserve Act to just housing and Treasuries, just GSE debt and Treasuries, we need to think about that as it’s going to relate in the future, because what was a break the glass, is now part of the normal toolkit.

What happened in 2008 is the exception, not the norm, unless we have another housing disaster that causes this. That’s why I think the ’08 example, which is a very fair response to my question back, is different. The 2020 example is the one that has more future relevance for policymakers.

Beckworth: Let me frame what my response would be, and see what you think of this. I think another reason that housing packed such a punch, the mortgage-backed purchases did, is because fiscal policy was so supportive. There was a quick recovery. It was truly a V-shaped bounce back. We did not have that in 2008. We lost potential GDP. We have forever lost that, but we had a very robust fiscal and monetary policy response. For someone like me who likes to make up policy, I was pleased to see it, but then we overshot dramatically, where we came back, and then we went way above that trend path. I think the story you could tell is the housing story, the reason we went above.

I guess my question would be, what if we didn’t do mortgage-backed securities? We would have still had that quick recovery, because, the other fiscal stuff, the checks, the stimulus, unemployment support, all of that would have taken us back to full employment quickly. Your argument, I think, it’s the housing that took us beyond where we needed to be.

Klein: Inflation X housing goes back to 2%. Yes, you have this little spike. I’m reminded when I was in the Treasury Department at the beginning of the Obama administration, we were sitting down trying to forecast what the recovery would be, and I was introduced to Zarnowitz’s law, which may be, if assumption is the first most dangerous word in economics, “law” is the second, because this is not Einstein or Newtonian laws of physics. This is social science based on a small number of datasets. Zarnowitz’s law was the size of the recovery is proportional to the size of the recession. Mild recessions, mild recovery; sharp recessions, sharp rebounds. 

Lo and behold, COVID was a sharp recession, and a sharp rebound. ’08 was not; ’08 didn’t follow Zarnowitz’s law, which is why the Treasury, the CBO, OMB, private forecasts kept getting wrong the size of the rebound. There was all this expected situation. My take on why ’08 was different was financial crises are different than Federal Reserve-engineered recessions to control inflation, which was the vast majority of them. Except 1946, which had a sharp recession and recovery, which was the demobilization of the war. I actually think that’s the smarter analogy to COVID, because COVID was more like a war.

Beckworth: Yes. For sure.

Klein: In that world, you had a very big spike in inflation right after the war came over, because all the soldiers came back, and everybody wanted to chase a good time of what they’d been missing. Eventually, we got the baby boom as part of that and other aspects, and then it settled down. By the way, that sharp recovery and all that was why Truman was going to lose to Dewey, and the economy moved quite quickly in that situation.

My response to you would be, the story you’re telling about the stimulus checks can’t be the story of why the house prices went up a $100,000, orders of magnitude. You’re sending $2,000. You say, “Well, we should have sent $1,000 versus $2,000 versus $3,000 to people.” We can debate that. I’m a little more sympathetic that we didn’t overshoot as much. That’s not what caused a $200,000 house to become a $300,000 house.

Beckworth: It was the mortgage-backed security purchases.

Klein: Purchase and the asset. Then, when you strip housing, which is one group of things out from all the rest of inflationary goods and prices that you saw, you see the US inflation comes down to 2%, as opposed to the headline where it’s stuck at 3%, which was largely housing. As the Fed, in 2022, is still buying mortgage-backed securities in the name of COVID economic stimulus.

There’s a magnitude question, which you’re saying they just did too much COVID QE for too long when the underlying economy was helpful. That’s fine. That is not in tension with my very specific asset back point.

Beckworth: No, I think we’re saying the same thing here. I’ve had on the show George Hall, who’s had papers with Tom Sargent, and they’ve compared COVID as a big war effort, like World War I, World War II. What happens? You end up having to finance those expenditures somehow. Inflation is inevitably part of it. What you’re bringing to light, and the new angle, at least I’m seeing through your paper, is we could have had a robust recovery, even in the absence of the mortgage-backed securities. Is that a fair reading?

