Pushkin.

I'm Lydia Dean Kott.

And I'm Michael Lewis.

This is the Big Short companion series on Against the Rules.

So in the last couple of episodes we talked to people who were in the book, and this episode's going to be kind of different because it's actually about an institution, the Federal Reserve.

In two thousand and eight, the chairman of the Fed was an economist called Ben Bernanki, and there's a clip of him from your new audiobook of The Big.

Short, Chairman Bernanki, The floor is yours.

At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.

Chapter seven, The Great Treasure Hut.

We will continue to monitor this situation closely.

That's Ben bernanky of the FAY.

Why are we doing an episode that's about the Federal Reserve?

The financial crisis is just an excellent opportunity to teach people what the hell of the Federal Reserve is, where it came from, why we have it, why it matters that it might be in jeopardy right now.

And there was this person Emi Nakamura, who is World class monetary economists knows more about the Federal Reserve and monetary policy than like most anybody walking the planet who lives around the corner from me, and I just thought, like, sit down with Emmy and answer questions I have about it.

I liked this episode because I went into it not knowing anything about the Federal Reserve and kind of feeling like I'm too far behind, I'll never know well.

I mean I feel that way sometimes.

That's what it was nice about it is that you actually had questions, like it seemed like you were learning too about the Federal Reserve.

So that made me feel like there's not something wrong with me for not fully understanding it.

And it's possible well to understand it.

I mean, do you feel better having understood it a bit more or do you feel like, oh, you learned about it and that was an hour of your life you can't do, yell.

I think it's good that I know about it, for sure.

I mean, it is in the news right now.

It is a huge deal that the Trump White House wants to take control of the Federal Reserve and make decisions about monetary policy that were previously made are currently made by nonpartisan experts, and the presence of an independent federal Reserve in the financial crisis was critical to resolving the crisis.

It was critical to restoring any kind of trust in the system.

So that they're fiddling with that institution now and threatening the trust.

It has such big implications.

I think that, like our culture should just understand it better.

My hope for the episode is that people like me, who have you any interest in it and some knowledge about it, but not expert at all, they find it really interesting cause you're hearing it's explained in plain language and some deeper questions are being answered.

But that also people who have no idea what the Federal Reserve does, well, all of a sudden have a picture in their mind the next time they hear the phrase Federal Reserve bank.

All right, let's get into it.

Here is Michael Lewis's conversation with Emmy Nakamura, an economist at UC Berkeley and an expert on all things FED, including where they keep our goal, which apparently they still have some of quite a bit, quite a bit, and if you listen you can know where to find it.

I began my conversation with the economist Ammi Nakamura by asking her win the FED got created.

So the FED is a fairly modern invention as things go.

It was created in nineteen thirteen, and I think the approximate cause is why the FED was created was banking crisis.

So in the previous century there had been something like twelve banking crisis.

Basically, these banking crises were happening all the time.

Banks failing.

That's right, banks failing.

Banking crisis is more than just one bank failing, it's lots of banks failing.

And there was a particularly bad one in nineteen oh seven where lots of banks failed and the banking crisis didn't end until John Pierport Morgan put in his own money to try to end this banking crisis.

And at that point, the story goes that people sort of realized that something had to be done so that you didn't have to depend on John Pierpoint Morgan to come in and be superman and save the day.

And was this so this was in the United States.

Did any version of the Federal Reserve exist outside the United States?

Yes, so in some other countries, for example, in England there were central banks for a much longer period of time.

The US was relatively late to the game.

This is probably connected partly to this sort of fear of government and centralized institutions and centralized power that's been around in the United States for a long time.

There are prominent figures in the United States like Andrew Jackson, who actually you know, some of the earlier attempts to create a FED.

But the original reason why why central banks were created in other countries, and this is going to become part of the FED story also later on, was to finance the government.

So if you want to own to lend money to the government.

Exactly so, you have to have someone like the Bank of England, for example.

The government needed to borrow money, for example, for wars and other purposes, and then someone has to oversee that.

So let's explain what this thing is that gets created in nineteen thirteen, is like a central bank.

We throw that word phrase around, but what is it?

What is it doing in nineteen thirteen.

So the most basic thing was to create a system for issuing money.

So in the so called free banking era, which had you know, which.

Was some time before, there is no central bank, no central just a bunch of banks, private banks owned by.

