The Power of the Fed

>> The coronavirus pandemic has left millions of Americans out of work... >> People have gone now without four, five, or six, or seven paychecks and it's starting to catch up-- they need food, it's the most basic thing.

>> JACOBY: Over the past year, we've seen how many Americans are living on the edge.

>> Have you got any income at the moment?

>> No, no-- and we have kids too, so.

>> So you're not making any money at the moment?

>> No.

>> JACOBY: But while businesses were shuttered, and millions were left unemployed, one place has been thriving like never before.

>> Stocks surging even as America enters its darkest chapter yet of this pandemic.

>> JACOBY: On Wall Street, it was a banner year.

>> The market has been open for 30 minutes and we've gone straight up.

>> The Dow rising nearly 18%, its best performance since 1987.

>> JACOBY: After a major dive, markets reached record highs.

The pandemic would turn out to be a blip in the longest bull market ever.

The price of stocks have skyrocketed-- and so has the wealth of those who own them.

>> Elon Musk has added over $10 billion to his wealth-- just this week!

>> JACOBY: Some see signs of mania... >> This GameStop situation, we will never encounter a setup like this again.

>> JACOBY: As more Americans try to get in on the party.

>> Right now we're in a raging mania.

>> JACOBY: Some worry a crash is to come.

>> It's the burst of euphoria that typically brings these things to an end.

>> JACOBY: As the financial world has been diverging from the real world, I've been trying to understand the many forces at play.

And I found one institution has been at the center of it all: the Federal Reserve-- the nation's central bank.

>> It is the most powerful and least understood institution in the country.

It really is difficult to overstate how important this story is, and how big this story is, and how much it matters.

>> JACOBY: I've been speaking to current and former Fed officials... Is that really the first time you're in a suit since COVID?

>> From the waist down.

>> Can I take my mask off?

>> JACOBY: ...Economists, and titans of finance.

>> Nobody knows how this is gonna turn out.

This is an experiment.

>> JACOBY: I've heard that over and over-- that we're living through an epic experiment run by the Fed.

>> I believe this is the economic story of our time.

>> JACOBY: An experiment that's been dramatically changing the American economy.

(overlapping news reports) >> Right now, breaking news here, stocks all around the world are tanking.

>> JACOBY: If you want to understand how today's financial world has grown so far removed from the real world-- and the role of the Federal Reserve-- you need to go back to 2008, when investors, speculators, and Wall Street bankers nearly brought down the global economy.

>> Get on the train!

Otherwise it is gonna leave the station without you.

>> Wall Street shaken to its very foundation today.

♪ ♪ >> We will need to stabilize, repair, and reform our banking system and get credit flowing again to families and businesses.

>> JACOBY: The new president and Congress spent hundreds of billions of dollars to restart the economy, but at the center of the rescue effort was the Federal Reserve.

Richard Fisher was the head of the Fed's bank in Dallas at the time.

>> What the Federal Reserve does is provide the blood supply for the body of our capitalist economy.

And what happened in 2008 is all the veins and the capillaries and the arteries collapsed.

So every financial function had failed.

It had collapsed and we had to restore them.

>> JACOBY: That's when the Fed stepped in.

Its job is to promote employment and keep inflation in check, primarily by raising and lowering short-term interest rates.

In 2008, Fed officials decided to do something they hadn't done in half a century-- they began dropping rates, eventually to almost zero.

>> Those massive rate cuts have not been stimulating the economy.

>> JACOBY: With Americans still suffering and the banking system on the verge of collapse, Fed officials there at the time told me they felt compelled to go even further.

>> And then the question was, "What else can we do?"

And the committee came up with the idea of quantitative easing.

>> Quantitative easing, what in the world is it that?

>> Quantitative easing, that's just a Greek term to a lot of people.

>> A lot of people want to know what they're gonna say about what we call quantitative easing, what are some of the... >> JACOBY: Quantitative easing, or QE, was championed by Ben Bernanke, then the Fed chairman.

>> Mr. Bernanke, what does this do to the financial crisis?

>> The Federal Reserve has been putting the pedal to the metal.

So we're doing everything we can to support the economy, and we hope that that's going to, you know, get us going next year sometime.

>> JACOBY: QE was an experimental way for the Fed to inject money into the financial system and lower long-term interest rates.

The way they did it was to literally create new money and use it to buy huge amounts of things like mortgage-backed securities and government debt from banks and other institutions.

Their hope was that the lower rates would spark more spending and borrowing throughout the economy.

>> It's almost like alchemy.

You can create money out of thin air if you're at the Central Bank.

So creating more money puts more money in the banking system, put more money out there for the economy to take it and put it to work and to grow, and to restore itself.

>> JACOBY: As news of the Fed's actions spread throughout the financial world, Andrew Huszar, a former Fed official who'd left to work on Wall Street, got the offer of a lifetime.

>> I was sitting in a cafeteria in Stamford, Connecticut, when I got the call.

I was eating a sandwich, I almost choked on it at the time (laughs) Basically I realized very quickly what I was being asked.

I was being asked if I would manage the largest financial markets intervention by a government in world history.

>> JACOBY: The job was to join the Fed office in Manhattan and manage a massive expansion of its power in the financial markets under QE-- buying more than a trillion dollars in mortgage bonds from the banks as quickly as possible.

