Review of Trillion Dollar Triage: How Jay Powell and the Fed Battled a President and a Pandemic---and Prevented Economic Disaster by Nick Timiraos

We remember when the 2020 pandemic was first hitting our shores being puzzled by the financial implications. If a movie theater is forced to close, does it still have to pay rent? If not, does the landlord still have to pay its mortgage? If not, does the bank that holds the mortgage still have to pay interest? There were proposals to pause or stop financial time until the pandemic passed.

We were not sure what would happen but we thought that business owners would bear the brunt of it. After all, from a capital structure perspective, equity is the cushion. By putting up the equity investment - and agreeing to be in the first loss position - the movie theater owner is able to borrow many of the inputs to its business, such as the real estate it occupies and likely the furniture and fixtures of the theater too. At the end of the day, it gets an equity-like return on its equity. Fair reward for the risk.

But equity investors did not lose their equity as a result of the pandemic, for the most part, even in sectors where demand collapsed. Royal Caribbean Cruises shares (RCL) have now climbed back to where they were in February of 2020, even though shareholders were diluted. Instead of a wave of bankruptcies and business failures, the Federal Reserve and the federal government stepped in with unprecedented financial support such as substantial weekly payments to the unemployed and direct purchases of junk bonds and other riskier securities by the central bank.

We have become more cynical and hopefully wiser after sixteen years of writing this blog. One thing that we mistook when the pandemic was setting in is that the role of business owners is more than just financial, and it needs to be looked at more broadly than just from a capital structure perspective. 

We know that there is a huge difference within industries between the most productive and least productive firms. You can read about that in a paper called "What Determines Productivity?" by Chad Syverson, whose research has found that plants at the 90th percentile of an industry productivity distribution make twice as much with the same measured inputs as the 10th percentile plants. (He also finds that the productivity for firms has “serial autocorrelation,” that is, firms stay efficient or inefficient from year-to-year.)

His results imply that it would have been hugely value-destroying to take American enterprise and auction it off during the middle of a pandemic to curmudgeons on the sidelines holding T-bills. So, regardless whether bailouts are "fair" or good policy, we have come to recognize that they need to be incorporated in our investing framework.

We came up with a reading program in that vein that starts with Trillion Dollar Triage, which is a hagiography of Federal Reserve chair Jerome Powell by his current Wall Street Journal mouthpiece, Nick Timiraos, who calls Powell an "unassuming civil servant."

Trillion Dollar Triage gives a chronicle of Powell's career before the pandemic. He was a lawyer, investment banker, and private equity investor for the first 13 years after he graduated from Georgetown Law. He was a Treasury under secretary during the G.H.W. Bush administration, worked for a think tank from 2020-2012, and was nominated to the Fed's board of governors in 2012.

During the years that Powell worked for the Treasury, the think tank, and the Federal Reserve, he was closely involved in six financial embarrassments or crises. Each time, there was a question whether the parties involved should take their lumps, to protect against moral hazard in the future, or whether they should be bailed out in order to protect against broader "contagion" or "panic". The essential takeaway from this book is that Powell has faced six such situations in his career and has recommended, advised, or chosen the bailout every time.

In 1991, while Powell was working for the Treasury, a regional bank called the Bank of New England failed as a result of losses in its loan portfolio. At its peak it had been the 18th largest bank in the United States. There was a question whether accounts above the $100,000 FDIC insurance limit should be paid: the classic question of moral hazard versus risk of further runs. In 2013, Powell said, "We came to understand that either the FDIC would protect all of the bank's depositors, without regard to deposit insurance limits, or there would likely be a run on all the money center banks the next morning--the first such run since 1933. We chose the first option, without dissent." As Timiraos puts it, "the fear of a bigger crisis trumped the concern about bailouts."