People yes, but there was paper money.

But the thing about paper money is that inherently, you know, the paper is not worth very much.

So the whole point of the paper is it's something that you're expecting someone else to be willing to take.

But in the era of free banking, there are all these individual banks that were offering this paper money.

Their own paper money, that's right.

And literally, if you went to try to buy something grocery store or whatever, they'd have to kind of think about how valuable is this piece of paper you're handing me as it was to some other piece of paper.

So that's obviously very inconvenient.

So if I'm the grocery store, I'm actually have to be a bank analyst.

That's right, because I'm taking paper that was printed by this bank.

That's right.

If the bank is sound, what is it back by it?

Back by gold, gold, gold, So I have to believe that I take, you know, Joe Schmo's bank's notes to Joe Schmoe, He'll give me gold of this value for it.

That's right.

And it's also really crucial that everybody at that bank believes, because otherwise they start going to the bank and trying to take out their money and then the bank actually does veail, which is what was causing all of these banking crises.

So this was a situation in the free banking era.

During this whole period, we're on the gold standard, so it's a situation where you know, there's sort of some rate at which paper money can be exchanged for gold.

But even before that, there is a period of time when people were literally using gold in transactions, and during that period of time, the big problem is just the gold is very heavy.

People have a tendency.

So I talked about paper money and how you had to check whether the paper money was really worthwhile, but that was actually even true with gold.

If someone gives you a gold coin, it might have been that they've shaved off a little piece of it and it's actually not worth as much as supposed to be.

And that was something was.

Always happening to scale with you when you're doing a transaction, to make sure the goal weighs what it's supposed.

To work, that's right, And this was called the debasement of currency, So this was always happening.

And then there was the fact that during the gold standard era, if you had a ship which was filled with gold, and it sank that gold was just gone.

Yeah, so that meant that now the whole economy had to function on less money.

So there was literally less less money to buy all the stuff you wanted to buy.

So I think in the modern world we never really worry about having enough money to buy stuff.

That's not a concern, But in the in this era, you really did.

And another example of this was actually the interest rates before the founding of the FED, they actually went up during the harvest season, and the reason was the farmers needed a lot of money to transact during the harvest season, and because there was no Federal Reserve, there was basically a fixed quantity of money.

And when more people weren't the farmers.

One of the more transactions, there's more demand for the money cause the.

Interest rate exactly exactly, so it was actually seasonal.

So one of the early reasons, aside from you know, dealing with the banking panics, that was used for why you had to have the founding of the Federal Reserve is what they called a more elastic currency.

Elastic, you know, in the sense of an elastic fad means that when people want more money than the FED provides more money.

So that was one of the earliest functions.

And even just in terms of the seasons of the year, there's some times a year when people want more money.

We don't get to this till nineteen thirteen, that's right.

So you're saying, for this country operated for one hundred and fifty years basically with this.

Money's right, and everybody just live with it, lived with it, but in various ways poorly.

I mean, there were a lot of banking crises.

You know, we've seen one serious banking crisis in the United States since the Great Depression.

Imagine if that was happening all the time.

Right, So the thing that gets created in nineteen thirteen, what does it explain to me?

So I really understand it what it's doing, Like, Okay, it's a building somewhere with some people in it who have some relationship to all the banks in the country.

What is that relationship.

Well, it's it's willing to provide money.

So a basic situation is so we talked about the case of the harvest.

So suppose interest rates are rising because people want to use more money, but there's no more gold.

So if you had a very strict kind of system of how the ratio between the amount of money and the amount of gold, then interests are going to rise.

But in this case, the central bank is going to say, no, we're just going to provide more money.

So we're not going to Does that mean we are abandoned the gold standard?

So the gold standard is a very complicated concept.

Okay.

The most basic idea in the gold standard is that you will exchange one dollar bill for a certain amount of gold.

And that's how people usually refer to what it means to be on a gold standard.

And that was true before and after the founding of the FED until Roosevelt went off gold.

If so, but how if they can just print money whenever in nineteen fourteen, yes, after they've created this bank, right, right, how can they maintain the same price of gold?

Right?

More paper for the same amount of gold means the gold should be.

So did you know that today you actually cannot go to the Fed and ask for gold.

I did know that.

So it turns out that that money is something that has value in and of itself, even if you can't exchange it for gold.

So it's not entirely such a strict relationship.