>> The idea was that the Fed was trying to get more credit and cheaper credit into the hands of the average American.

There were millions of people losing their jobs, millions of people in mortgages that they couldn't afford, and how could the Fed use its financial tools to actually help the average American?

>> JACOBY: Is this something that had ever been attempted before?

>> No.

You have to realize we were in the midst of the next Great Depression, this was an incredible collapse of the fundamental structure of the U.S. economy in a very short period of time and we were building the plane while we were flying it.

♪ ♪ >> Everything in the markets is a confidence game.

So, the Fed exists to restore confidence when all confidence is lost.

>> JACOBY: William Cohan is a writer and former banker who worked with us during our months reporting this story.

>> JACOBY: The idea of lowering interest rates and the idea of quantitative easing was basically pulling out all the stops to make it cheaper to borrow.

>> Basically by making money so inexpensive, by suddenly it being abundant and cheap and easy to get, they just flooded the zone with capital.

>> JACOBY: Easy money.

>> Easy money-- trillions of dollars of easy money.

Like, the greatest experiment in easy money in history.

(indistinct chatter) >> JACOBY: All that easy money sparked a rally in the stock market.

>> We saw it take its effect almost immediately.

The market reacted.

I was a little bit surprised it took off that fast.

>> JACOBY: How is that viewed inside of the boardroom?

Was that seen as success?

>> Yes, it validated what we thought would happen-- that's what we thought would happen.

When you drive interest rates down all the way out, it forces investors into taking bigger steps on the risk spectrum.

Cheap money is the fuel for a financial speculator and for a financial investor.

>> JACOBY: What Fisher and other former Fed insiders told me is that the stock market rally was no accident.

By design, the Fed's QE program effectively lowered long-term interest rates, making safer investments like bonds less attractive, and riskier assets like stocks more attractive.

It was hard to argue with the results.

Stock prices kept going up.

>> The old saying is don't fight the Fed.

>> Don't fight the Fed.

>> Don't fight the Fed.

>> Rule number one as a young trader you're taught is don't fight the Fed.

>> I don't know what the hangover's gonna look like down the road from all this extraordinary stimulus, but for now, the markets love it.

Don't fight the Fed.

>> A cam roll one... >> JACOBY: You look at me.

So we're approximating an in-person interview.

It'll work, it'll work.

Mohamed El-Erian remembers it well.

He was running the largest bond fund in the world at the time, and made a fortune for his firm following the Fed's lead.

>> Don't fight the Fed.

The Fed is the one institution that has a printing press in the basement, and there's no limits to how much it can use.

That is what makes the Fed such an influential player in the marketplace.

Keep an eye on the treasury market... >> JACOBY: El-Erian's firm helped advise the Fed on it's QE experiment.

He told me the expectation was that the low interest rates and QE would have a strong knock-on effect on the wider economy.

>> That was the theory.

In practice, the Fed was very successful, in terms of moving asset prices.

It was much less successful in moving the economy and the result of that is we got the largest disconnect ever between Main Street and Wall Street, between the economy and finance.

>> The banks are sitting on their butts and they're still not lending money.

>> JACOBY: One of the problems was that the banks were holding on to the money instead of making it available to borrowers.

>> The banking sector is broken.

>> JACOBY: At the Fed, Andrew Huszer was disappointed by what he was seeing.

>> I have great respect for the Fed.

I never questioned, and I, to this day, I will never question the intention.

What I question, rather, is whether their tools are able to help the American people in the way that they believe.

I came out of QE1 100 percent believing that it was necessary, because we had actually helped to stabilize the economy, but wondering if there wasn't a fundamental problem with the approach, in that the tools of the Fed worked through the Wall Street banks, and in so doing, were disproportionately benefiting the wrong people-- the people who didn't really need the help.

>> JACOBY: So basically, what you're saying is that you were seeing, in practice, something very different than what was supposed to happen, theoretically.

>> Yeah, I saw that Wall Street is a private sector actor, and Wall Street has its own interests, and Wall Street can do what Wall Street wants.

And the Fed was, on some level, at the mercy of, of Wall Street.

>> JACOBY: Huszar and others inside the Fed had been counting on Congress to step in and help correct the imbalance-- target more money to Main Street and the wider economy.

But then politics took a sharp turn.

>> We've come to take our government back!

>> JACOBY: Tea Party supporters put Republicans in charge of the House... >> We need to restore fiscal sanity to this nation.

>> JACOBY: ...dimming prospects for Congress and the White House to work together to stimulate the economy.

The Fed was on its own.

Was it palpable that the Fed was sort of the only game in town here?

>> Yes.

The fact was we were carrying the load all by ourselves.

>> JACOBY: The day after the midterm elections, the Fed announced it would do another round of quantitative easing-- not just to stabilize the economy but boost it.

Fed Chair Bernanke promoted the plan, writing that it would create a "virtuous" circle, with with lower mortgage rates making housing more affordable, and higher stock prices boosting consumer wealth.

He went on television to counter critics who were warning the decision risked causing inflation.

>> They're looking at some of the risks and uncertainties associated with doing this policy action.

What I think they're not doing is looking at the risk of not acting.

>> JACOBY: I wanted to talk to Bernanke but he wouldn't agree to an interview.

But I did speak to Sarah Bloom Raskin, who was on the Board of Governors at the time.

>> So, many of these tools had not been tried before.

