Episode 204 – FTX and the Fall of Cryptocurrency with Robert Hockett

Macro N Cheese – Episode 204
FTX and the Fall of Cryptocurrency with Robert Hockett
December 24, 2022

 

[00:00:03.330] – Robert Hockett [intro/music]

Most cryptocurrencies that are out there right now are crypto pseudo-currencies. They’re not real currencies. They’re not real stores of value as packaged and used by the purveyors of them, that will, in any way, aid economic growth or the actual growth and the prosperity of the real economy or the citizenry.

[00:00:26.090] – Robert Hockett [intro/music]

Financial institutions on which we and the real economy depend, didn’t yet get into all of this crypto nonsense in a big way, as they did in the leadup to 2008. And, so, the broader economy, I think, is a little bit better insulated this time against these crashes.

[00:01:35.150] – Geoff Ginter [intro/music]

Now, let’s see if we can avoid the apocalypse altogether. Here’s another episode of Macro N Cheese with your host, Steve Grumbine.

[00:01:43.150] – Steve Grumbine

All right. This is Steve with Macro N Cheese. Welcome everyone. I appreciate you joining us. We got a heck of a good show for you today with crypto collapsing all around. Something’s going on and we’re going to get to the bottom of it. My guest today is none other than Cornell Law’s own Bob Hockett. He is the adviser to many folks in Congress today and hopefully Bob will be able to provide us with a really good insight to the collapse of FTX and others. Without further ado, Bob Hockett. Welcome, sir.

[00:02:17.850] – Robert Hockett

Hey, great to be with you again Steve. Thanks so much.

[00:02:20.770] – Grumbine

Absolutely. It’s kind of funny, ’cause FTX five minutes ago was sponsoring the Super Bowl and now they’re circling the toilet bowl, proving once again the fair market value of crypto is zero. What in the world is going on right now within the crypto space?

[00:02:41.410] – Hockett

Well, I think it’s a classic case of a bubble that comes into being in connection with the new technology or perceivedly new mode of finance that everybody lets their imaginations run wild on, in view of the initial promise that’s offered by the new thing. For example, if you consider the so-called junk bond market up the middle to later 1980s at the beginning, essentially what the junk bond market was doing was enabling a kind of financing or a kind of investing that had previously not been possible.

And that did, in a certain sense, add a certain kind of value, insofar as it made something possible that hadn’t been quite as easily possible before. The problem was that people got excited about that initial promise or that new increment of value that was promised by the new instrument and then got so excited about it that they started hyping it to other people and other people got caught up in the excitement of it.

And in no time at all, the wealth that the new product represented was not really the product of new value added, but was instead the product of other people crowding into it and buying it and thereby bidding up the price of it. So it became a classic Ponzi structure without any need of any specific Ponzi. You didn’t need a Charles Ponzi to do it.

You didn’t need a Ponzi in the form of a person who was literally scheming. All you needed was a product, the market for which developed a structure that in effect replicated the structure that we associate with a Ponzi scheme or what’s also known as a pyramid scheme. So Stephen gets into this particular product or this particular market at the front end.

He invests a little bit in it, he buys it relatively inexpensively because it’s new and so it’s not big yet. He talks other people into getting involved in it and buying it too, partly on the basis of actual legitimate value added that the product represents. But he gets so many people to crowd in that they drive up the price and then a huge increment, or the increment of that price, that’s attributable to people crowding into it, ends up becoming larger than the increment of that price that’s attributed to the actual value added by the product.

And then in time, more and more people crowd in. And basically at each stage of the crowding-in process, more people are doing it. That’s where you get that pyramid shape or pyramid structure. And more and more people are actually borrowing in order to buy. That is to say, they are crowding in, in effect with borrowed funds driving the price even higher and higher and higher.

And then eventually what happens is that the credit available for people to borrow speculatively in order to buy speculatively within that new market runs dry. And at that point everything collapses. And all the people who borrowed in order to get in are now of negative net worth. They all basically have less than they began with because they owe more than they own, precisely because the thing that they borrowed in order to own has now suddenly dropped in value.

 It’s the classic Minsky-style structure, which is effectively a pyramid structure, or again a Ponzi-style structure. And we see it again and again and again with new fad products. A quick aside here that links up—you’ve probably noticed, certainly I’ve noticed—if you go to various social media sites and you’re looking at a friend’s post or you’re looking at somebody’s Instagram post or whatever, and you look at the comments underneath the friend’s post, some of them are relevant and actually pertain to the post, but tons of them will say, I got into bitcoin.

Wouldn’t you like to get in too? If so, contact me at this particular address or this particular contact site—has nothing to do with the post. There’s a reason for that: the people who are doing that are people who have already bought in, and they understood and understand that the continuing growth in the price of the thing that they’re into depends on more people coming in and buying it.

And anytime that becomes the principal driver of the price of the product—instead of, again, the actual value added and the actual long-term value additive potential of the product—in other words, the fundamental value or fundamental potential of the product—anytime that crowd-in value comes to exceed that actual fundamental value-add capacity value, that’s when you know you’re in that Minsky territory, you’re in that bubble territory, you’re in that basically pyramid territory.