And there are these two things all the gold standard.

One is that there's this fixed exchange rate of money for gold.

But the second is this idea of a gold cover ratio that you're actually holding some real asset to return for any paper money that you're given.

But the second part, like how much real assets do you have to hold for each dollar, that doesn't have to be so inflexible.

You know, this is something it can vary over time, and in practice, all of the countries central banks who are running a gold standard during this period of time, their gold cover ratio would.

Vary over time, but the gold price wouldn't change.

That's what it meant to be onest.

So after the central bank is created, the Federal Reserve is created in nineteen thirteen, I could still go in with my dollars and get gold at the same price.

So even though they printed dollars, at what point does who's the first person to point out that, oh, maybe they don't have enough gold for all the dollars.

So those are called runs, and that happened substantially in the early stages of the Great Depression.

So all of a sudden you had this situation where people should to show up at banks and ask for their money back.

And the Federal Reserve did not provide that money, and you know, something like half of all the banks in the United States failed, and you could ask why, and there you do end up coming back to the gold standard, because the fundamental fear that the US Federal Reserve had at the time was that itself itself would face a run.

The government did not have enough gold, and everybody would know it, and so they'd be a race to get your gold out before it was gone exactly.

And today there's an academic debate on how constraining that really was.

I mean, the Fed in the early nineteen thirties actually had a pretty decent amount of gold, so perhaps they could have withstood the pressure, but they didn't think they could, or they certainly worried about it, and so that had a real impact on interest rates on the extent to which they were willing to provide money to banks during this period, and it ended up with just a huge amount of banks failing and complete breakdown of the financial system.

So this thing gets created in nineteen thirteen, it isn't really tested until the nineteen twenty nine and then their thirties.

The Federal Reserve was supposed to come in and prevent depressions on the back of banking crises.

It doesn't do it.

The depression happens, like half the GNP was lost, you know, it was economically catastrophic unemployment of whatever thirty percent.

So what is explain what they did in that period.

So I think the first thing to say is that the FED actually had a hand in the onset of the Great Depression in the sense that, you know, stock markets were really booming in the late twenties, and the FED actually raised interest rates.

So that's that's the first thing.

So the FED thought that, you know, that there was too much speculation on Wall Street and so on.

They raised interest rates.

But people the speculation in particular, people were borrowing money to buy stocks, right, and it made them upset, right, and so they said, we're going to try to stop that activity.

It was creating this boom in the stock market, right.

So then they raise interest rates, and of course it does lead to a slow down in the economy.

The banks start to fail, and once the banks start to fail, there's a panic.

At this point in time, there's no deposit insurance, so you really did have to worry that if you had your money in a bank, see it again exactly.

So then what happens is that people start withdrawing their money from the banks, and there's this thing that, you know, all the money that's out there is actually much more than just the cash or the gold.

There's this idea of the money multiplier that if you put your money in a bank and then they lend out ninety percent of it, that creates a lot more money.

But then when they take the money out of the bank, it means that exactly.

And of course some of the money that's being created a deposited in other banks, and so there's this chain reaction where the banks start to fail.

But at this point in time, the FED doesn't see itself as an institution that was designed to manage the economy in the same way that it is today.

It didn't the FED was really still learning its job.

I'm back with the economist Emmy Knockhambrock talking about the surprisingly dramatic history of the Federal Reserve.

At many points in the history of central banks, they've played this role of raising money for the government, and in the United States, this is one of the things the FED was doing during the Korean War, and there was some tension between the Fed and the Treasury during this period of time, because you know, the FED was starting to get concerned about inflation, and of course the Treasury wanted wanted to borrow more money and exactly, and so partly out of this antagonism, there was this Fed Treasury Accord in which there was an agreement that the Fed was going to be able to manage interest rates to sort of support the economy but also to manage inflation.

And that Fed Treasury Accord is typically viewed as the start of modern monetarpe policy.

Win exactly was that nineteen fifty.

One, and so the FED now is going to be granted some independence and it's going to manage interest rates.

That's going to be the thing it does, which is effectively managing money.

So it's a price of money, right.

The next major event that happens is in the nineteen seventies and early nineteen eighties.

So the early nineteen seventies are the time period of the most explicit political pressure on the FED.

So this is a time when you have Nixon as president and you have Arthur Burns as Chair of the FED, and we now know based on tapes and so on, of their conversations that there was a lot of political.