They were definitely like break the glass kind of tools.

Like, what are we going to do in order to restart the economy here?

>> JACOBY: You voted for quantitative easing two.

What was your thinking there?

>> Right, so, my thinking was that we still had an economy that was far from its potential.

As QE began, it showed great promise.

We started to see that people's sense of economic wellbeing was ticking up somewhat.

People were finding jobs, people were finding homes.

The foreclosure rate had slowed.

So there was a sense that something was working.

And for that reason it was, in my mind, worth supporting.

>> JACOBY: But outside the Fed, some were saying that the costs of quantitative easing might already outweigh the benefits.

>> A lot of talk about quantitative easing, QE2-- the likelihood that that will have a significant effect is close to zero.

>> But the markets love it.

>> JACOBY: Joseph Stiglitz is one of the most well-known economists in America and a winner of the Nobel Prize.

>> So you're doing a documentary on the Fed and monetary policy?

>> JACOBY: We are trying to.

>> (laughing): Okay.

>> JACOBY: Are we insane?

>> No, no, no, I think it's a great idea.

>> JACOBY: Okay.

Stiglitz told me that while the Fed was doing some good, he also had concerns at the time.

>> The main thing I was concerned about was that the way they were trying to revive the economy was a kind of trickle down economics.

The way quantitative easing works is that it's a lowering of the interest rates that leads stocks to go up.

And so who owns the stocks?

It's the people in the top.

Not just the top ten percent, one percent, one-tenth of one percent.

And so it increases enormously wealth inequality.

We had had increasing inequality really since the late '70s and this was putting that on steroids.

So the immediate objective of saving the banking system was achieved, but the broader objective, which was helping the economy recovery quickly in a robust way, in a way with shared prosperity, total failure.

>> JACOBY: What sort of response did you get from folks at the Fed to what you were saying at the time?

>> "Our mandate is to do what we can to increase employment, to use the tools that we have, and that's what we're doing."

>> JACOBY: Was that even part of the discussion at the time in the boardroom, whether there was any risk of exacerbating wealth inequality?

>> There were strands of that, I would...

I recall.

The... these kind of costs were considered speculative, because again, the tools hadn't been used before.

So there wasn't a clear sense as to what would... you know, sort of what the impact would be.

There was some discussion of it, but nothing definitive.

>> JACOBY: Some saw wealth inequality as a trade-off.

>> There was nothing you could really do about it.

But it was, in my mind, in my discussion, what I would present at the table, it would be one of the consequences we just had to be mindful of.

That doesn't mean we shouldn't have done what we did.

>> JACOBY: For Andrew Huszar, it was time to walk away from the Fed.

>> It was a while ago, but whenever I come back here, it's a very special feeling.

>> JACOBY: I bet.

You were still working in this building when the second round of quantitative easing happened.

What was your reaction to it when that happened?

>> I was not surprised by the announcement, but I was incredibly demoralized.

What I was seeing outside of the Fed was rising demands from Wall Street that the Fed continue its stimulus-- the idea that the sky was gonna fall if the Fed didn't continue to print money and give it to the Wall Street banks.

And yet, nobody was giving a coherent explanation as to how the Fed showering trillions of dollars onto Wall Street banks was actually directly benefiting the average American.

And I'll tell you why they weren't talking about it, because it doesn't.

We did not see the knock-on benefits that we had hoped for the average American, as much as we wanted to.

>> JACOBY: Why is this kind of an emotional issue for you?

>> Well, perhaps it's because I was a true believer of the Fed.

And I worried about what this meant, in terms of the future, about how much more the Fed would double down, and how addicted the, the... Washington and the markets would become to this extraordinary stimulus.

♪ ♪ >> JACOBY: The Fed would keep the money flowing under successive rounds of quantitative easing, injecting more than $2 trillion into the financial system.

And by 2013, unemployment was continuing to fall, and the Fed saw signs that its policies were having a positive impact on the economy.

Fed Chairman Bernanke signaled that the easy money might start to taper off.

>> If we see continued improvement, and we have confidence that that is going to be sustained, then we could, in the next few meetings, we could take a step down in our pace of purchases.

>> I was on the trade floor.

I remember Chairman Bernanke saying that he would taper.

First we had to figure out what does taper mean?

And the minute people realized what taper meant, which is that the Fed would step back from buying all these securities, and even though the Fed said it's gonna be gradual, it's gonna be measured, the markets had a massive tantrum.

>> The markets selling off as the Federal Reserve Chairman Ben Bernanke said that the central bank could start tapering.

>> The markets went into a fit.

Became dysfunctional.

It was known as the taper tantrum.

>> We all know it, when Ben Bernanke talks, if the Federal Reserve speaks, the markets listen.

Taper tantrum!

>> Markets are like little kids.

They want candy, and the minute you try to take the candy away, they have a tantrum.

>> You have big Wall Street reaction, right?

You have extreme volatility where Wall Street says, "Whoa, whoa, no, no!

No, unacceptable!"

and values plunge.

And of course the Fed doesn't like that, nobody likes that, that's a... that's a precursor to instability, right?

But it put the Fed in a real bind.

>> Chairman Bernanke.

>> And Chairman Bernanke had to go in a conference in Boston and say, "No, no, no, we're not tapering."

>> You can only conclude that highly accommodative monetary policy for the foreseeable future is what's needed in the U.S. economy.

