JW Verret is an associate law professor at the Antonin Scalia School of Law at George Mason University and a senior affiliated scholar at the Mercatus Center. Previously, he served as the chief economist on the House Financial Services Committee. He joins Macro Musings to discuss his experience working on Capitol Hill and his thoughts on the CHOICE Act, the current legislation designed to replace the Dodd-Frank Act.
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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: JW, welcome to the show.
JW Verret: Thank you, David. It's good to be here. Big fan.
Beckworth: It's great to have you on. We've worked together before on some projects, but I want to hear about your journey into finance and economics and how you got involved with Capitol Hill and your work on policy.
Verret: Well, I started teaching at George Mason Law School in 2008, September 2008. And, came as a securities in corporate and banking law professor, right at the height of the crisis, at the height of the meltdown.
Beckworth: Great timing.
Verret: I was first learning how to teach banking law when Lehman, the same week that Lehman went down.
Verret: So, I came across the … from Mercatus Center, and I said, "Hey guys, I'd like to get involved in the action across the river." And they said, "Yeah, we can definitely figure that out." And I think, from there the next 12 months, I think I testified in Congress six or seven times, did a lot of CSPAN, a lot of op-eds and kind of got into the policy side of the academic life. So, I've kind of had two, a leg on each side of the Potomac, really. One in the academic here at George Mason, and then the other on the goings on in Washington. And so, when I had a chance from 2013 to 2015 to go work for Jeb Hensarling, on the House Financial Services Committee, on the hundredth anniversary of the Federal Reserve and work on a Federal Reserve Oversight Project, I took it.
Beckworth: Very interesting. So, you had a good run there. Now, why did you come back? You wanted to maintain your tenure clock here?
Verret: That's right. I was actually still untenured at the time. Everybody said it's crazy, "You don't go for leave to go work on the Hill when you're untenured."
Verret: But, my dean was supportive, my faculty was supportive, and I kept publishing while I was up there too, which was hard but, they have recess so, you know, you can try to write during recess but yeah, it was a lot of fun.
Beckworth: Well great. Well let's talk about your life as the chief economist for the House Financial Services Committee. What was day to day life like? What did you do?
Verret: Well, I was a committee staffer. So, that meant, I was sort of like a resident scholar, I guess, there. Chairman Hensarling wanted a lot of material for every hearing we put together. And, my job was to put together the Federal Reserve reform legislation, and base it on a series of hearings into the history of the Fed, and the basics of monetary policy, and its impacts and all sorts of areas from seniors and savers to international impacts. And so, we held some 15 hearings I think over the course of a year. So, I put together briefing books for the hearings for all the members that, you know, sort of 100 page books full of suggested questions, and background, and that sort of stuff.
Verret: Then, we put together the hearings. And, you know, my first hearing a few weeks into it was the Humphrey–Hawkins hearing. A few days before we had breakfast with Bernanke. So, I showed up, and it was an incredible, cool thing. Four of us were there. Chairman Hensarling and I was sort of his back up guy, and then Bernanke brought a guy, and we all sat down at breakfast. And, I showed up that morning wearing a heritage tie, and a blue suit, and cowboy boots. And Jeb Hensarling had on, I kid you not, a heritage tie, blue suit and cowboy boots. And, he looks at me and he's like, "Well I guess we picked you for a reason."
Beckworth: You got the memo.
Verret: That's right. That's right.
Beckworth: Well that's awesome.
Beckworth: So, just for our listeners, many of them know this, but explain what the Humphrey-Hawkins hearings are about, and how often do they happen?
Verret: Well twice a year, the Fed chairman comes up to testify in Congress. And, they alternate every six months which chamber in the House or the Senate goes first. So, it's always more fun to have the first hearing. So, that was always a project on the back burner to get ready for the next Humphrey–Hawkins. And then, we had a series of hearings. My first one actually, I want to mention because Allan Meltzer was my first witness at my first big hearing. I had known Allan when I spent some time at Hoover. I was always a big fan of his work, and read all the histories and loved him.
Verret: And so, I'm all excited and I say, "Allan, you know what? I took leave to come here and I'm doing this project on the 100 year anniversary of the Fed." And he, in his Brooklyn accent, he takes me by the hand and he looks up at the wall at a photo of an old chairman of the Financial Services Committee. He said, "Don't get your hopes up, kid. On the 50th anniversary of the Fed I did the same thing for that guy, and it's a long road, you know." It's kind of like, "Wow." That's...
Beckworth: That's neat. Yeah.
Verret: That's amazing, yeah.
Beckworth: And, we had him on the podcast actually not too long before he passed away. A really good ... Even in his old age he was really sharp, I mean, a lot of fun. Good sense of humor. So, it was … to meet him, and I imagine to work with him would've been a great experience, too.
Verret: It was. It was.
Beckworth: So, you have the Fed come in twice a year with Humphrey–Hawkins, and, you know, that's something that someone like myself who follows Fed closely, and I get on Twitter, follow other Federal watchers, you have the hearings. And, it's been my experience that sometimes, oftentimes, many of the people in Congress are not well informed about monetary policy, because it's a hard topic. I mean, you know, it's difficult. So, your job was to inform them, get them up to speed. Did you get frustrated, did you get a sense that they weren't reading your briefing books, or do you think that they did? What is your sense of the level of engagement between the average congressperson and Fed policy?
Verret: Yeah it depends. Some of them were more engaged than others. I would say some of the rockstars though, were amazing. Mick Mulvaney, who is now the OMB director, was a junior member at the time. And, he wouldn't even always necessarily get time at the Humphrey–Hawkins, but when he did he ran with it, man. He did some incredible things with his time. Mastery of monetary policy, but also, you know, knowing that prosecutor skill of how do you get something meaningful out of five minutes of time, when the Fed chairman has already been well prepped to filibuster as much of that time as humanly possible. And, they're very good at that. Especially Chair Yellen I think.
Beckworth: They're very good at officiating and not giving a clear answer and hedging, and... Yeah.
Verret: That's right. And, Chair Yellen is especially good at looking the congressman in the eye, seeing the congressmen prompts that he wants to get back to his question, looking him in the eye, and just continuing to talk with a nice, soft smile on, and just eating up as much of that five minutes as possible.
Beckworth: So, what you're saying is she's looking at him and in her mind she's going, "Burn." I caught that.
Verret: Well maybe.