Pressure Nixon screaming and in the lower interest rates exactly.

And then you know, faster he does absolute fast forward, you know, several years, and inflation is really really high, and what we see is that people actually hate high inflation.

And then this amazing thing happens that you have Paul Volker who gets to interview for the job of Chairman of the Fed, and in his interview he explains what he's gonna do.

He says, I don't think gradualism really works.

I don't think it's going to work to you know, just raise interest rates a little bit.

I think we're gonna have to go all out and raise interest rates dramatically.

So then he goes home and he tells, is you know his wife, I don't I don't think I got the job.

No politicians is gonna let him.

Do it exactly, And then amazing that he gets the job.

Who gives him the job, Carter?

Carter gives him the job and then loses.

It's very probably probably over this.

So it's an incredibly brave and self sacrificing thing to have done.

Yes, But inflation was also really unpopular so I think that's something that maybe I didn't have a sense of in the politics of and tell I saw the inflation during COVID.

People really hate inflation.

So let me stop you there.

Because people hate inflation above a certain number.

Yes, they're completely fine with steady, small inflation, right, So what's the number?

I think this is something we've been learning about.

So right now, the FED tries to target two percent inflation, and.

We all say that's fine, that's right, But if it gets to be five percent, we all get furious.

Right, And the question of where that line is is not something we have, you know, scientific evidence on psychological maths.

It's absolutely psychological.

And you know, right now inflation is close to three percent, and so there's this obvious question maybe we should just leave it at three percent.

And then the question is how angry does three percent inflation make it?

And if you talk to people who are a little bit older, remember the period of the nineteen eighties and so on, they'll say people were five with three percent inflation.

But then, on the other hand, from the perspective of the FED, there's this whole slippery slope issue that if we go from two to three, you know, who know, we.

Acclimate them to three, then all of a sudden they'll be okay with four exactly.

Yeah, okay, that but that's interesting, right, It's like, it isn't that people hate inflation.

People actually kind of secretly like inflation in small amounts.

Below two percent.

We mostly just don't think about inflation.

Yes, all right, So Jimmy Carter appoints Paul Volker to be the head of the FED in a period of high inflation, in which everybody's angry about the inflation.

And what does he do.

He raises interest rates to something close to twenty percent.

Short term rates, that's right, And how does he do that politically?

Like, how does he even pull that off?

It is extremely unpopular.

Can you imagine someone doing that right now?

If we woke up tomorrow morning and all of a sudden, the FED rate was twenty percent, so your credit card rate was forty percent or whatever it was, thirty percent or whatever it would be.

I mean, they'd be cataclysmic for people.

What's amazing is that he didn't get fired.

It sounds like it's almost more of a norm shift than a legal shift.

I think that's right.

So the institution is the institution, but the norms around the institution are changing, and we've realized that we kind of need it to be independent for all of us to be to prosper.

That's right, and in so many of our institutions there's this complicated relationship between norms and rules.

So this is one of the most important ideas in monetary economics that if politicians have short horizons, they don't have very long until they need to get elected again, and in this short period of time they want to boost the economy.

But on the other hand, if you have a really high inflation period like the United States did around nineteen eighty, and people start to expect this high inflation and they build it into wage contracts and all kinds of things, it can take a decade to bring inflation down, and so that's something that's mostly going to affect a lot of future politicians.

So there's always this tension, and any country that you read about with central banking, this tension is sort of front and center.

On top of that, the government often also just wants to borrow a lot of money, So that's another reason why the government wants to keep interest rates low.

And central bank independence is all about trying to manage that tension.

I was just thinking back to the time when they were kings.

That's right, that a king actually might be quite reasonable about what you do with the money supply, because he's going to pay the price if you do lower interest rates and jack up the economy artificially for a couple of years.

And yet monetary policy was terrible during this era, and I attribute that mostly to the fact that they really just had had no idea what was going on.

So I think I think for humans, the idea that you can print pieces of paper in some form and use them as money and this will sort of work out well is just actually a really profound idea that takes people a long time to understand and a long time to manage, and.

A long time to understand who pays the price if you.

Introduce more exactly exactly so you know, you look at what happened in France, for example, under various kings, and there were huge amounts of inflation as they created huge amounts of money in various forms.

And my sense is that a lot of this was about just not really understanding cause and effect.