>> JACOBY: Bernanke's successor, Janet Yellen, had better luck the following year.

She was able to pause quantitative easing without a tantrum, in part, by promising to maintain the Fed's massive balance sheet of assets it had bought-- and to keep short-term interest rates low.

>> The F.O.M.C.

reaffirmed its view that the current zero to one-quarter percent target range for the federal funds rate remains appropriate.

>> JACOBY: Low rates spurred companies and individuals to borrow in record amounts.

And the Federal government took full advantage of the low interest rates as well, running the national debt up a trillion dollars a year, to new highs.

>> Good afternoon, everyone, and welcome.

>> JACOBY: By 2018, the new Fed chair, Jerome Powell, was saying the economy was in a good place, citing historically low unemployment numbers and the fact that concerns about inflation hadn't materialized.

>> The U.S. economy is in a good place, and we will continue to use our monetary policy tools to help keep it there.

>> JACOBY: There was a growing debate about whether the Fed should raise interest rates and slow the flow of easy money.

For those who were saying during that period of time, you know, you should've been concerned about other side-effects of keeping rates so low.

Tell me what the downside of raising rates would've been.

>> The downside is keeping Americans on the side-line who want to work.

>> JACOBY: I raised these issues with Neel Kashkari, president of the Minneapolis Fed.

He's been outspoken about how the Fed's policies have helped lower unemployment and improved the economy overall.

>> The Fed has been on a mission, I've been on a mission to put Americans back to work and help them get their wages up, especially for those lowest income Americans.

And if it has had some effect on Wall Street, to me, the trade off is well worth it if we can put Americans back to work, so that they can put food on the table, they can take care of themselves.

That is profoundly beneficial to society.

>> JACOBY: One of the things that we have seen in this country is a widening wealth gap.

The question is what role, if any, the Fed has played in widening that wealth gap.

>> Well, this is a great point, and I'm glad you raised it.

Most people who make this argument ignore the fact that for many Americans, they don't own a house, they don't own stocks, they don't have a 401K, the most valuable asset they have is their job.

So by putting people back to work and helping to boost their wages, we are actually making their most valuable asset more valuable.

>> JACOBY: But the critics I spoke to questioned the Fed's success and pointed to other indicators.

>> Wealth was becoming increasingly unevenly shared; in that quote "good place" the one percent held 32 percent of the nation's wealth and the majority of Americans said they were financially anxious.

40 percent of Americans didn't have more than a $400 rainy day fund.

Most Americans were tremendously fragile economically speaking.

>> JACOBY: Karen Petrou is an unlikely critic of the central bank-- she spent her career as an adviser to banks and large investors, analyzing how financial policy played out in the real world.

>> Despite the quote, "record employment," when you break those numbers down, you can see that more people had jobs and that's great, but the wages and the growth in the economy remained very tepid and very unequal.

>> JACOBY: When you speak to the folks from the Fed about the idea of raising interest rates, they'll say, "What was the alternative?"

And you say what to that?

>> I'd say, "What you were doing wasn't working."

We'll never know whether lowering rates would have dampened growth.

We do know that keeping rates ultra, ultra low didn't raise growth.

It raised markets.

>> JACOBY: Petrou and other critics were concerned that the Fed's low rates and easy money policies were fueling troubling trends on Wall Street and in corporate America.

One in particular was the amount of corporate borrowing.

>> Valuations are generally elevated, especially corporate debt.

>> We have flagged the rise in corporate debt.

>> We have entirely too much corporate debt out there.

>> JACOBY: Taking advantage of low interest rates, corporations were selling bonds to big investors.

I saw numerous studies and reports detailing the extent of the debt-- and how even marquee companies were so leveraged, their credit ratings plummeted.

The Fed had hoped that companies would put all that borrowed money to good use and invest in their workforce and their infrastructure.

But in reality it was playing out differently.

>> Buybacks.

>> Buying back stock.

>> Stock buybacks... >> Stock buybacks... >> JACOBY: Companies were often borrowing money to buy back their own stock, making the remaining shares more valuable and the prices higher.

>> As a corporation, you realize all that matters is the stock price.

So what do we have to do to increase the stock price?

And more often that is buying back the stock.

>> JACOBY: Financial reporter Dion Rabouin covered the growing trend.

>> So it used to be that the Fed would lower interest rates, businesses would then take on more debt, they would use that debt to hire more workers, build more machines and more factories.

Now what happens is the Federal Reserve lowers interest rates, businesses use that to go out and borrow more money, but they use that money to buy back stock and invest in technology that will eliminate workers and reduce employee head counts.

They use that money to give the CEO and other corporate officers big bonuses and then eventually issue more debt and buy back more stock.

So it's this endless cycle of things that are designed to increase the stock price, rather than improve the actual company.

>> G.E.

just authorized a $50 billion stock buyback.

>> JACOBY: The numbers were astounding-- more than $6 trillion in corporate buybacks in the decade after the financial crisis.

>> Warren Buffett likes Apple's buybacks.

>> Well, why wouldn't he, he's a shareholder and they're buying back a hundred billion dollars in stock.

>> Buybacks used to-- it's just another example of things that used to be viewed as kind of, ugh, you know, just going mainstream.

>> JACOBY: Sheila Bair, a former top banking regulator, was issuing public warnings at the time that the Fed was incentivizing bad behavior on Wall Street despite its best intentions.