Beckworth: Well, that's my interpretation of the events, right? Okay. Now, you've worked with government officials. You mentioned you've met Ben Bernanke over breakfast. Did you ever go to dinner with Janet Yellen?
Verret: Breakfast with Janet Yellen, yes.
Beckworth: Janet Yellen, too?
Beckworth: So, I mean, are you guys like, is it formal? Are you shooting the bull? Or, is it kind of like, "Hey, what's up, Chair Yellen?" Or...
Verret: Well the first time with breakfast with Chairman Bernanke I was new, so I stayed quiet, and I just listened and watched. A year later, I guess it must have been a year and a half later or so, breakfast with Chair Yellen, I talked for about 45 minutes asking her questions. Everybody had finished their breakfast except her, because I was asking her, "What about the stress test, ma'am? We need more transparency on the stress test."
Verret: And she was saying, "Well no, no, no. We don't need transparency around the stress tests. It's better if they don't know how we're grading them." And I said, "No that makes it a bad test." She's like, "Well they'll just, you know, prep for the test." I'm like, "Yeah, if it's a good test, the right test, they'll prep for the test." You know? Anyway, Chairman Hensarling was nice to give me some leash in some of those and we had some fun.
Beckworth: Well, would Hensarling, you know, "Hey Bernanke." You know, "How're your kids?" That kind of casual conversation? Or, was it always business?
Verret: He's a pretty substantive guy.
Verret: And, he's very well read. You know, it would amaze me sometimes when I would be working on a draft, getting ready for the Humphrey–Hawkins, and I'd get comments from Chairman Hensarling, and it would be like, "Footnote 58 like, did you see this IMF study? Wanted you to incorporate this into the draft." I'd be like, “you're out raising money, and having hearings and doing all that." Yeah, he was very substantive. So, it was a treat to work for us. He's definitely a guy, when he retires from Congress I hope he comes and runs a think tank here in Washington, because he'd be good at that.
Beckworth: Okay. That raises the question, how does someone like Representative Hensarling get on the committee? I know there's seniority issues, but you got to probably have some kind of interest. How do you find, you know, if I'm the House leader, how do I find people who are desiring, and have the ability to run a committee like that?
Verret: Yeah, well he had been on the committee a while. And, I think he had worked under Senator Phil Gramm. And, Phil Gramm is kind of like lion of banking loan reform, you know, on the Republican side. So, he had been a mentee of Phil Gramm's. And, I imagine he got to the Financial Services Committee probably right away is my guess, or soon. And, he just rose up kind of through the committee, and impressed his colleagues. It's not a pure seniority system, it's from among the more senior members to House Hearing Committee typically chooses the next chairman.
Beckworth: So, you've got to show an interest, be there for a while... Okay. So, it's both merit and seniority-
Verret: Yeah, probably a combination.
Beckworth: ... a combination of the two.
Beckworth: Very interesting. Let me ask this question though, not to get all cynical on Congress but, I get the sense that sometimes they are trying to score points with their people back at home. They may say things that...
Verret: The Constitution was designed to force them to do that.
Beckworth: You know, they say things that are outlandish but, you know, it's going to be a bone to your constituency back home. And, you just bashed the Fed chair, and they're like, "Yeah that's my representative," you know? Is that fair to say that happens?
Verret: Do members look for in every hearing, not just Humphrey–Hawkins, do they look for a clip to send back to the local TV station show? But, you know, I like to tell when I go home to my family, they're cynical of Washington too. I like to say, "Washington's just a mirror. Washington just reflects what we are, what the median voter wants, or thinks they want." Which there's often quite a disconnect between them. But, Washington's just a mirror, and the Constitution designed it that way because, the thing we had before that, was a king who didn't care what his constituents often thought. So, we got the system we wanted.
Beckworth: Okay. All right. Well, let's move on to some specific issues that have been before the committee. The Fed policy in particular here. I know there's banking issues you dealt with, as well.
Beckworth: At least on the Republican side, what were the big issues that they were concerned about? We'll talk about rules based policy a little bit later in the show, but were Republicans concerned about the quantity of easing program? Were they concerned about interest on reserves when you were there?
Monetary Policy Issues for the Republican Party
Verret: Yeah, both of those. And I think, you know, in part, I think our interest in that, and also on the development of reverse repos as an alternative tool of policy. For a time the Fed was flirting with building up the reverse repo program as essentially a standalone tool for monetary policy co-equal with the others. We pushed back very strongly on that notion. I think our goal was to get back to the world of beyond Greenspan Fed, and get back to simply just using the Fed funds rate as the chief tool of policy. Making it clear what the Fed's planning to do, moving towards something like a Taylor rule based approach, or any kind of a rule based approach, getting rid of hide the ball games that they play now, and pretend are clear entrance…
Beckworth: So, the Fed has always been clearly wanted to shrink the balance sheet, but that is something that I imagine you pushed anyways, because they, you know, the deadline for the shrinking of the balance sheet always got pushed back every year.
Verret: It's funny how that happens.
Beckworth: Yeah. I mean even QE, and right now as you know, they've set, in fact are surprisingly clear benchmarks for how much they're going to reduce every month, which, you know, kind of confines them. Right? They've kind of put it on a straight jacket with this release they gave a few months ago that tells how many dollars they're going to, you know, pull out of the system with their running off of investments.
Verret: I would say another primary concern was the Fed's involvement in credit policy, which is to say, you know, the investment of the huge MBS portfolio, the Fed holds. And, the fact that the Fed is getting involved in the subsidization of housing through his decision to go beyond just treasuries. I think we were very concerned about that. Because, it's a very small step to go from that to buying up the debt of Detroit, or Illinois.
Verret: Right now, there's just one or two voices in the house pushing for that, members from Detroit, very liberal members from Detroit, but their voice is going to grow over time, as the state based pension crisis slowly, you know, emulates over the next couple of decades. And, I think whatever statutory authorization limits the Fed from doing so, they're free to ignore. And, they have in the past with 13-3, which we can talk about too. The Fed is very good at reading the law and saying, you know, I think we actually do have the authority to do whatever we want…
Beckworth: You know, to take their side on this, that was a crisis time. I would suspect that they too would be very concerned about going down that slippery slope.
Verret: Right now they are.
Beckworth: They don't want to buy a Detroit. They don't want to buy Illinois. I mean, they don't… these localities...