Klein: I think so.

Beckworth: I would argue the reason we had a robust recovery, and I think we could have had a quicker recovery even in 2008, if fiscal policy would have been as supportive in—

Klein: If Romer had gotten her way with $1.2 trillion—

Beckworth: Yes, I do.

Klein: —as opposed to the pushback that came from her within other parts of the Obama administration.

Beckworth: Absolutely. I know that’s strange for someone from Mercatus Center to be saying this. In my view, there’s many angles to financial stability. One of them, very simple, I’m a simple man, is stabilize the country’s nominal income. If people continue to receive their dollar incomes, make their payments on their debt, you don’t have as much. Now, there’s far more at work there.

That’s one thing that happened in 2020, 2021. Now, it was overdone. I think too much at some point. The idea is we’ve preserved nominal incomes. Had we done a better job in 2008, 2009, I think it would have been less severe as well. All that is to say is, it’s an interesting story to weave in what you’ve written that, yes, we did better on fiscal policy, monetary policy combination, but where we really overdid it was mortgage-backed securities, which would then put the blame back on the Fed, less so on fiscal policy.

I guess I had been arguing up until now, it was excessive fiscal policy. What you’re suggesting is, well, maybe it wasn’t excessive fiscal policy, it was excessive buying the mortgage-backed securities that really pushed us.

Klein: I think that’s right. One of the reasons I find your work so persuasive in many different ways is because it’s simple. Part of my argument is the simplicity. If you buy 90% of a market, you’re going to increase the price of that market good. It’s very difficult for me. Oh, well, let’s assume that doesn’t happen. Well, that’s really nice, but let’s live in the real world. Play through my mortgage element.

Everybody’s house price goes up a $100,000. That has a consumption effect. That has a wealth effect. It also makes buying a house out of reach for the next generation because what we’ve seen is the share of first-time home buyers has fallen drastically. The median age of the first-time home buyer has shot up. People got angry. They got angry that they had a track to buy a house, they’ve been saving for a down payment, and now that’s out of reach.

Housing is not just part of Section 14 of the Federal Reserve, because the GSEs are special; it’s because owning a house is part of this American dream concept. A lot of that anger about housing and affordability translated into the political anger of inflation. People tend to say, “Well, inflation makes people upset, and they don’t decompose the—

Beckworth: I see what you’re saying.

Klein: —different elements of inflation.” The argument about how much fiscal stimulus went into how much monetary policy stimulus is also an interesting question that, if I’m paying you more, there’s an equity element. One group of people owned their homes when COVID hit, and a group of people rented. The group of people that owned their homes when COVID hit, saw their house price go up $100,000, and they’re really happy. That group is older than the people on average who didn’t own their homes. Young people got angry. What did you see young people do in the last election? Change their voting patterns.

Beckworth: A few thoughts. One, you could argue based on what you’ve just said that the Federal Reserve helped get Trump elected.

Klein: Absolutely.

Beckworth: They didn’t mean that or know that.

Klein: I want to be very clear on this.

Beckworth: That’s not the point of your paper.

Klein: The Federal Reserve’s QE policies, et cetera, were done in a nonpartisan, best economic point of view. The consequences are a different story.

Beckworth: Right. Your point is the incredibly hard challenge of making a budget in this period, and it seems everything’s more expensive, was really being driven by and large by the cost of housing, being a big part of that. People are unhappy. They blame inflation, which things are more expensive, and then they vote for change at the office. We have this policy that made housing more expensive, but you would also still acknowledge all the other factors that’s been debated for years. We don’t build enough.