>> I can't fault the companies so much, because these interest rate-- this interest rate environment creates very strong economic incentives to do exactly what they're doing.

It's hard to create a new product, it's hard to come up with a new idea for a service, it's hard to build a plant and hire people and run the organization.

It's real easy to issue some debt and pay it out to your shareholders to goose your share price.

That's real easy to do, but it doesn't create real wealth, it doesn't create real opportunity, it doesn't create jobs, it doesn't improve the labor market.

It's just another example of how these very low interest rates have really distorted economic activity and frankly been a drag on our economic growth, not a benefit.

>> JACOBY: Corporate buybacks, the elevation of corporate debt, how was that viewed by you and others at the Fed?

>> Something we pay a lot of attention to, but when companies are buying back their stock, one of the things they're telling us is we don't have profitable places to invest, and it's easier for us to just to buy back our stock.

That's concerning in terms of the future of our economy.

But that's not because of the Fed, so we pay attention to it, it really matters, but in my view, we don't, it's not something we control.

>> JACOBY: In our conversation, Kashkari was also quick to dispute the criticism that the Fed is really just boosting financial markets and helping Wall Street.

There is this idea on Wall Street that the Fed kind of has our back and that because you may have well-intentioned policies that are trying to get everybody to work, there is this side effect, this unintended side effect of just, kind of, really helping the rich.

>> That argument ignores the benefit to the poor.

And if... sure, if you're gonna ignore the benefit to the poor, then we're only helping the rich but, of course, that's an incomplete analysis.

When you actually sit down and say, well, let's go through the trade-offs of the choices that the Fed has, whether it's interest rates or it's quantitative easing, it's not just about Wall Street, it's not just about asset prices, it's also about thinking about the men and women in America who are trying to find work and who want to have higher earnings and who deserve higher earnings.

If we are benefiting them by helping them find work and helping them have higher wages, I will take that trade off.

>> JACOBY: There's an ongoing disagreement among people I spoke to about how much the Fed has been helping Main Street.

But what most do agree on is that it's fueled the massive growth of the financial sector-- a "golden age" for Wall Street, as some have called it.

Even some of the largest beneficiaries of this trend told me it made them uncomfortable, like legendary investor Jeremy Grantham.

>> In my career in America, the percentage of GDP that goes to finance has gone from three-and-a-half to eight-and-a-half.

(laughs) Where in a way, we're like a giant bloodsucker and we we have more than doubled in size and sucking more than twice the blood out of the rest of the economy.

And we do not generate any widgets, we do not generate any real increase in income.

We are just a cost.

>> JACOBY: When you say "we," you mean you and other members of the financial community have been this kind of bloodsucker on the economy?

Is that what you're saying?

>> Yes, collectively we fulfill a completely necessary service, but what we have done is created layers upon layers of more and more convoluted, expensive financial instruments.

And that's what makes all the profits for the financial industry, and it's taken a lot of ingenuity and salesmanship to make this happen and a lot of lobbying in Congress, etc., etc., and we have imposed on the rest of the economy the idea that banking and finance are utterly important at all times.

If you do anything wrong to us, the entire economy will collapse in ragged disarray.

>> JACOBY: As finance grew, so did the risks.

One concern was what would happen to all those companies that had gone into debt if there was a downturn-- and what would happen to the trillions of dollars in corporate bonds that had been sold to investors.

There were also increasing warnings about a key player in all the borrowing going on, little known and unregulated financial companies that had been flourishing in the easy money economy, known as shadow banks.

>> Shadow banks are large financial institutions that don't have bank charters.

So they don't have a special relationship to the government.

They have other financial licenses to conduct other types of financial businesses.

>> JACOBY: Lev Menand, who'd been an economic advisor to the Fed and the Treasury Department, said the biggest source of worry about the shadow banks was their lack of a cushion in the event of a downturn.

>> The core of the problem of the shadow banking system is that it's extremely fragile.

Anybody who is an investor in a shadow bank, who has their money in a shadow bank, instead of a real bank, is going to have an incentive to withdraw in the face of any uncertainty.

So little economic shocks that cause asset prices to fall have the potential to trigger runs and panics.

And so what we've, what we've done is, by allowing this shadow banking system to develop, is we've inserted a source of instability in our entire economic system that doesn't need to be there and that has the potential of throwing us all off course.

>> Let me start by saying that my colleagues and I... >> JACOBY: That potential instability posed by the shadow banking system was on the Fed's radar.

>> How are you thinking about potential risks bubbling up in the broader shadow banking system?

>> You know, this is a project that the Financial Stability Oversight Council is working on now, and also the Financial Stability Board globally is looking carefully at leveraged lending and, you know, we think it is something that requires serious monitoring.

>> JACOBY: Despite those concerns, little action was taken by the Fed, other regulators, or Congress, and the system remained vulnerable to a shock.

It would arrive in early 2020.

>> A preliminary investigation into a mysterious pneumonia outbreak in Wuhan, China, has identified an previously unknown coronavirus.

>> When the pandemic hit, it was so unlike anything any of us have experienced in our lifetimes.

We'd been paying attention to what was happening in China for a few months.

I was calling my contacts, global businesses that had big operations in China, to understand what their employees and staffs were seeing.

And we were all trying to learn as much as we can about pandemics and what it's likely gonna mean.