Verret: But, ten years ago, you would say, "They don't want to buy Fannie and Freddie's junk?"
Beckworth: No. I agree. No one would have guessed that they would have bought that, but even the plans they have now, I mean, on their behalf, they're going to shrink their balance down just to treasury holdings. Right?
Verret: Yeah. That's the plan for now.
Beckworth: And, you can be skeptical and say, "Well, let's see if it happens." Right?
Beckworth: Right. But again, the fact that they're talking so much about it, they have explicit plans, and it signals to me, they're pretty serious about going down a path. And, my views have evolved on QE. I thought QE actually was going to pack a big punch. I don't think it did that much. I think winding it down won't make that much difference either. Other than I mean, look, there's been a lot of studies that show that it did lower yields on the margin. It does affect, you know, spreads and credit. But I think overall, I think the real influence on the economy is going to be when they alter the interest rates. But in any event... So, one last thing, interests on reserves. So, what was the committee's concern with the use of that tool by the Fed?
Verret: Well, you know, I think part of the interest in that tool is political, was just that this is something we can... The sophisticated critiques of the Fed are hard to message back home, but this is something that messages back home. I mean, the reality of interest on reserves is number one, the Feds paying interest, paying banks not to lend. It's not exactly true, but it's mostly true, paying banks not to lend.
Verret: And, the majority of the recipients of that are foreign banks, right? So, the Feds paying foreign banks not to lend money. And, they're paying quite a lot to them. So, that was the kind of cheap political critique, and they're going to continue to do that. And, that's Congress, and that's how it goes. But, I think part of it too is just a desire to bring the Fed back to the simple, okay. You know, Fed funds rate based monetary policy.
Verret: Yeah. That's right. Although we included in the rule based policy legislation, we included that if the Feds decided to use that as a primary tool of policy, it needs to develop a rule around that variable, rather than the Fed funds rate if that's what's going on.
Beckworth: SO, as long as they have some outline plan, it's systematic. But on that issue, I thought... Maybe I got this idea from you in some previous conversation, but I've always thought interest on reserves are horrible optics, politically toxic optics.
Verret: Yeah. Sure.
Beckworth: Particularly in the future, if the Fed doesn't shrink its balance sheet, and interest rates eventually do go up, an absolute dollar amounts being paid are going to get larger and larger. I just imagined that the backlash, and as you mentioned, and I've looked at the data too, and I made a graph, I posted on my blog a while back, but most of the excess reserves, most of the payment is either to foreign banks, or large domestic banks.
Verret: Yeah. Sure.
Beckworth: And, who was bailed out, was the large domestic banks. So, the banks you build out and foreign banks are sort of the ones getting interest on reserve payments. So, even if you wanted to keep it as a tool, there's theoretical reasons, I think it's a good idea. It's just bad optics. Is that a fair assessment?
Verret: Yeah. I think it's fair to make a clear statutory critique as well that the amendment in, I believe it was 2008 or 2007, that gave the Federal Reserve the authority to pay interest on reserves, was never intended to be a tool of policy. I mean, that was just a sort of a throwaway thing to pay people for keeping reserves. And, it also... Notably, one of the changes we included in the format is right now technically, interest on reserves are not set by the FMC. They're set by the Fed board. This would be quite a scandal, but if the Fed chairman decided to use that as a primary tool policy, they could say, "Well, the FMC has no say in interest on excess reserves. Only the Fed board does."
Beckworth: But interesting, George Selgin's critique of initial reserves also is that, they're supposed to be set interest on reserves, actual payment rate is statistically equal to market rates.
Verret: And, they're notably higher right now, than really short term treasury rates. And so, that violates, he says the laws. Well, but he also thinks more fundamentally it's an economic problem down the road if they begin to shrink the balance sheet. His critique is, you know, the economic one is that if they begin to shrink the balance sheet, they're pulling bank reserves out. You know, as those investments run off, they're effectively pulling reserves out of the banking system, those excess reserves.
Verret: And right now, excess reserves are getting higher interests, higher yield than our treasuries, short term treasuries. The new liquidity coverage ratio however, requires you have to hold one of those two. Those are the top tier assets for regulatory purposes. So, if I'm a bank, and I have to hold these safe assets, either treasuries or reserves. And, reserves pay more because under some reserves there's higher... And, treasury bills, there's a real demand for reserves, at the same time, the Fed is going to be pulling them out of circulation. And, George's worried that's going to create some real economics, and financial stress. So...
Beckworth: Which is usually right.
Verret: Yeah. Well, he was my main professor, so I'll defer to him on that.
Beckworth: All right, let me go onto another very interesting story that you're a part of. Since you are a lawyer, and you're a part of the House Financial Services Committee, there is a real interesting development that took place. I believe it began in 2012, and that's the Medley Global Advisors scandal.
Verret: Right. Naughty. Naughty.
Beckworth: Naughty. Naughty. Okay. So, tell our listeners what exactly happened and where does it stand today?
The Medley Global Advisors Scandal
Verret: Well, I got involved in the... I started, I guess at a staff level, an investigation into this leak of FOMC information by someone at the Federal Reserve. I got to be honest, I wasn't the real scoop. A journalist scooped this, Craig Torres at Bloomberg wrote this up. And, the day I saw it in the paper, I went back to my crew and I said, "What is this?" This is something that happened like three, at the time, it was three years ago. And, it seems like the Federal Reserve has done nothing. I think we should look into the Federal service response to this leak of confidential FOMC information.
Beckworth: Well, this real quick, explain to our listeners who may not understand, why is it important that this information not be linked? Why does it matter... Why do we care that the Fed keeps everything concealed?
Verret: Yeah. This is market moving information. The information that was leaked by a political intelligence person was market moving information. It was specifics about the QE tapering program, and exactly how it would work. That language was clearly leaked to a political intelligence firm who sold it to their clients. So, you had some really rich clients getting preferential access. Part of the problem is preferential access. Part of the problem is, it probably distorted in some way the Feds intended, you know, sort of affect some crazy trading before the actual. But, more than anything else, I'm pretty sure it's insider trading under the stock act. So, it's a crime. It's a felony. It's a felony.
Beckworth: Right. Pretty serious then.