And I don't blame them.

I think this is a really subtle concept.

There's this really fascinating example of this island called the Island of Yap, in which it was one of the first ledger systems.

So there were these large stone coins, but they were not moveable, and this was actually the monetary system.

It was your ownership of these stone coins, but they were a very large size.

That you couldn't move around.

You couldn't move them around, but everybody knew that you owned one.

So in fact, even if one sank to the bottom of the ocean, it didn't matter.

You could still own a piece of it.

So this was kind of a very early sense INTUFE did they transact with it was it was a ledger system, so it was just your ownership in bitcoin exactly.

It was exactly like bitcoin on the Island of Yap.

That's great, but it's a subtle idea.

But were the stones fixed so that you could never introduce a new stone?

So that I think is the crucial thing, right that you couldn't I don't know what the details were on finding new stones, but they were large objects so that it wasn't easy to create new ones.

But later on, you know, you had this difficulty that other societies that came later, but weren't as evolved in some sense as the island of Yap.

They wanted to have coins that you could actually transact with, that you could carry, that you could pick up.

And so that's kind of how we got to gold.

You want something that you can't just create new gold, but at the same time it's small enough that you can transact in it.

I love this idea that a central bank as we now the central banks that we now have, are in part just an expression of an evolved understanding of what money is and how it works, and that we had to they have a lot of trial and error.

Exactly exactly, all right, So walk.

Me from from Vulcar.

When all of a sudden we have basically the Federal Reserve that we now know, very powerful head of the FED, who becomes a kind of high priest of money.

It becomes even more powerful because he raised interestates and it worked, and inflation fell much more rapidly than anyone expected.

Yes, so he's a success, inflicted a lot of pain, but a success.

And so from that moment we have this character the head of the Fed, who everybody is looking to as a kind of priest, who the priest of money and who is regarded as outside the reach of politicians.

They can appoint him, they can grill him, but they can't tell him what to do with the money supply.

So I think in a way that's an exaggeration because if you read the memoirs of central bankers, like for example, Alan Greenspan, even though you have central bank independence, he's constantly interacting with members of Congress.

So it's not true to say that the FED is not a political institution, but it's alit a It's not a party political institution.

What it is is it's managing.

It's got to manage its relations, and it's more insulated.

There's no doubt that it has independence.

But to say that it doesn't have to worry about its independence at all is an exaggeration because there are always political pressures, and it's clear that the FED chairs have never thought that they could just completely ignore those political pressures.

Is it fair to say that from the moment that Vulgar sort of reinvents the role of the head of the FED, that role is not tested again until the two thousand and eight financial crisis.

Yes, I think that was the biggest test.

We're going to take a quick break, and when we return, Emmy and I will talk about what the FED decided to do as banks started to collapse.

In two thousand and eight, I'm back with UC Berkeley economist Emmy Nakamara described to me the FED going into the financial crisis and described to me who the players were, what happened, and what it did in response.

So Ben Bernanki was at the helm of the a reserve going into the financial tis And who is Bemberdanki is a scholar who started his career by studying the Great Depression, and then it's this incredible coincidence that he happens to be the person who's chairman of the FED at the time of the next big financial crisis in the United States.

Let's quickly describe what this crisis looked like.

So, going into the financial crisis, you'd have this enormous real estate boom.

House prices in the United States had risen dramatically.

This had peaked in two thousand and six, so house places were kind of on their way down by two thousand and seven.

But there was a general view, including at the FED, that this might not be a huge issue for the rest of the economy.

Thousand prices go up, they go down, but it doesn't really affect what Americans are doing with in their.

Economically exactly exactly.

So at the very beginning, there were a few hedge funds that lost some money on real estate backed assets.

But the view of the Fed and a lot of other people was that this was going to be something that you could sort of sail through.

And so early on the monetary policy they interest rates were over five percent.

It was sort of normal monetary policy.

There wasn't at all a sense that this was going to become a sort of historic event for the macro economy as opposed to some elements of the financial system.

But then after this sort of benign starting point, you started to see things happening more quickly.

And so this is the beginning of when the Fed in some sense starts to gamble.

It's independence.

What they're arguing.

What Bernanki argues very forcefully, is that so he says he lived as a child on street called Main Street.

So he says, I don't come from Wall Street.

I come from Main Street.

You know, I come from Main Street.

That's my background.