>> Major selloff across Europe this morning... >> I think we all figured out very quickly the pandemic and the virus would drive the economy.

>> Investors are spooked by the growing number of infections outside China.

>> But how fast would it hit us?

How widespread?

What would the health care response be?

It was maximum uncertainty.

And you were seeing that uncertainty manifest in financial markets.

>> What you have here are concerns, fears, worries, and deep uncertainties about what's likely to happen next.

>> People were scared.

Investors were scared.

Individuals were scared.

And they said, you know what, I just want cash.

>> Markets giving us the worst two-day point drop ever in history.

>> I don't even want treasury bonds, I don't even want corporate bonds, I don't want stocks, I just want cash.

And when everybody in the economy says "I want cash" at the same time, that leads to potentially a collapse of financial markets.

>> On the bell, on the bell!

>> It's the first circuit breaker, has been triggered.

>> Market functioning was starting to cascade into failure.

>> The Dow plunging again today, the 11-year bull market has ended.

>> Stocks were just on a downward freefall.

You had credit markets seizing up.

People were selling anything that wasn't nailed down.

>> Investors are really growing incredibly pessimistic.

>> The U.S. economy, the biggest economy in the world, is in freefall.

>> Then comes the realization that we have to lock down.

>> The list of closings and activities being suspended is growing from coast to coast.

>> JACOBY: COVID hit the global economy hard and fast, but it wasn't just the pandemic that was causing a financial crisis-- it was the vulnerabilities of a now highly leveraged financial system.

Attention focused on the shadow banks.

>> What we saw in March of last year was a full-blown panic in the shadow banking system.

It wasn't something that you have when you have a pandemic, you have a bank panic.

It was, you have a bank panic because you had some exogenous shock in the economy and you have these underlying vulnerabilities in your monetary system that you haven't resolved.

♪ ♪ >> JACOBY: The Fed sprang into action.

They turned back to quantitative easing-- buying hundreds of billions in debt from financial institutions.

By mid-March they made more than a trillion dollars available to the shadow banks.

And they cut interest rates back down to near zero.

>> The Federal Reserve cut interest rates to near zero.

>> What that tells all of us is that the economic impact of the coronavirus is going to be crippling.

>> The Federal Reserve lent half a trillion dollars to securities dealers, half a trillion dollars to foreign central banks, bought $2 trillion of treasury securities, another trillion dollars of mortgage-backed securities.

It flooded the zone with new government cash to stabilize this system.

>> JACOBY: But it wasn't enough to stop the panic.

>> The emergency rate cut failed to calm investors; in fact, it did the opposite.

>> JACOBY: The corporate debt market had frozen up, and companies were unable to finance themselves, putting the wider financial system at risk.

>> There's just this corporate debt picture out there and we're just beginning to see how those dominoes are gonna fall.

>> JACOBY: So, on March 23, the Fed took its economic experimentation to a whole new level.

With Congress' backing, Fed Chair Powell announced a range of new loan programs.

He said the Fed, for the first time, would be willing to buy up corporate debt.

>> We often talk about the Federal Reserve using a bazooka to tackle markets and the economy.

This is bazooka, cannons, and tanks all at once.

♪ ♪ >> So this was huge, this was the Fed stepping in on an unprecedented scale, and saying to the market, "We will do whatever it takes."

>> The motion is adopted.

(cheers and applause) >> JACOBY: By the end of March, Congress would also act, passing the largest economic stimulus bill ever-- the $2.2 trillion CARES Act.

>> The bill rushed to the president after clearing the House in a voice vote.

>> JACOBY: It provided support for individuals and small businesses.

>> I wanted that to be a nice signature.

(applause) >> JACOBY: A big portion of the bill-- nearly half a trillion dollars-- was earmarked to go to the Fed to support its lending programs.

I don't think most people are aware that we came this close to a bona fide financial crisis.

>> Yeah, I think a lot of it is missed for two reasons.

One: there was a lot of other stuff going on in the news at the time.

And the other is the Federal Reserve did an amazingly good job at putting out the flames of this panic.

And even though the panic in March 2020 was more severe along many metrics than anything we saw in 2008, the government's response was more powerful in certain respects.

And we're lucky that-that the government was successful or we could be living through a true depression.

(bell ringing) >> And there's the opening bell.

Looks like markets are set to rally... >> JACOBY: But in staving off unemployment and economic disaster, the Fed had also used its powers to rescue some of the riskiest parts of the financial system, like the junk bond market.

>> Is this just like a high yield junk bond bailout?

I mean I don't get... >> We've got to live with it now, Tom.

>> ...why is this an emergency?

>> We've got to live with it.

>> JACOBY: To the critics, the Fed was sending the wrong message, rewarding the wrong people.

>> Over the years, we've been trained to believe that the Fed is on our side.

What the Fed has trained us to believe is that if we make a bet in the market and we win, we're on our own, we get to keep the profits.

If we lose, they will bend every effort and every dollar they can get their hands on, one way or another, to bail us out.

This is asymmetry of the most splendid kind.

>> A speeds, go ahead and clap it off please.

>> JACOBY: Billionaire bond investor Howard Marks called the Fed out at the time, saying it was undercutting the way the free market is supposed to work.

>> There are negative ramifications to this.

One called moral hazard, which means conditioning people to believe that if there's a problem, the government will bail you out.