Verret: So, what did the Fed do? So, I had a few questions. The first question I had for the Federal Reserve was, you've encountered this before in the 90s. In the 90s when you encountered it, you immediately called the FBI. You didn't do that this time. Scott Alvarez, who was general counsel Federal Reserve, did not call the FBI to say, "Hey, we think something bad happened. Someone leaked FLMC information and someone else profited off of it." They called the FBI in the 90s, but they didn't call the FBI this time. Why not? Why did you just sit on it? What didn't you tell the SEC or the CFTC or the DOJ or any of those people? And, what did you do? Right? So, we looked into it, and we found out what the Federal Reserve did was, the general counsel sent out a survey to a number of folks and said, "Did you do it?"
Beckworth: A survey?
Verret: A survey. They sent out a survey. They sent out a survey and said, "Was it you. Did you do it?" And...
Beckworth: Just tell me it wasn't an anonymous survey.
Verret: No. No.
Beckworth: Isn't that bad?
Verret: And, it came back and Alvarez went back to the FOMC and said, yeah, we did the survey. And, nobody said it was them. So, that's all we got. And, that was it. That was all that happened until months later, someone went to the Fed IG and said, "Look, this is a problem." And, we know that at least one member, I've heard from folks I've talked to, at least one member of the FOMC went to Bernanke's offices and said, "This is ridiculous. We can't just leave this here." And, sort of stormed out. So, I don't know who it was, whether it was a board member or not, but... And, incidentally, everything I'm telling you is it contained in stuff that's already public, either the new stories, or the Fed's own releases that we forced them to give about what they've done.
Verret: Anyway, someone goes to the Fed IG and says, you got to investigate this. So, the Fed IG starts something, and about a year later they stop and they say, "It's inconclusive." So, a year and a half after that, Craig Torres does this story, and I start developing some investigative material. And, ultimately we subpoena the Fed for information about their own investigation. And, the Fed IG says, "We reopened the investigation. It's completely irrelevant that a month before we reopen it, you open this inquiry. We just reopened it." And one of the things they used, the Fed knows every trick in the book. One of the things that the Fed IG says is, "Alas, we cannot provide you with information about our investigation, because it's an open investigation." We said, "You just opened it because we just asked you about it."
Verret: And, they said, "Yeah, I know. Sorry, we've got new... New facts have come to light coincidentally, so we can't share information with you because of our open investigation." So anyway, around that time, around the time the subpoenas went down, I had to miss the rest of the fun, and come back to teaching. And, I had to watch from the sidelines. But just, what an incredible abuse of power, not to just call the FBI, you know. Who were they protecting? And, after I left, it came out. One of the people that had regular contact with this political intelligence firm was, Janet Yellen when she was vice chairman.
Verret: And the time of this investigation, was the time the original IG investigation, when the Fed did nothing, didn't call the FBI. It was around the time Janet Yellen's confirmation was just starting to begin. So, I wonder if concerns about them political risk from making that public were mentioned, or were in the mind of the Fed when they decided not to do anything further. It's just incredible to me that they sat on this for a long time until we poked them, and prodded them, and eventually, you know, we've had some news that something happened from that.
Beckworth: Well, so did the health services committee eventually get back to pursuing this, or they continually sideline because of the Fed's own investigation.
Verret: I know they sent a subpoena. I don't know what was sent to the house in response to the subpoena, because that was after I left. And also, it probably would be something I'd be prohibited from talking about, even if I did know.
Beckworth: Okay. Well, we're keeping this really above board here, all public information. So, one of the big things that did come out of this was that Federal Reserve Bank of Richmond, president Jeffrey Lacker resigned. He was about to retire anyways, but he resigned because he accidentally, or let it slip. Now, what we know is, he wasn't the original source, but he confirmed to this political intelligence from the medley global advisors from the information they already knew.
Beckworth: And, Pedro de Costa at business insider, who's also Wall Street Journal previously has been on top of this. And, he has, you know, some pretty a skating pieces. He's written about this piece. And, he says like Jeffrey Lacker is the fall guy, he's the patsy. He's the guy taking all the blame and, you know, he gets real critical. He says, look, the Fed is using him, you know, he's the target. Let him, takes the fall, wash their hands and move on.
Beckworth: But, he quotes Lacker’s own statement here, and he says, "Look, what Lacker said is that he just unwittingly confirmed the information about the Fed deliberations already out there." That means someone else is still guilty.
Verret: The primary source.
Beckworth: Yeah. And so, that's where the investigation hangs right now. That's where we are standing.
Verret: And, I think he's right. I think there is a second gunman.
Beckworth: Yeah. Well, you know this gets to another question, and I know actually we've talked about this before, when the Lacker event took place. And, you know, you know a little more about the scenario, but I felt some sympathy for Lacker. If I can imagine, you know, if someone's a Fed president, and you talk to newspapers, you talked to people. In fact, Ben Bernanke had a famous episode soon after he became Fed chair, I believe it was Maria Bartiromo who was at CNBC at the time, may have been someone else who was talking to her at a dinner, and accidentally said a few words then she told the world, you know, "It seems like to me be very easy to accidentally let something slip if you're at the Fed. I mean, you know, it's not like you're the CIA, you know, you'd keep your mouth shut. You're at the Fed, you interact with market observers. And I think, a takeaway for me from this, so this is why rules-based is important, when you're interacting, when there's a lot of discretion, it opens up the door, or the opportunity to be sloppy, to be careless.
Verret: But, with rules-based policy, none of this would matter. It wouldn't. Unless there was some major change in the rule, which…
Beckworth: Right. Right.
Verret: It would all be... Everybody would know what's going to happen at the Fed meeting.
Beckworth: Right. So, if you want to get away, so there's no point to … So, again, I had some sympathy for Lacker.
Verret: I was heartbroken, because he was a, I guess you could say an ally of the house federal services committee. We talked to him and his staff very often. And they were, you know, they're very hawkish traditionally. And, they were not, I think supporters of our legislation. They weren't willing to endorse it publicly, but they were supportive of our restrictions on 13-3, statutory restriction, 13-3 that we developed. And, we got some feedback from them about my language. He's a very nice guy. I got to know him, and I was kind of heartbroken. And when it happened, I told him, "You know, I'm glad I did what I did, but I'm sorry to see that this impacted you in this way." And to his credit, he said, "I'm glad you did what you did, and I'm glad you reopen this because it needed to be done.
Beckworth: Good for him.
Verret: Nice to him to say. Good guy, he's going to bounce back I'm sure.
