In 1981, during an unprecedented period of escalating interest rates and double-digit inflation, as federal bank regulators, we attended meetings in Washington that focused on developing a strategy to avoid financial collapse. We learned some important lessons from these events that can serve us well today.
In mid-1981, we visited with Paul Volcker, chairman of the Federal Reserve Board, to ask him to open the discount window to the country’s 4,500 savings and loans, every one of which was failing. The alternative was systemic illiquidity, depositor runs and a collapse of the housing industry.
Chairman Volcker and his colleagues at the Fed worked diligently to ensure that savings institutions would be able to access funds at the discount window as we shuttered 20% of them over the next two years. Stopping inflation was his No. 1 priority, but as the Fed raised interest rates to extinguish it, it further sealed the fate of S&Ls by exposing them to a blunder that Congress had made 15 years before. Lawmakers had capped the interest rates that savers could be paid in order to subsidize long-term, fixed-rate home lending. That would eventually crush the S&L industry in an economic vise by forcing it to borrow short and lend long (30 years, at a fixed rate) based on the false hope that interest rates would remain low forever.
In the weeks that followed, we had meetings that included the director of the Office of Management and Budget, the White House chief of staff, the secretary of the Treasury, and senior White House policy advisors and Treasury officials. We also visited with the chairs and ranking members of the Senate and House banking committees. The receptions we and our problems received ranged from cool to stunningly hostile. Most neither understood the reasons for the crisis or the economic devastation that it would cause if left unattended.
In contrast to our meetings with Chairman Volcker, the White House, Treasury and the OMB asked us to make believe that the problem didn’t exist. We were asked to sit tight because the problem was only “temporary,” or as Chairman Jerome Powell had been accustomed to saying until recently “transitory.” The administration’s position was that inflation and interest rates would “eventually” return to normal, and all would be right again. There was no need to close any more institutions. We begged to differ as to the impact on financial institutions and the economy and declined to accept the offer to ignore reality.
For the next two years, we worked collaboratively with the Federal Reserve to maximize liquidity and prevent a crisis in confidence from raging across the country. Given our refusal to accept the administration’s view of reality, we should not have been as surprised as we were when the White House and Treasury began to work against us. OMB ordered us to reduce staff so we would not have the people necessary to close failed institutions. Republicans and Democrats in Congress refused to recapitalize the Federal Savings and Loan Insurance Corp. so that we could not sell failed institutions to healthy ones, and OMB threatened us with criminal prosecution if we continued closing institutions under the arcane Anti-Deficiency Act.
If that weren’t enough, the Treasury dispatched an assistant secretary to testify in a lawsuit brought by shareholders of a failed S&L, arguing that our agency did not have the authority to close the institution even though it had lost all of its net worth. The court bluntly questioned the credibility of the assistant secretary’s testimony, and ruled in the agency’s favor, but a barrage of friendly fire continued to come our way over those two years.
Try as they may, governments can’t dictate economic reality or the unanticipated events that occur. By 1982, the 30-year T-bill and the prime rate hit 21%. Over the next decade, about 1,400 S&Ls and 1,600 commercial banks would fail, while hundreds more would be merged. Oil prices collapsed from $111 to $22 a barrel, and real estate markets cratered, creating the worst financial disaster since the Great Depression. Difficult decisions had to be made to save the economy even though they would damage significant parts of it in the short run.
We mention these events only because history, as it always does, is repeating itself. Inflation is the product of a complicated brew of long-term economic neglect, excess credit availability, fiscal recklessness and market aggressiveness, not episodic greed or corporate price gauging. It is always temporary. The issue is how long “temporary” is and what long-lasting damage is done in the meantime.
Our conclusion from living through the devastating economic events of the 1980s and having to make economic life and death decisions was that things in Washington, D.C., are never quite what they seem to be. Too many try to force reality to conform to what it needs to be for their political purposes. That is always a dangerous roll of the dice for the taxpayers who have to bankroll it.
The present economic environment is fraught with perils that are similar to those that existed in 1980. Inflation is once again hitting high levels, thanks in part to government policies over the last decade. Forcing zero-interest rates on the economy for so long has devastated the value of savings accumulated by working Americans, who are receiving less than zero returns.
At the same time, low interest rates and profligate government spending increasingly are pricing working Americans out of the housing market, even as the Federal Reserve injects massive amounts of low-cost credit into the economy by ballooning its balance sheet to an unprecedented $9 trillion.
Only real independent leadership can make the kind of tough decisions that years of economic abuse require to steer us out of this current morass. Political slogans make catchy headlines and draw clicks and eyeballs, but they often distract from finding the real solutions that can actually avert financial disasters.
To paraphrase Simon and Garfunkel, where have you gone, Chairman Volcker? The coming months will provide a test of the leadership qualities of those in the government who are driving economic and monetary policies. This time, we are happy being interested observers. But we think we know how it will turn out.