And that happened, as I mentioned before, with junk bonds. It also happened then with subprime mortgage loans and associated products about ten to 15 years after that. And now it’s, of course, happening in crypto. And the irony is that in every one of these cases, there is a clue in the name of the product in question that ought to warn you.

If it’s called a junk bond, there’s a reason for that word “junk” being used. And if it’s called a subprime mortgage loan or subprime mortgage-based product, there’s a reason for that subprime term. Similarly with cryptocurrency or crypto assets, one of the most ironical names ever conceived for this kind of product. But if the word “crypto” comes into it, then that’s a pretty good tip-off that there’s something non-transparent about it, that there’s something opaque and occluded and difficult to understand about it. And that’s a pretty good hint that maybe one should proceed with caution if one is to proceed into this territory.

[00:08:08.590] – Grumbine

Well, the FTX bomb that just went off had so many ripples. There’s a great article on Reuters, breaks down all these different folks. It talks about FTX going bankrupt, then Binance failing, and Block Five and Three Arrows Capital going down, Singapore-based 3AC blew up with 10 billion in crypto in 2022. And then now they’re bankrupt. Voyager Digital going bankrupt, Celsius Network, on and on.

And yet these are the same buffoons, same individuals that are talking about the collapse of fiat, the collapse of the nation’s unit of account. It’s humorous, it’s laughable, but in that space, these people have got to convince others, invest in. And then the owners of these exchanges decide to buy islands in the Bahamas instead of back their investments the way that they should with this deregulated world.

Because after all, free markets, private currencies, private exchanges, all this libertarian nonsense that keeps creeping into the left, it’s scary. But there’s a little bit of justice in this collapse to some extent, because by selling the lie, they’ve exposed the lie in this collapse. What brought these collapses on? The gentleman, I see him as kind of a young dude that blew up, had a big-brain moment, and it’s done. He fell apart.

[00:09:50.870] – Hockett

Yeah.

[00:09:51.810] – Grumbine

What created this?

[00:09:54.610] – Hockett

Well I think a couple of features that are worth singling out because these are features again that you find in earlier cases of the same general phenomenon as well. So one is there always has to be some kind of a story, some kind of a narrative that essentially makes apparent sense, or it makes a provisional or preliminary sense of what is otherwise a difficult to understand or difficult to use as a guide to action event.

So in, for example, the tech-stock bubble that began to inflate in the middle to late 1990s and then ultimately came a cropper early in the year of 2000. The story was “oh, we’ve got this new technology that’s going to revolutionize our modes of production across the economy. It’s going to be usable in all the different spheres, all the different industries, all the different sectors of the economy; it’s going to add value in the form of increased or boosted productivity, economy-wide.”

And so it’s best to get in on the front end of this if you really want to benefit maximally from it. And so, all sorts of people began crowding into tech stocks in the late 1990s, even stocks issued by firms that told an interesting-sounding tech story but hadn’t actually shown any records yet of profits or hadn’t proven any actual capacity to earn, actual capacity to exploit, potential markets.

But people thought “well, if I’m going to get in on the front end I had to get in before they actually prove their capacities to revolutionize the economy and to add all sorts of value and thus to recoup all sorts of value for initial investors. After all, if I wait until they’ve proven themselves I won’t make as much money. Best to get in the front end.”

And to a certain extent that’s true. But the problem with it is that for every one of those prospects that is ultimately going to pan out, there are probably ten or 100 or a thousand counterpart prospects or neighboring prospects that aren’t. So what people tend to forget is that the overwhelmingly greater part of the invested money during the fad phase of a new investment product ends up being lost.

It’s only a relatively-small number of folk who actually benefit by it. I think the same thing then happened, of course, with the subprime mortgage-related products. When these were brand new there were certain synergies and certain capacities to capitalize value that they captured that hadn’t previously been capturable.

Effectively, what they did is they recognized that some people who, according to the old actuarial models employed by lending institutions, would not tend to prosper or would not end up being able to pay off their loans, indeed might be able to pay off their loans, and furthermore that if you could put together portfolios of lots of different loans like this, people who would have previously failed to qualify for loans according to the old actuarial models that were used to determine who to lend to, they enabled more actual profitable lending to be done.

And in so doing, they actually enabled more people to be able to buy their own homes than had previously been able to do so. But as always happens, so much money crowded into this new technology, essentially mortgage lending technology. And so many rascals were invited to enter into the market, essentially to offer crap alongside the non-crap, that the crap ultimately came to outweigh and outsize the non-crap.

And that’s, of course, where you got the trouble. Now, the same thing I think has happened with crypto; the initial technology, the original technology on which all of these so-called crypto assets were based, the so-called blockchain technology, enables all sorts of peer-to-peer transacting that wasn’t previously able to be done.