And I've never been on Wall Street, and I care about Wall Street for one reason, and one reason only, because what happens on Wall Street matters to mainstream.

His dad was a pharmacist, you know, and he says, the only reason I care about this is because people like my dad will not be able.

To get a loan.

Where do they end up?

What do they do?

They end up at that point in a situation of backstopping a bunch of loans that are made to bear Stearns.

Basically, they take on some of the worst parts of bear Sterns balance sheet so that they facilitate private sector loans to bear Stearns and sort of they allow things to continue in a somewhat orderly manner.

So this is something which even at the time, there's a lot of skepticism about, because first of all, there's the idea that, you know, what is the FED doing to be bailing out this private sector actor who made a lot of mistakes.

And second of all, there's the question, even if it was a good idea in terms of what's happening right now, shouldn't we be worried about what this tells other banks about the risks.

Bail you out too.

It's kind of incredible, this step, right you've got a character Chairman of the Federal Reserve who only relatively recently in the grand sweep of history, has by norm become this kind of like God of money and God of finance, picking winners and losers in the economy.

So briefly, walk me through the rest of the financial crisis.

I think there's a hope that things will simmer down after this point, and maybe for a period of time it looks like they might.

But there's still problems being caused by these real estate assets.

All these banks have made really stupid loans, and you.

Can sort of line them up in order of which banks have the most of these.

Do that for me, so Lehman is sort of next on the list.

And then the question is with these banks that are at risk because they have a lot of these real estate assets on their balance sheets, which have lost a lot of money.

There's a question of what does that bank do.

So if there was no one who is going to help them, then a natural thing for them to do would basically be to sell themselves to another bank which had a stronger balance sheet.

And actually there are some banks that sell themselves during this period of time, but there's a big pushback against that, because there's of course this hope that maybe the federal Reserve will will step in and help you, right, And so this is one of the immediate reasons why you start to see what people call moral hazard, that if you think somebody might save you, right, like you know, when you go hiking or something like that, if you know that there's a mountain patrol, then you might be a little bit more blase about whether you might go on this you know, tough mountain trail because you really want to go, and you think someone will save you in the event that you kind of get stuck, you might do it.

And so this is this is happening over the over the over the summer that you know, Leman, for example, you know, clearly has these bad assets on its balance sheet.

So Leman actually becomes insolvent, bankrupt.

And then there's some question.

Nike does not save Lehman Brothers, Right, if he believes is so important to save these places because of what he's learned about the Great Depression, why doesn't he save Lehman Brothers.

So in the aftermath that's become a big question.

And at the time, what Bernanki said was that it was not within the federal reserves purview to do that.

That they simply didn't have enough good collateral.

I've spoken to various economists after this crisis, you know, including people on the right of the political spectrum, and there are quite a few people who will say that if they had known how bad the financial crisis would be, they would have said that the feed should have offered more support.

So you now have Lehman Brothers fail.

Then what happens.

So after Lehman Brothers failed, then the whole financial market really starts to freak out.

And if you think about the mortgage market, so this is something that affects, you know, lots of people, you know, including you know, like Ben Bernanki's dad, the pharmacist, if he had been trying to get a loan for his business at the time.

That market, all of these asset backed securities that were being used to finance a lot of mortgages.

That market is completely falling apart during this period of time.

So now we're so we're in a vicious cycle of mistrust and real problems.

I want to stop right there, and I want you to imagine for me, if from that moment on, there is no Federal Reserve, there is no central bank.

How do you think it plays out.

I think that a lot of banks would fail.

Do you think all of them would have failed?

No?

I mean my baseline starting point is this is a Great Depression when half of them failed.

But there were some improvements relative to the Great Depression even without the Federal Reserve.

So in particular, there's deposit insurance yep.

So that's sort of keeping things a little bit more stable than you would have seen without the Federal Reserve.

But there are a lot of sort of non bank bank like entities that are out there that would have failed, and there would have been a lot of fear associated with that.

One of the anecdotes that I remember people really thought was scary at the time was was General I think it was trying to get a working capital loon.

A working capital loone is just companies in general, when they want to pay their employees, they often have to borrow money because they have to pay their employees before they get paid for the products that the employees are producing.

And so this type of loan is typically quite safe, you know, happens at very low interest rates.

But even a company like General Electric was having trouble borrowing money to pay its employees.