And, if people really believe that, then there's no downside to risky behavior.

Because if there's a problem, it won't fall on you, you'll get bailed out.

If you, if you play it aggressively and-and succeed, you make money, if you play it aggressively and fail you'll get bailed out.

>> JACOBY: So has moral hazard gotten worse as a result of this bailout?

>> There's no barometer of moral hazard, so I can't give you a reading.

All I can say is that for the last year or so, risk-taking has been rewarded, and that tends to bring on more risk-taking.

>> JACOBY: Do you see moral hazard in what has just happened?

>> Oh, absolutely.

I-I think now, you know, the entire business community is... has had a taste of bailouts, you know.

And-and, boy, doesn't it work really, really nicely?

Yeah.

So, I-I fear that now, the Fed stepping in, not just to bail out Wall Street, but the entire, you know, corporate America is-is starting to be embedded into people's thinking.

People talk about the survival of capitalism, but this is the biggest threat to capitalism.

In good times when anybody can make money you reap those profits.

In bad times, the Fed, the Fed just keeps stepping in.

You have this never-ending ratchet up.

The markets never correct.

>> JACOBY: It's like a no-lose casino.

>> It is, it is a no-lose casino.

That's exactly right.

>> JACOBY: This is the second time in 12 years that you and your institution have had to funnel into the financial system trillions of dollars and there is this sense that the financial markets have an iron-clad backstop from the Fed.

>> Well, I completely agree that it is unacceptable that 12 years after 2008, we had to do this again.

I am proud that we did what we did, it was the right thing to do, it was necessary.

But it is unacceptable as an American citizen that we have a financial system that is this risky and this vulnerable.

>> JACOBY: What, if any, responsibility or accountability does the Fed have for the financial system having been so risky and so vulnerable to a shock?

>> Well, I think all financial regulators that have a seat at the table have a... have responsibility for what was left incomplete after 2008, and where we go from here.

We need to use this crisis to finish the work that we did not finish after '08.

>> JACOBY: With all due respect, I just I wonder if you could be a little bit more explicit with me.

What will the Fed own when it comes to the vulnerability of the system?

>> Well, I reject the thesis.

I actually don't think it's been the Fed's monetary policy that has led to these vulnerabilities.

I think it's been incomplete regulatory policy that has led to these vulnerabilities.

>> JACOBY: That's an idea Kashkari expressed repeatedly to me: that there are other actors responsible and larger economic forces at play beyond the Fed's decisions.

>> The shadow of the pandemic is going to be extremely long.

>> JACOBY: With unemployment still high, the Fed and Congress have continued to pump money into the economy.

>> Let's keep 'em coming this way.

>> JACOBY: Trillions to struggling individuals and small businesses.

And, once again, quantitative easing to keep the interest rates low and the cost of borrowing down.

>> Last March, the Fed announced that they've just decided it's gonna be the right thing to do to drive 100 miles an hour.

Okay, your judgment call.

A year later, they're still driving 100 miles an hour.

(chuckling) And you ask them, "Why exactly are you driving 100 miles an hour now?"

They say, "Well, you know it was a good idea last March and we don't wanna change things too quickly and so, yeah, we just think it's a really good idea."

>> JACOBY: Peter Fisher spent years at the New York Federal Reserve, and at Blackrock, the largest asset management firm in the world.

>> It's pretty basic in-in medicine that our doctor may give us a drug, which in a small punchy dose, for a brief period of time, might help us recover from whatever ails us.

But that the same medicine, the same drug, taken in massive doses over long periods of time might kill us, or make us ill, or have perverse side effects.

♪ ♪ >> JACOBY: Corporate America has taken on yet more debt, and investors are gobbling it up.

The housing market and the millions of people who own some stocks and bonds are seeing a boom.

>> Elon Musk has added over $10 billion to his wealth just this week.

>> JACOBY: And for the richest Americans, it's been a bonanza.

>> Just the billionaires in the United States, from March 2020 to February 2021, have grown their wealth by $1.3 trillion.

$1.3 trillion.

>> Billionaires now hold two-thirds more in wealth than the bottom half of the U.S. population.

>> The thing about wealth is what creates wealth is wealth.

When you have $100 million to invest, it's much more easy to become a billionaire than when you have $100 to invest.

♪ ♪ >> You ever think about trading stocks?

>> JACOBY: But that hasn't stopped many $100 investors from trying to get a piece of the action.

>> People like us can trade just like the big guys.

With Robinhood.

♪ ♪ >> All these brokerage platforms saw the largest growth of new users they'd ever seen because people said, "Now is my opportunity, I'm gonna invest my money in the stock market.

I may not understand what the Fed's doing, or how it works, or what exactly is going on..." >> The Dow rising nearly 18%, its best performance since 1987... >> "But I understand the Fed takes action, stock prices go up, these people get rich."

And it became a very clear mandate for people, "If I wanna get in on this economic recovery we're having, I've gotta buy stocks."

>> I'm gonna take my stimulus check and I'm gonna put it in the stock market.

>> So they're online, they're trading stocks, they're buying and selling, and putting money into these stock accounts.

They started creating their own communities >> Welcome Declan, Michael Lee, so many people, Bob Smith... >> JACOBY: Jerome Powell has become a kind of cult figure, master of the money printer.

>> Money printer go brr... >> Invest in these four tickers, I'll put them right above.