Beckworth: He was about to retire anyways. Right? That's my understanding. So, just kind of turn the clock a little faster for him.
Beckworth: Well, let's move on to some other interesting developments. So, president Trump has, you know, several opportunities in front of him in terms of picking people to the Board of Governors at the Federal Reserve, who will lead our, both the Fed chairs coming up and, you know, it’s hard to know from when they … really thinks. Because, one day he likes Janet Yellen, the next day he doesn’t. I mean, recently the talk has been Gary Cohn, his advisor might be the Fed sheriff. But, let’s talk about some people underneath that position. So, Randy Quarles has been actually nominated. He actually has had a hearing. So, we have one person in the pipeline for sure.
Fed Board of Governors Nominees
Verret: He is a brilliant banking lawyer.
Beckworth: Yeah. Tell me what you think about him.
Verret: Yeah, I've known him for I guess about five years now. And, I have the tremendous amount of respect for him. He's a brilliant banking lawyer. He got his start at Davis-Polk, which is kind of the top banking law firm in the country. One of the two, I guess, Sullivan-Cromwell and Davis-Polk are the two big ones. So, he got his start there, and then he's been at treasury, and a couple of stints at Treasury. You know, he institutionally knows the Federal Reserve and Treasury better than anybody. Now, he's got great old stories about Nicholas Brady and interacting with secretary Brady, and, you know, the Fed’s in his family, his wife's great uncle was Marriner Eccles.
Verret: So, but personally he's a humble guy. He's a brilliant and humble guy, which I think is a good switch from what we had before at the Fed in that role, which was probably I think a brilliant and maybe not so humble guy in now professor Tarullo. And … brilliant guy, but I think everybody sort of says he threw his weight around quite a bit. Randy's the opposite of that. He's going to be a consensus builder. And, he's a humble, brilliant guy. He's perfect for that position. And then, more of a good friend too
Beckworth: Yeah. Tell us about him.
Verret: Yeah, he's great. At that first hearing where we had Allan Meltzer there, I also had [inaudible] there as a witness. And, a lot of congressmen mentioned during the hearing we have professor Meltzer, and then we have the Allan Meltzer, professor of economics here next standing next to you and Marvin Goodfriend. And, Marvin was the other one, those hearings. And, he was terrific. That was the first time he'd ever testified in Washington. And so, he was new to that, and he was like, "How does this work? What do I say? What do I do?" And, he's come a long way now. He's going to be a great governor. And...
Beckworth: Real quick though, I haven't heard much about him though recently. His name was thrown out there, and unlike Quarles. I mean, you know where his status is? Does this just take time or...
Verret: Yeah. I guess he hasn't been nominated officially.
Beckworth: I haven't heard anything.
Verret: There's some slowdown in finding the name for the community bank representative on the Fed…
Verret: And, I guess the conventional wisdom is that it's hard, it can be somebody who meets that requirement to sell off their family bank basically is what you have to do.
Beckworth: Take a pay cut.
Verret: Take a pay cut, and sell off, you know, usually it's like a community banker who is like the fourth generation banker. You got to sell it off before… that’s right.
Beckworth: … bunch of new stress that maybe you don't want.
Verret: That's right.
Beckworth: So, Marvin Goodfriend and then two other names of course they've come up. Kevin Warsh, John Taylor, you know John Taylor well.
Verret: Yeah. Of course. Yeah.
Beckworth: You've worked with him on legislation. Do you know Kevin Warsh at all? Have you interacted with…
Verret: We met a few times. Yeah. I think he was in the administration when I went to Hoover. No, I guess not. No, he was gone by then. But, maybe not at Hoover yet. But yeah, certainly know of him, and know John really well. You know, in fact, I have to say probably the reason why the house you know, I was trying to kind of figure out what to do when I was there and in terms of the legislation. And, I went toward Taylor's work on rule-based policy because, really it all goes back to... We were sitting around having coffee and Hoover commons, in like 2011 when I was out there visiting.
Verret: And I was like, tell me more about this rule based policy. What is it? He's like, "Here's the way it works. It's predictable, and here's what the Taylor rule performed, and the great moderation." I was like, well that's fascinating John, because I'm not a macroeconomics economist... Suddenly had this job as the chief economist, you've got to legislate some fixed... The Republican asked about the bailout, and about QE. And, I immediately said, "Let's look to rule-based policy. I think that's what we should do. Taylor's got it right. Let's build legislation that helps to implement that idea. So, I'm really glad I had coffee with that guy, all those years ago.
Beckworth: That's interesting. So, you were at Hoover as a visiting fellows?
Verret: …Campbell visiting fellows.
Beckworth: And, you just happen to run into him or was there a meeting together with them?
Verret: No. It was just that at Hoover in the summertime, man, that place is completely empty. It's pretty much like John Taylor, the national security fellows, there's always five kernels there, and they show up at 7:00 AM, you know, they're there to five, and full dress. But, it was just me and John Taylor hanging out there, because he's always working. He's never, you know, and I was there visiting. So, yeah. A few times it would be nobody in the Hoover…
Beckworth: Sensitivity there. You guys are both...
Verret: Yeah. Me and Meltzer and Taylor. It was an incredible experience.
Beckworth: That is neat.
Verret: …sitting at the foot of giants.
Beckworth: Taylor has been good to me, I mean, when I went to treasury, he's one of the reasons I got hired there.
Verret: Yeah. Was he there at the time?
Beckworth: He was, he was the undersecretary and you know, and I didn't have the... I don't come from a great pedigree in terms of the top 10 school, but he took a chance on me and I feel real fortunate.
Verret: And, Randy Quarles was his assistant.
Beckworth: He was, yeah. Going back to full disclosure, I worked under Randy corals as well. I interacted more with John Taylor though. And, ever since being at treasury, I've had a relationship with Taylor we'll share papers, I've had him on the podcast. He actually invited me out to give a paper at Hoover ones. But I will say this, Taylor has been very generous and very...
Beckworth: I can see him saying, "Hey, I'll take time out."
Verret: Yeah. That's how he is. And, that's why I think he should be Fed chairman. I'm going to get a tee shirt that says John Taylor for Fed chair.
Beckworth: Okay. You're a big fan.
Verret: I'm a big fan.
Beckworth: Anybody else though on that? Any other names for Fed chair that?
Verret: Well, they always throw on Glen Hubbard's name. And, he's obviously a smart guy. And, you know what, I wonder if maybe the president would say, "What does he do? Dean of the Columbia business school." Okay.