So this idea that companies have to borrow money even just to pay their employees, even in the normal course of business, sort of tells you what could have happened in the event that the financial financial system it sort of started to destruct in this So if.

We imagine a world in which is just the irascibility of the American public and this suspicion of centralized power and all the rest had got us to two thousand as far as two thousand and eight without a central bank or or without a FED that's got real powers.

Just how bad do you think things could have got in the economy?

What kind of unemployment?

What kind of cost a GDP?

I think you could have had, you know, twenty percent unemployment?

You know we had we had almost ten percent in unemployment, but you could have had twenty percent unemployment.

You could have had, you know, investment sort of almost stop for you to have another great depression something like that.

So Burneki goes into this with bear Stearn's eyes open, realizing that he is jeopardizing the independence of the FED gambling I would gamble gambling because he knows that it's going to get hot politically when you were picking winners and losers, when you are distorting.

Markets, and when there are always critics of the FED.

So there, if you look at Congress, there are always people who are saying that we should go back to the gold standard.

So previously the FED pretty narrowly had a balance sheet.

So if the FED is kind of like a bank, it has assets and liabilities, the assets were all amost entirely government debt.

So I mentioned before US government debt is viewed as the safest debt there is.

Right, right, So when they print money, they get collateral, right right, and so so until two thousand and eight, that collateral is treasuries.

Did it used to be gold in gold?

Yes?

Yes, And in fact the FED still has some gold.

Yes.

And back in the day, you want money, I have to come for gold and they give me some money.

And you can actually go to the New York Fed and you can go on the gold tour.

You can see the gold.

You can see they have gold in little cages from different countries around the world.

They have special shoes, special titanium shoes that you wear when you're holding a gold bar, because if you drop a gold bar on your foot, you know, you'll break your toes.

Is that true?

Yes?

And they have a scale for measuring you know, gold in the event of a transaction between two countries, which just means moving one piece of gold from the cage of one country to another country.

And they have a person who knows how to use the scale and titanium shoes.

But when I visited the New York FED and went on this gold tour, I asked them when the last transaction made, you know, it was like five years ten years ago.

You know, the goal is no, so I think you know, we built like the stones and yap, you know, absolutely, it's a relic, relic.

We went down a rabbit hole there.

But it's so back to the two thousand and eight.

Up to this moment, the FED is accepting treasuries to get if you want dollars, right, and now it will accept other things, that's right.

What other things?

Well, for example, they're starting to loan against asset backed securities, so in particular mortgage backed security.

So we talked about my home mortgage.

That's right.

So we talked about the idea that you know, the US housing market was starting to slow down, peaked in two thousand and six, and there were all of these mortgages.

And it's not that the FED was holding individual mortgages, but the banks had played a big role in repacking these mortgages into what we're called mortgage backed securities, and some of them are guaranteed by these quasi governmental at the time institutional.

They're almost like tragedy, that's right, But.

The market wasn't treating things that way at the time, and so that's the sense at which it was a real decision by the FED to be willing to take these kinds of assets.

But if I'm the pharmacist on Main Street and I'm just watching this from a distance, what it looks like is, oh, these banks made these crappy loans.

Now they get to go take those loans to the FED, and the FED will give them actual dollars for those loans, getting them out of their problem.

Right, And that's not wrong.

But what brend Burnanke said, and this was one of the things he did to try to sort of battle against risking the independence of the FED, was he tried to speak directly to people.

So there was this famous moment when he went on sixty minutes which was not something that any prior FED chair and had done.

But he wanted to speak to the public, and he made the argument that while it looks terrible for the FED to be bailing out these banks that lost a lot of money and probably, you know, maybe should have known better, on the other hand, if we don't do something about this banking crisis, then you're not going to be able to get a mortgage.

Let me give you an analogy.

If you have a neighbor who smokes in bed and he's a risk to everybody, and suppose he sets fire to his house, and you might say to yourself, I'm not going to call the fire department.

Let his house burn down.

It's fine with me.

But then, of course, what if your house is made of wood and it's right next door to his house.

What if the whole town is made of wood.

That's where we are now.

It was a very unusual thing that he was making this case directly to the public, but it was really brought on by the fact that the FED couldn't afford to be a completely technocratic, insular organization.

Right.

What I'm hearing is that the actions of Ben Bernaki in the FED probably prevented another depression.