Klein: Oh, look, I’m a big YIMBY. I frequently, if you follow me on Twitter, will see that I get very angry in my very liberal enclave of Montgomery County, Maryland, where I was born, raised, lived my whole life. My kids go to the same middle school and high school I went to, that I’m furious that we have a liberal Trump who refuses to build new development and housing, and puts people away, and drives up the existing price under preserving neighborhood. All of those arguments on the supply side of housing are valid. I will point out that in the middle of the pandemic is not necessarily when you’re going to—

Beckworth: Right. On top of that.

Klein: —build a bunch of housing. Those things are a different situation. The structural long-term consequences of our housing supply mismatch, which is a geographic situation, which is also, to a large degree, a transfer-of-wealth point of view. My neighborhood, which votes very liberal, but then zones very conservative, will say, “Oh, well, if you allow more dense housing development, you’re going to hurt my property value.”

“Okay, well, yes, and I’m going to create an opportunity for my kids to live in the neighborhood that they grew up in.” You know what? My house may be worth less. That’s okay. Part of my point when I was getting to before, is by increasing everybody’s asset price, when you have asset bubbles, they’re very tricky to deflate, because deflating asset values make people appear to lose money.

Everybody talks about, “Oh, the stock market went down. All this wealth was destroyed.” Nothing was destroyed. I didn’t create something and blow it up. It’s just what we decide something is worth on a trading market-to-market basis. What we’re pricing to is the marginal share of the last good transacted, which is different than the liquidation value of all sales were trying to be done at once.

Yet when we do a market capitalization, we pretend that all things could be sold at the same price of the top marginal value. This is how crypto companies are able to radically inflate the market capitalization of their coins when, in point of fact, only a thin share of their coins that could be issued are being issued at any one time. It’s a fundamental problem with the view of market capitalization, but my point is it creates a political entitlement that becomes much trickier to handle, particularly as it relates to housing, which is the largest source of wealth for the vast majority of Americans.

Beckworth: We recently had on Mike Bird on the podcast, he has a new book called The Land Trap, and he goes through the history, not just in the US, but all around the world. This is an issue that vexes governments, because housing is both an asset, it’s something people save for retirement, but it’s also a consumption good. It’s an investment good, a consumption good, and there’s a tension.

Where do we err? Where do we lean? In recent decades, we’ve been leaning more toward the asset investment side, but this comes as a cost. As he noted in his book, it’s a damned if you do, damned if you don’t situation because, if we allow prices to go up, well, there’s someone who’s getting left behind. If prices fall dramatically, we could end up in 2008, so it’s a tough nut to crack.

Klein: It’s a difficult thing, and this is why it’s so pernicious that we one time ratcheted up the median home price by $100,000, which is a big number, right?

Beckworth: That’s huge.

Klein: People have to understand this $100,000 price. The median home price when COVID started was a little bit under $275,000. Now, it’s $375,000. This isn’t $100,000 on a million-dollar home. This is $275,000 to $375,000. This is a massive change over its core base, which pushes homeownership out of reach for a lot of people. Now, you can’t really ratchet it down without having all these other negative consequences.

How are you going to save for a down payment? Because now you’re 10% or 20% down or whatever you want to do has gone up substantially. This is the median house in America. Again, for people who are living in Montgomery County, Maryland, you may go, “$375,000 sounds like a steal.” It’s hard to find any place that does that. Across the country, you went from $275,000 to $375,000 very quickly under the guise of COVID relief. It’s going to be very difficult to unwind that situation. 

One last thing I want to say is, as a public sector economist, one of the other benefits of housing is investment in the community. I care about my community. Homeowners care a little different than renters about the long-term benefits of their society. They’re a little more vested. It’s one of the reasons we subsidize homeownership in America.

One may argue we’ve overshot that in terms of the tax code and other preferences to mortgages, as opposed to other forms of debt, but it is difficult to underscore that when you own your home, you view yourself and you view your community a little bit differently, and that has a positive externality toward your neighbors.

Beckworth: Absolutely. Let me add, as a parent, and we’re both parents, I have kids in college about to graduate. I also think about their future homeownership prospects. This is very near and dear to me as well. 