Beckworth: He's from New York.
Verret: But, he's from New York. Yeah. Who knows if maybe that gets you ahead. I don't know. I don't know.
Beckworth: Well, let me ask this. When the president is floating a name, does he go to like Hensarling, does he go to the health Fed committee kind of, behind closed doors and say, "Hey, is this the name that you guys had... Or, to the Senate I guess and say, is this a name you would find acceptable?"
Verret: I don't know. At that level, the Fed chairman, I know some people at much lower level nominations, and some of that stuff seems to happen. The Senate's inputs important. But at the level of Fed chairman, I just don't know what...
Beckworth: What goes into... Okay.
Verret: When seals that deal. There's a story, it might be apocryphal, but there's a story about why John Roberts was chosen as chief justice over Lido, and the fact that it's because he and Dable bonded over the fact that Robert's works out a lot. And, that is what made the difference.
Beckworth: That tipped the scale in his favor.
Verret: Tipped the scale. So, you know...
Beckworth: Russell Capital... Interesting.
Beckworth: No. No, that's true. You never know, little things in life can come back now to help or to haunt you. Here's something else that's been fascinating to see as the name Ceylon unfolded, is that they've been rather conventional. Well, some people complain, you know, these guys were conservatives are the two rules-based. But, all the names we've talked about maybe other than Kevin Warsh are people who have a lot of, really a lot of experience who would probably be nominated on many presidents. Right? Who hasn't been nominated or some of the people during the transition team that were on president Trump's staff. Some of them advocated the gold standard, or train or Britain woods. And, he kinda got the sense during this period that they were going to be appointed to the Fed. And, you know, there are some individuals, I don't know if you need to name them, but there were some individuals that were freaking people out, the mainstream media out. And, I guess it's interesting that Trump has turned to pretty standard conventional safe picks. Is that…"
Verret: Safe mainstream conservative kind of...
Beckworth: Yeah. As opposed to some of the, you know, returning to the gold standard.
Verret: Yeah. You know, even outside of this policy area across the board, I've been really impressed with the picks, with the salon, with the personnel selection, everything from, you know justice Gorsuch to nominees at EPA and DOJ. And, I mean it's been great. It's been what you would expect from mainstream Republican candidate…
Beckworth: … roaming.
Verret: Yeah. probably some of it goes to, I mean I think, by all appearances is a great working relationship between the vice president. And, the president and the vice president kind of knows all these people and knows these names. And, I think the president is trusting him to put some good names forward. And, I think that's a healthy thing. That's great for somebody like me who works in Republican politics and is libertarian. I think it's terrific.
Beckworth: Let's move to the format. All right. We've been kind of talking about it on the margins here, but tell us what is the format, and you recently had an Op-Ed that was all about this. The Op-Ed was on the show. It's called *Demystifying the, Foggy Haze of Federal Reserve Policymaking.* But, it speaks to the format. What is the format, what's his motivation and how would it work?
Setting Up a New Monetary Policy Framework and Steps for Reform
Verret: The core of the format is for the monetary policy portion format. The core of the format says a few things. It says first, Federal Reserves required to submit a policy rule that describes the course of monetary policy. Could be the Taylor rule, and we have sort of some definitions of what is a variable, what does equation have to say to make sure the Fed doesn't do something like, you know, sending the Hill. At the time, Bernanke had these targets of, we won't raise rates. We definitely won't, unless unemployment gets below 5.5, and inflation gets below something like 2%, I guess. But, if that happens, we won't tell you when we will raise rates, right. Which is not a policy rule, but he was trying to tell people like," Yeah, it's a rule." It's not a rule. We have a rule.
Verret: So, we say, you know, it has to have an equation and independent variable one side, and dependent variables on the other. And, it has to have coefficients, from zero to one that tell us how the dependent variables result in changes in the independent variable of the Fed funds rate, or whatever else you're tracking, like interest on reserves or something. So, we define that. So, there's a little math in the statute, which is rare. The legislative council, were kind of like, "What do we do with this? How do we put math in a statute?" We were like, "Yeah, man, it'll be fine. It'll be fine." So submit a policy rule. Any rule, pick any rule you want. It could be a pure unemployment based rule. It could be in GDP targeting, it could be the Taylor rule.
Verret: It could be a gold based standard. It could be, some clause I rule we haven't even heard about. It could be anything. Submit it to Congress. And, if you don't, here's the penalty. We'll get to send GAO after you to come do a study of why you didn't do it. And, we get to force you to come testify. That's a horrible penalty That impedes on Federal Reserve independence, right? If you don't do it, if you don't submit this rule, which you can pick any rule you want. Again, I can't say this enough times, you get to pick any rule you want us the Fed. You have to describe how your rule is different from the Taylor rule. Okay. From the, you know, the basic 1993 paper description of Taylor rule. And, that's it. And, you get to change it whenever you want. You get to change it.
Beckworth: So, really all you've done is set up a very basic, bare minimum benchmark.
Verret: You know, I thought it'd be simple. I thought we'd just get this through. But the first time I had a briefing with the Fed staff, and bill English, who was the head of monetary affairs at the time, told me with a straight face, he said, well, the effect of this would be, it would completely destabilize foreign exchange markets. It would cause a recession. It would... He rattled off a long list, a parade of horribles. So I said, doctor English, I'm sorry. I just, you know, I don't know what further we can talk to each other about. I'm pretty sure this briefing is over.
Beckworth: Interesting. I've been surprised too by the receptions received because, most of the comments make it sound like it's the Taylor rule, you have to rigidly follow it.
Beckworth: And, there's huge consequences if you don't.
Verret: And, the Fed wants you to think that.
Beckworth: Yeah. The thing is it could take a close read there, if you listen to what you just said, you pick the rule number one, it's a benchmark, and all you really do is explain why you deviate from the bench. You can deviate from your own rule, just explain why. Tell us why. I mean, so it's not, it's not as if, you know, Congress is saying you need to go do X, Y, Z... Congress wants to know, just tell us why. And, I think that's useful for the point I raised earlier with you, that is, and that is the Humphrey-Hawkins hearings are often, I think awful sometimes.
Verret: I was excited for my first one, by my fourth one, I was like, this is a complete waste of time. I can't wait to go back to teaching.