>> JACOBY: Billions have been piling into so-called meme stocks.

>> This GameStop situation, we will never encounter a set-up like this again.

>> JACOBY: New financial assets like NFTs-- non-fungible tokens.

>> From art to music to sports, it's a new phenomenon that is moving quickly, and with big numbers.

>> JACOBY: And cryptocurrencies.

>> Bitcoin has been on a wild ride during the past few months.

>> It doesn't really matter if something is a good buy or if it's fundamentally sound.

>> The money is crazy and awesome and I think... >> There's been so much money injected into the economy that people just need things to buy.

>> JACOBY: I mean, what you're describing is mania.

>> (laughing) Yeah, yeah, you could call it mania.

I mean certainly we are in a mania because, again, the Fed has put a floor underneath asset prices.

There's only one direction that things can go and that's up.

Otherwise, the Fed will step in and act.

So if things can only go up, why wouldn't you just buy?

>> When I look out at what's been going on the last six months, I see financial mania.

I don't know what the right value of some companies is.

But when they change by 50% in six months, I think we should all recognize, boy, that's hard to estimate the value of that.

If it's 50% higher now than it was six months ago, I guess we were pretty bad on estimating its value six months ago.

>> JACOBY: I assume you're somebody who has assets, who's invested, and that this has been a good period for someone like you, in part because you own assets.

>> The Fed having pumped asset prices to historically high levels doesn't make me feel comfortable.

I'd be...

I feel as anxious today as I've ever felt about the financial world because of my belief that the Fed has been pumping up asset prices in a way that is creating a bit of an illusion.

I think the odds are now sort of one in three-- very high-- that we will look at this as an epic mistake and one of the great financial calamities of all time.

>> They have the housing market, the stock market, and the bond market all overpriced at the same time.

And they will not be able to prevent, sooner or later, the asset prices coming back down.

So we are playing with fire because we have the three great asset classes moving into bubble territory simultaneously.

>> JACOBY: There's a growing conversation right now about the Fed's role, about whether it's driving wealth inequality, whether it's driving asset prices into dangerous territory that could pop right in our faces, and whether the... whether the financial system can withstand that.

I mean there are these seemingly legitimate questions about being in what seems to be unchartered territory.

>> These questions come from people who are keen Wall Street observers or Wall Street.

I never have once heard this line of questioning from a member of Congress that represents a low income or minority district, never once.

They come to us and they say, "Why can't you do more?"

They never say, "Oh my gosh, you're just benefiting Wall Street, you know, raise interest rates, because I wanna keep Wall Street in check."

They say, "Help my constituents find work."

So that's why, I mean, I find these questions amusing because I hear 'em all the time from Wall Street.

And these are folks who don't care about what's actually happening on Main Street.

I don't hear it from Main Street.

I certainly don't hear it from low-income communities.

And I've heard all of these questions before.

>> The price of virtually everything seems to be going up.

>> From used cars to plane tickets to furniture.

>> If you're going to get in your car and drive to work, your gas costs more.

>> JACOBY: There are now signs of inflation percolating through the economy.

>> Annual inflation is expected to top 3.5% in the fourth quarter.

So now there's speculation the Fed may speed up its interest rate plans.

>> JACOBY: The Fed insists it's temporary but has signaled it may taper quantitative easing and raise interest rates as early as 2023.

>> Fed Chair Jerome Powell said while the economy has rebounded, the job market is still hurting.

>> Federal Reserve Chair Jerome Powell announced that tweaks to monetary policy may still be needed.

>> It is an awfully daunting task.

I pray for Jay Powell and I pray for the committee.

Doing this successfully will be a heck of a hat trick.

>> I would imagine people at the Fed are scratching their heads about how they are going to be able to get that faucet calibrated to a lower level when necessary.

>> JACOBY: And the risk of them turning off the valve right now is what?

>> The risk of turning the valve off is-is economic collapse, right?

You would, you would see asset values actually drop through the floor.

You know, and a complete lack of confidence.

The Fed, by the way, would not, I can't imagine, turn it off in one, you know, sort of in one move.

But when the Fed does move, it's going to want to do it probably quite gradually.

And the question is: will they be able to do it in such a way that doesn't create this kind of massive economic dislocation?

♪ ♪ >> JACOBY: Whatever the Fed does next, the consequences will affect us all.

>> Go to pbs.org/frontline for more on the current Fed Chair Jerome Powell and the other officials at the Federal Reserve.

>> The US economy is in a good place, and we will continue to use our monetary policy tools to help keep it there.

>> And a closer look at the growth of the stock market compared with people’s incomes.

Connect with FRONTLINE on Facebook, Instagram, Twitter and TikTok and stream anytime on the pbs app or pbs.org/frontline.

>> NARRATOR: As the United States withdraws from a twenty-year conflict... >> It’s time to end America’s longest war.

>> NARRATOR: Iran is stepping in... And the Taliban is gaining ground... >> Correspondent Najibullah Quraishi investigates the consequences of leaving Afghanistan.

>> The most likely scenario is a civil war.

There is no one to stop it anymore.

Captioned by Media Access Group at WGBH access.wgbh.org >> For more on this and other "Frontline" programs, visit our website at pbs.org/frontline.

♪ ♪ Frontline's "Power of the Fed" is avaliable on Amazon Prime Video.