Fed Assets

Okay, let’s bring this full circle here. Going back to the Fed, what would you recommend they be able to buy in a crisis? What would be acceptable assets for QE?

Klein: That’s a very good question. First of all, I want to commend the Fed. I thought they took my argument very seriously. Chairman Powell addressed this paper, direct citation in the NAIB conference, and even though he defended the Fed’s action, I decoded that Fed speak as a, “Hey, listen, we’re hearing this criticism, and we’re reviewing it because we think you may have a point.”

I think as it relates to monetary policy, the Fed has followed the law, acted in its best judgment. It doesn’t always get everything right. Umpires don’t get 100% of the calls right in a game. That’s fine. They’re calling balls and strikes at their best judgment. It’s a tough job. I give a lot of sympathy for the Fed, and they’re following it, and they’re behaving by the law on this element of QE.

I think they need to do a few things. One, they need to revisit the basic assumption about what QE impacts it has on the types of assets it purchases. Two, Congress could consider changing Section 14. The Fed could have done some of these things through a Section 13(3) facility. They were not shy in using their 13(3) authority under COVID, and Congress was not shy in providing resources to the Fed to do that.

Look, the Fed bailed out junk bondholders in the name of COVID relief, which I thought it was a mistake. I think we have a little too much car seat capitalism from the Fed, where they don’t want holders of institutional wealth to lose money. I’m a little less focused on financial stability, and a little more focused on risk-based pricing, as you might say, which may be odd for a liberal to say, that I want to have a situation where when you make a bad decision, you bear the consequences as a holder of junk bonds.

I do think that we ought to also stop financializing our responses to recessions. I think Congress over-learned the lesson of the financial crisis, which is, “Oh, wow, we can use the central bank to stimulate the economy.” A financial crisis was very different than COVID. Congress putting all this CARES Act money for the Fed, did that help Main Street businesses? No. The Fed couldn’t figure out how to generate Main Street businesses through a 13(3) facility, because it’s not the right way to do it.

Congress erred in pushing that to the Fed. I don’t fault the Fed for not being able to figure it out, because it’s not the workable way. Now, what I do fault is, I take a step back and go, “Well, you could work out a way to help junk bondholders, but not Main Street businesses.” Junk bond traders got rich, and Main Street businesses suffered, and that makes my broader critique about the inequality of society that much worse.

I don’t fault the Fed, because, you should have given folks directly money. Why were we doing PPP through banks? Why were we giving small business loans, loans, grants? We gave grants to small businesses through banks disguised as loans in PPP. In TARP, we gave loans to banks disguised as grants under the capital injection program. One is very popular, the other isn’t. One cost the taxpayers hundreds of billions of dollars, particularly in outright fraud.

The other made a net profit for taxpayers. TARP made a net profit for taxpayers in money that was lent to banks, repaid in interest. The Paycheck Protection Program had guys in jail cashing fraudulent PPP loans. Sometimes you drive around, and you’ll see a Ferrari with the license plate “PPP”. It makes me throw up in my mouth, just like when the Lakers qualified as a small business, and took out a PPP to pay LeBron’s salary. I think LeBron was okay through COVID.

Look, I think the central bank was asked to do too much under COVID. I put part of that blame in Congress. I think the Fed needs to fundamentally reassess its QE assumptions under the underlying model. I think we could learn a little bit from the rest of the world. ’08 was a little different in the US. COVID was pretty global. I wish we kept our schools open like Sweden. I wish that we’d learned a little bit about how other central banks had done.

Frankly, I think we ought to be a little less worried about upsetting markets in day trading, and a little more cognizant of the impacts. People like Kristin Forbes recognized this COVID housing thing in real time as it was happening. I think people inside the Fed had some questions about it. “Oh, but we got to give them a long runway. We got to announce with a lot of clarity. We can’t upset the markets.”