Beckworth: Yeah. I mean, the Fed chairs, talking right past people and, yeah. And, you know, congressmen and women are getting scoring points for a TV station back home, you know. But if he had a common reference point, they could refer to, they could speak to, I think that'd be immensely useful. And again, the flexibility you've put in that law, it's not this onerous, this thing. And so, I think it's a massive overreaction. You know, I know, we had Andy Levin here, and he was against it, but he was still for something I think similar in spirit.
Beckworth: He wanted to have the Fed and Scott Sumner also talked about something along these lines, having, you know, the Fed have like an annual strategy they lay out the beginning of the year, have quarterly reports. Why didn't we get to that point or not throughout the year? And, you know, Andy's with the Fed up group from the other side, other direction. It's the same idea. Let's set some kind of objective up, one that we can have as a benchmark. Do we deviate or not? It's kind of like, you know, every year as employees we have, you know, wherever you are, you have some kind of goal, you set goals for the year, you're evaluated at the end of the year. It's not that foreign. And, I think actually what you...
Verret: I think Meltzer had been suggesting that for a long time. Although he adds punch to it, if you don't meet it, you get fired.
Beckworth: Well that, you know...
Verret: You tender your resignation.
Beckworth: There is the... I would be open to that maybe over the business cycle, like New Zealand, their central bank has that …
Verret: And Allan takes credit for it… we used to say it wasn't Allan who, but he would say yes, it was me.
Beckworth: But, I think over there though, it's not like in a given year, maybe over the two or three years. So, it's kind of like over the business cycle, you've hit your inflation. No one's ever been fired yet. So...
Verret: Yeah. Right.
Beckworth: And that's, going back to George Selgin, his critique is, it's not really a binding rule because they can always find little room to justify. But nonetheless, I think going back to the format, and, you know, I don't want to spend too much time on this, but if you look at it, my impression is, and you're the lawyer who seemed to confirm it, is that it's not that onerous. It's just a benchmark.
Verret: That's right.
Beckworth: And, you can deviate from it. So, I think it would clarify communication between Congress and the Fed.
Verret: Yeah. And, you know, there were a few I think surveys of academics about my legislation, and our legislation. And, it was so frustrating cause the way they were awarded would be like, do you think Congress should tell the Fed how to set monetary policy? And of course a hundred out of a hundred economists would say, "No, we don't think that." But, that wasn't what we were doing, wasn't what we were doing.
Beckworth: Well what's ironic, I just sort of mentioned this in passing too is, there's been a lot of critiques from the left about the Fed having too much independence. So, you know, the critique of your proposal is, well you're taking away the Fed's independence. People might say, look, "The Fed was too timid." Like, inflation has been persistently below its target, and they too wonder if it... Which is ironic, they too kind of see some maybe need to reign in the Fed, make it more accountable. I'm going to give one example here. Narayana Kocherlakota, I've had him on the show, had a recent Op-Ed piece on Bloomberg view, and the title was, *Maybe Central Banks Are Too Independent.* Congress might want to reconsider placing limits on the Fed.
Beckworth: And he goes in, you know, the Fed has been too timid, is his argument. You know, they need to have more these guard rails that kind of keep them doing what they're supposed to be doing. So, it's, it's fascinating that you've taken a lot of the heat. The format's taken a lot of the heat, and yet you see similar concerns on the other side
Verret: It comes in cycles.. You know, the chief critic of the Fed from the 90s was Henry Gonzales who was a Democrat from Houston, and chairman of the house and the serves services committee. He was the one who prodded the Fed to release minutes. You know, for the longest time the Fed said, "We don't keep minutes." And then one day they said, "Yeah, okay fine. We do keep minutes and we'll share them after five years. We take back what we said earlier under oath, that we don't keep minutes." Okay. So it comes...
Beckworth: With the transcripts.
Verret: Transcripts, sorry. Yeah.
Beckworth: Yeah. So, and to be fair, I mean, you know, I think the Republicans sometimes, I mean, going back, treated Bernanke awful too. I remember a hearing in 2010, I think it was the Senate side where they were blasting Bernanke for having, you know, the base, the currency, runaway inflation and Bernanke said, "Look, inflation has been the lowest, it's been in a long time. I mean, kind of counted that effectively." So, it swings it, you know, who's the biggest critic? So, maybe we'll see the left, you know, being the big critic. Take the reins and being the critic going forward. So, anything else you want to add about the format?
Verret: Yeah. In addition to monetary policy reform, the format also includes restrictions on so-called 13-3 powers, which the Federal Reserve use to provide liquidity to non-bank financial institutions during the crisis. So, this was the power of the Fed, used to bail out AIG, give them $85 billion in the main lane facility. So, we included some restrictions. We said, look, everybody in macro world says, follow Bagehot’s Dictum for lender of last resort lending. Okay, fine, let's actually follow it. Let's have a penalty rate. So, we set a penalty rate by statute, trailing average of the spread between corporates and treasuries on top of the discount rate, as the penalty rate. Not the, I think in some of the AIG facilities they got 1% interest rate. That's not a penalty rate. Walter Bagehot wouldn't agree that's a penalty rate.
Verret: So, we have a real penalty rate that's set as a trailing average of the spread between corporates and treasuries at the time 13-3 is used. We require a super majority vote of not only the Fed board, which is in there now, but also the Fed presence. Because, they were the only ones who stood up, Lacker was the only one who stood up to the AIG facility. So, we want some of those guys having more of a voice a requirement that the institution be solvent. And, their primary Federal regulator has to certify that they're solvent, whether it's the OCC or the FTC or whoever. And also, requirement and collateral that your own common stock doesn't count as collateral. I'm sorry. That's not … in what world other than the Fed bizarro world is common stock, good collateral. It's not, so you can't use it. So... Again, very simple things, but to hear Bernanke tell it, I'm destroying the world with the draft. So...
Beckworth: Okay. Fascinating stuff. One of the pieces of legislation that you've been a part of is the Choice Act. So, tell us about the Choice Act. What is it doing?
The Choice Act
Verret: Well, the Choice Act has a whole bunch of a bunch of stuff in it. It's the Republican answer to the Dodd Frank Act. It doesn't entirely repeal Dodd Frank, but it takes a different approach to... Primarily it's about capital requirements, the ways that banks finance themselves. And, it creates an off ramp for some banks if they want to hold a 10% leverage ratio, source of funding, essentially just 10% of your total funding needs to be relative to your assets, needs to be common equity. And, the leverage ratio, the main virtue of this leverage ratio approaches, first of all, the ratio is tough, although some people say not enough enough. Our colleague Steph Miller would probably tell you not tough enough.