It avoided a lot of pain on the one hand.

On the other hand, it infuriated a huge number of Americans.

I think it just it just feels terrible to see these institutions get bailed out who made such bad decisions.

It was also the case that there were big bonuses that were paid out by the Wall Street banks during this period of time, you know, which was a period of time when a lot of Americans didn't have jobs.

And it's also the fact that in macroeconomics in general, but in this episode, for sure, you never get to see what would have happened without the intervention.

So in the Great Depression, we saw this awful thing happen.

The argument that Ben Bernanki was trying to make is it well, it could have been even worse, and he, you know, he made it compellingly enough.

He's maybe the world's expert on this subject.

That's right, and he convinced congress people on both sides the aisle that it was true.

And that's why the interventions were so large.

Right, So we go from nineteen thirteen with a fed that's yoked to the political process and is there mainly to kind of smooth out the money supply over the harvests to two thousand and eight, where you've got a FED that is master manipulator of the entire economy.

Two things.

One is, is it now just generally understood that the role of the FED is not just to smooth out the money supply over the harvest, just to run the money supply, but it's also got this other unconventional role in the event of crises where it can buy and sell all kinds of stuff to make things better in their view.

I think it is widely understood that that part of what the FED does is probably here to stay.

There are these questions, you know, the FED is a big actor in financial markets that affects people.

It affects different people, different companies in different ways.

And how does it sort of try to make that neutral or can it make it neutral?

Those are things that are certainly sources of controversy today.

It's a source of controversy, but it's kind of undeniable.

But the power of this our potential power of this institution has just grown.

It's incredible the power of this institution, and it is happening now in a climate where it's independence is being threatened that a private actor, a president, could get a hold of this institution and use these new powers in a completely unorthodox way.

Now, one thing I would say is that its power can also be destroyed.

In the nineteen seventies, nobody believe the thatt about anything, So you really had to get into a situation with Vulker where you know, people didn't believe them until they saw it.

Right, He just he raised interest rates dramatically, but that of that time did not have the power to promise things.

And the same goes for inflation.

So during the post COVID inflation surge, inflation got up, you know, to something like seven percent.

Through that whole time, professional forecasters were completely convinced inflation would get down two percent again, completely convinced basically, you know, they had no worries about this, And that actually matters for regular people because if you went to get a mortgage, the mortgage rate you faced was based on the idea that inflation was going to be two percent.

Again, right, because they believe the FED.

Because they believed it, So that there's enormous value in the trust in this insist that's right, and that absolutely can be destroyed.

Do you worry about the fed's independence.

Of course, this is probably one of the most frightening times for FED independence, or maybe the most frightening time for FED independence since maybe the Mulcar disinflace or something like that, for a long time since Nixon.

Yes, but it's happening in a different environment where the importance of the institution is just bigger than it was.

The awareness of how to use it is for more top of mind.

It's like this big insurance policy in the on the financial markets, and it's a money maker, and it's a money maker.

It's a huge money maker.

So you know, around the world, investors are willing to lend the US government money at incredibly low interest rates.

So that means the US government can run these huge deficits year after year and pay very little interest.

But most countries around the world don't have that luxury.

And we would lose that luxury if people cease to trust the FED.

Because part of the reason people want to hold US debt is because they trust that the US government will not default.

In a sense, if you borrow one hundred dollars, they'll pay you back hundred dollars.

But also they won't have a lot of inflation.

Right, So those two things are required to make people really value your debt, and the second one is controlled by the Fed.

What do you make the odds that we're going to emerge from the Trump years with an independent Fed.

You're a betting lady.

Eight that will have it, I hope.

So yeah, that sounds about right.

Yeah, that sounds about right.

I want to thank Emmy Nakamura for giving us an absolute masterclass on the Federal Reserve bag, it's history and the way it's changed.

Emmy is the Chancellor's Professor of Economics at UC Berkeley.

You can find links to her work in our show notes.

Against the Rules.

The Big Short Companion is hosted by Michael Lewis.

It's produced by me Ludy jin Kott, and Catherine Girodel.

Our editor is Julia Barton.

Our theme was composed by Nick Burtel, and our engineer is Hans Dale.

She special thanks to Nicole opten Bosch, Jasmine Faustino, Pamela Lawrence, and the rest of the Pushkin audiobooks team.

Against the Rules is the production of Pushkin Industries.

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