Hey, listen, if you’re trading and bond speculating, traders can lose too. I think we could have nipped that in the bud faster, if we’d been a little bit more engaged. If there’s a temper tantrum in the markets, okay, people are going to lose money. I don’t think the Fed’s goal is that bonuses on Wall Street should be high. As we said earlier, I think the Fed’s goal is that people should be able to access their own money that they’ve worked for and earned, so that they can buy a Christmas gift for their kid, and not have to eat an overdraft fee.

Beckworth: Yes. A little bit of volatility is actually good, because it leads to price discovery, and adjustments based on what’s happening around us. Now, let me end on this question, because you made this great point. We could learn from the rest of the world. I want to go back to what should the Fed be buying, what type of assets? There are different models out there.

The US, the model is focused mostly on, well, let’s just buy government securities, because from a consolidated government budget balance perspective, it’s a wash. We’re just swapping one asset of government for another. The UK has this perspective. If you go to Germany, the ECB, they say, “No, don’t take that approach. A more neutral approach would be to buy a portfolio of asset that represents typical investment out there in the market.” They would involve some corporate securities, other instruments. They would say, “If anything, the US model weights government securities.” The US said, “No, we’re being neutral. We’re just buying government. We’re not tapping into the private market.” Europeans would say, “We’re being neutral.” What do you think?

Klein: I think a couple different things. First, I think we should rely less on QE. I think that we’ve overly financialized our responses to these questions. I think we should focus a little bit more on, as you point out, fiscal policy directly impacting people. I don’t think the answer to COVID is to worry about junk bond issuances. I think we’ve, one, over-focused on quantitative easing as a solution to recessionary and other problems.

Two, I think the government accounting stuff is somewhat insane, right? Some of this stuff is predicated on Fannie and Freddie having been private companies, and maybe they’ll be private companies again, and we have this weird government accounting that, like, Fannie Mae books a profit, but then that profit is swept back into the taxpayer, because they took out 79.9% of common ownership.

Then, Fannie has one set of books, and they are sending money back. The Federal Reserve has a different accounting system, which you’re an expert on. They’re sending money back, or they’re losing money, or it’s getting very confusing. Then, Treasuries are paying interest to the Fed, who’s paying interest to remitting it back to Treasuries. It gets very confusing very quickly. I’m a little more cognizant. I think the European model has more to point out.

I think you also have to step back and ask, what are the magnitudes of these things? Magnitudes matter. If the Fed had bought 9% of mortgage-backed securities, I don’t think I would have written my paper. I also don’t think housing prices would have gone up from $275,000 to $375,000. When you buy 90% of an asset, you are going to change that asset’s price value. Part of the answer to your question about what to buy is, what is the magnitude of the purchases that are coming online? That should correlate to that.

Beckworth: To be fair to the Europeans, one of the reasons they had to go broad, and again, they would argue it’s neutral, but practically, they had to go broad in terms of assets, because there wasn’t as much government debt in the first place, so they had to start buying up private securities.

Klein: One, I think we’re going to have to worry about too much government debt for a long time. When I started in Congress in 2001, Alan Greenspan was afraid that the government was going to pay off its debt too quickly, and accumulate private assets. That’s why he supported very large tax cuts that created the structural deficit. An example of the Fed, in my opinion, going beyond its lane, and green-lighting a disastrous fiscal policy, which has let too much debt on the marketplace, in my opinion, particularly debt that went into the wrong types of investment.

There’s good debt and bad debt. There’s borrowing debt to finance your future, and then there’s borrowing debt to speculate on a third condo that is getting flipped in Miami, or the price of a meme coin, or a Beanie Baby, or other things like that. I do distinguish between borrowing to fund cancer research and borrowing to fund at-present consumption.

Beckworth: With that, our time is up. Our guest today has been Aaron Klein. Aaron, thank you so much for coming back on the program.

Klein: It’s been a pleasure. Thank you for having me back.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show @Macro_Musings.