Verret: But, it's high relative to where they are now. Big banks hate it right now. They hate the Choice Act. It calculates assets in a simple way, just very basic. You know, no adjustments in the value. I think it's brilliant. I mean, I think the Basel approach is insane. You have this giant bureaucracy of sorry, committee of bureaucrats meeting in Basel who are deciding, yes you know, 25% a is the right to risk rate, all times for this particular commodity? No, I mean, the risk rates are a terrible metric for risk. I think the leverage ratio is absolutely the way to go.
Beckworth: So, this…
Verret: Under the Choice Act, if you meet a 10% leverage ratio, you get some deregulation as a sweetener for that…
Beckworth: …cap requirement.
Verret: Like Volcker and Durbin and those kinds of…
Beckworth: So, the Dodd Frank still stands. It's just, you can have exceptions to it if you, if you're funded by sufficient amount of capital, which is going back to the crisis, one of the big issues, right? So, that's the thing. I mean, I would stress is that, the Choice Act is not, you know, gutting everything and saying, look, we're going to kind of narrow in on what we think the big issue, and this is. The capital banks weren't funding enough with capital, their own money. Right? They were highly leveraged. And we want to get away from that. And, this is an incentive to do that.
Verret: I think they came at that number 10% capital funding relative to assets, because no one who had that level of capital failed, you know.
Beckworth: And, some people would want it higher, but it's a compromise.
Verret: It's a start.
Beckworth: It's a start.
Verret: I think the way to make a financial system resilient is to make it heterogeneous, multiple different types of institutions, inner meeting capital in different ways, holding different types of assets. So, when they fail, they don't all fail at the same time. That's the opposite of what Basel's dream is, that everybody funds themselves in the same way, and invest in the same stuff. That's a terrible way to design a financial system. So, the Choice Act adds a new lane. I think we should add more and more lanes, and I think that's the promise of FinTech going forward. Just add new lanes of ways to intermediate … capital.
Beckworth: So, this leads to the next question. Do you think we are any safer today because of Dodd Frank?
Beckworth: Is the financial system safer?
Verret: In the way that my kids would be safer if they all wore helmets all the time and never left the house? Yes, but that's not a full life, and that's not a full and growing environment…
Beckworth: Way too much risk aversion.
Verret: Way too much of risk aversion.
Beckworth: Okay. Well yeah, I had a colleague on here Hester, she's, you know, the director of the financial markets working group as you know, a lawyer as well. And, we talked about some of the issues with Dodd-Frank. I mean I've learned a lot from you guys. You know, I'm the macro guy learning more about finance and banking.
Verret: I've learned from you too.
Beckworth: Thanks. This has been a dream job. Great job. I love it here. But, among many things that I learned from her, and this in the book you guys put out recently too, is that under Dodd Frank, all, you know, all the derivatives that were never done party to party are now done through a clearing house. And then, motivation is good. You want to have information about what's being traded, because the concern was the credit default swaps. No one knew for sure what was out there. So, let's bring all these two rivers onto a clearinghouse. But now what you've done, is you've brought all of this risk to one institution, or several of them. There's several out there. And, the FSOC has declared several of these as systematically important institutions. So...
Verret: With access to the Feds discount window.
Beckworth: Yeah. So, it's ironic that, you know, Dodd Frank has created new institutions that are too big to fail.
Verret: Yeah. A lot of them.
Beckworth: They've concentrated risk. By creating these clearing houses.... Again, the motivation is understandable, but they've created a new set of risks, and if one of those go under, it's going to create contagion and go elsewhere.
Verret: And, with the right level of capital funding and banks, you don't have to worry about contagion. I mean that's essentially it. You make failure an option, you make failure easier. Through a more resilient system, you wouldn't have to worry about this approach to, you know, centralization of all matching of traits in a couple of specific intermediaries.
Beckworth: Yeah. So, that's just one example. There's other issues as well, but that's...
Verret: Central planning nightmare.
Beckworth: But, it's ironic though that, you know, it's creating a new set of problems but trying to solve an old set of problems. So, maybe we'll end on this. What is the probability of the form and Choice Act actually passing. Now, my understanding is the Choice Act made it to Congress...
Verret: Right. Through the house.
Beckworth: Through the house, I'm sorry, through the house. I'm sorry. Through the House, and it's not going to make it through the Senate. Is that your sense as well? Okay.
Verret: Unfortunately, no.
Beckworth: But, there will be maybe some relief for some of the small banks. Because, one of the other critiques of Dodd Frank is it really puts a burden on the small banks. Can you speak to that?
Verret: Sure. I think small bank regulatory relief is on the table. And, some limited regional bank relief as well. But, I think it stops there.
Verret: So, I think that for example, the designation of $50 billion institutions is as systemically significant, too big to fail, and therefore regulated by the Fed. I think that threshold is going to go up quite a bit. 100, 150 billion that leaves a few institutions, a few regional, or super regional banks. It takes them out of the Feds, kind of a primary regulation. So, that's possible. Possibly some Volcker reform to allow smaller institutions to do some proprietary trading might be possible. Although… not really big enough to do much of it. So, I don't think it's going to change much from a macro in my perspective.
Beckworth: Okay. And just to be clear, these small banks... And, I had the opportunity to meet a president of a regional bank near where I live in Tennessee. They hate Dodd-Frank.
Beckworth: And, I can speak from this one experience anecdotal, from what I hear, it's systematic among all these presidents is that they have to spend so much on compliance costs. They have as many compliance officers as they have loan officers, or sometimes more compliance officers than loan officers. But for a small bank, that kills them. For a big, you know, big, too big to fail bank, not a problem. They've got the resources to have compliance officers, and so it's no big deal.
Verret: No. Is it not a problem with the scale economies, it's a barrier to entry for them. It's great.
Beckworth: Right. It kind of knocks out the small regional banks so...
Verret: They can go buy them up cheap.
Beckworth: Which creates more concentrated risks.
Verret: That's right.
Beckworth: So, another way that Dodd Frank may be actually exacerbating financial risk. Okay. Our time is up. Our guest today has been JW Verret. Thank you so much for being on the show.
Verret: Thanks for having me too.