Then while he was Under Secretary of the Treasury, he oversaw the investigation and sanctioning of Salomon Brothers - and the negotiations with Warren Buffett - after one of its traders submitted false bids for a Treasury securities. And as Powell now says, "Salomon was clearly understood to be outside the safety net, and I recall no discussion of a government rescue. But the firm's failure would almost certainly have caused massive disruption in the markets. To this day, I am grateful that we resolved that crisis with neither a bailout nor a failure." (ibid)

In 2011, Powell was working for the Bipartisan Policy Center think tank for a salary of $1 per year. Although Powell is nominally a Republican, he took a strong stance against Congressional Republicans who were using the Federal debt ceiling as a weapon against the Obama administration: "'So, I feel like I have to say this — there’s only one way forward here, and that is for Congress to raise the debt ceiling so that the United States government can pay all of its obligations when due,' he said at a Feb. 1 press conference. 'Any deviations from that path would be highly risky.'" 

Trump made Powell the chair of the Federal Reserve, replacing Janet Yellen, in February 2018. He immediately began raising interest rates and proposed to shrink the size of the Fed's balance sheet from $4.5 trillion to $2.5-3 trillion. But as we know, the Fed blanched and the balance sheet never even made it under $3.75 trillion. By the fall of 2019, it was expanding again. As was said at the time: "Powell and his Fed aren’t really economic-data dependent. They are market-data dependent — the Fed is afraid that it’s causing the stock market to go down." 

And as Timiraos puts it in the book: "The Fed is an enormously conservative institution, one that rarely changes course as quickly and fundamentally as it did in January 2019. On two fronts - rates and the balance sheet - the Fed had made extraordinary U-turns. These course corrections were even more humbling than normal because they corresponded with what Trump had been loudly demanding."

Powell's fifth and largest bailout (so far...) is of course the pandemic one, hence "trillion dollar triage". The Federal Reserve's balance sheet expanded from $4.15 trillion in early 2020 to almost $9 trillion at the peak in April 2022. The head of the NY Fed's market desk said what was "most frightening" was that "Treasury yields were spiking higher at the same time that equity markets were plummeting." Note that today (July 27th) the S&P was down at the same time the ten year yield was up 15 basis points.

That brings us to Powell's most recent (sixth) bailout in response to the bank failures earlier this year that were caused by losses on Treasury securities and deposit flight, both as a result of higher interest rates. Our thought at the time (1,2) was that a handful of bank failures was all that Powell would have the stomach for, and he would have to give up on using monetary policy to control inflation. The Fed did create an unprecedented new "facility" for bailing out the banks, the Bank Term Funding Program which lends 100% of the par value (not current market value) of U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities.

It remains to be seen whether Powell will keep tightening into a deflationary collapse, as the permabears think, or whether he will take what seems like the path of least resistance and go back to expanding the Fed's balance sheet. We should appreciate that Powell's commitment to bailouts has never been tested against conditions of rising inflation. However, interest rates this high will continue to threaten the banks, paralyze the residential housing market, and cause the interest on the federal government's debts to spiral higher. 

And it is the positive feedback elements that make us think that Powell will likely choose bailouts once again. What is the point of tightening if it causes bank failures and federal deficits that just need even more printing to mop up?

Consider also that this decision is not happening in a vacuum. With a year of heavy jawboning and a modest reduction in the size of the Fed's balance sheet, our best measure of inflation has come down close to two percent. Now we are less than a year and a half from a Presidential election. 

The way that you get to be the Fed chair in the first place is if you can be trusted to back bailouts for the rich and to tighten only when politically appropriate. Tightening would certainly never be appropriate if it would cause a populist to get elected (or re-elected) President.

Trump gave Powell an unprecedented amount of public abuse. Also, Trump's base can be fairly described as blue-collar white labor. Capital, as a class, did not like the instability that Trump created during his presidency. Timiraos claims that "every time Trump took a swing at Powell, Powell's inbox exploded with supportive notes from reserve-bank presidents, corporate executives, and Wall Street luminaries."

Our best cynical prediction is that Powell and the Federal Reserve will not tank the economy and the stock market in the final eighteen months before a presidential election. But we would expect stormy weather starting after Biden's second inauguration.