And it also, of course, provides for the possibility of certain indelible transaction records and their replication across databases or across servers, so that you didn’t have to worry about losing data or being unable to verify data. And that is a genuine advance or that’s a genuine value-add that we can indeed, as a society, make something out of that makes for better financing and better distribution of funds and better payment systems.

But as usual, the crowd of people who have essentially decided to try to capitalize on this and capture some of the gains that this legitimately, potentially helpful new technology offers, the number of such people who are actually scheming and scamming in this space comes fairly steadily to outpace the number of people who are actually adding value.

And in each of these cases though, what you do is you start with the legitimate value-add story and then you blow it up into something bigger than what it really is, and that’s what enables people to think they’re getting in on it. Now, if you then add to the value-add story something that’s culturally resonant, in addition to, say, financially or economically resonant, like, “oh, the people who are doing this are cool,” you’re cooler if you’re one of these people than if you’re not one of these people.

And as you know, you’ve probably encountered the buzzword or the buzz phrase “self-sovereignty” that began to be disseminated or used widely to the point of making people like you and I throw up, about five, seven years ago, and it’s still current now. Or the idea of taking control of your own financial and economic destiny simply by buying something that you don’t actually even understand, like a bitcoin.

That, of course, further accentuated the appeal. But the whole point was not simply to accentuate the appeal, but to accentuate the appeal in order to bring even more people in. And now we’re right back to that pyramid structure. You always need more people coming in now than were in before, if the people who came in before are actually to profit, because again, at some point the actual value base of profit potential comes to be exhausted.

And then the value base is replaced by, effectively, the speculation base, the pyramid base, the incoming of new, quote unquote, “investors” who are simply driving up the price of the thing that the earlier comers have already purchased and already own and hence realized the property.

[00:16:19.530] – Grumbine

I have two books here. One of them belongs to a gentleman named Robert Hockett and it’s called The Citizens Ledger. And then I got another book by my good friend Brett Scott and Cloudmoney. So these two books together, this is central bank digital currency, and then this one is about the payment systems.

I think it’s important to note that what you’re saying, and what I think most people that are in the know in this space are saying, is that while this is not the use you would have for it, these speculative tools that are used to pump and dump basically, there are underlying values to the underlying technology in terms of blockchain, et cetera.

And you’ve written extensively about the central bank digital currency, which I think is often completely misunderstood as it’s another speculative thing that we can just buy. Would a digital CBDC have had any impact on the implosion of FTX? Or is there a different form of regulation that needs to occur to prevent the type of collapse and the type of irresponsible management that FTX performed? How do we rein that in?

[00:17:39.970] – Hockett

I think both of the things you mentioned are essential and both of them are mutually complementary. And the easiest way, I think, to demonstrate this, or just illustrate the reason that I want to say this is by reference to the history of paper currency, for example, right? The digital space right now is, in effect, the 21st-century version of the 19th-century paper currency space.

So consider paper currencies in the US as they first came to be offered and used widely in the early-mid 19th century. At that time, they did represent a value add. They represented a legitimate advance in a money system. Because what they did is, they severed the link to exogenously-given quantities of so-called precious metals, externally-given, basically exogenously-given in the sense of so-called precious metals that people could not themselves create ex nihilo, that you were basically dependent on an antecedently-given stock of that, under the ground.

And if you wanted to increase the gold supply or the silver supply, you had to go around digging up in various places, and you had to enslave native populations and send them into silver mines as the Spanish did, of course, in South America and so forth. Which, frankly, let’s face it, it’s no way to run a money system, it’s no way to have a currency system.

And the US in particular in the 19th century was basically constantly perpetually short of adequate supplies of these so-called precious metals or precious-metal coins. And so the only way to grow the money supply in a manner that could remain in sync with the growth of the real economy itself and thus avoid slowing down the economy through a shortage of money (which as you know, is by definition something that’s deflationary) was essentially to untether money from precious metals, to sever that link, and essentially to start issuing money according as it was needed.

And using paper currencies was a way to do that. And so there was a legitimate value-add that came in the form of paper currencies, which were issued by private-sector banks, and hence they were called, of course, banknotes. Now, the move to that new form of currency was an advance, on the one hand, but it also gave rise to a new vulnerability on the other hand.

Because once people are willing to accept paper instead of gold coins that they can sink their teeth into to see if it’s really gold, or something made out of basically silver coins that they can check the purity of, once they’re willing to accept paper instead, a new problem emerges. Or at least two related potential problems emerge.

One is that counterfeiting becomes a thing, a possibility, because criminals like you or I can essentially imitate paper currencies more readily than we can imitate gold currencies unless we have a bunch of gold already, in which case we don’t have to counterfeit. Or, issuers even bona fide issuers of paper currencies like banks, if they are poorly regulated by the states in which they are organized, which in the 19th century they always were—there were no federally-licensed banks, there were only state-licensed banks.

Then again, the banks themselves could issue currency that ends up being bad currency, because the banks themselves are bad businesses that don’t run well or that aren’t reliable institutions to be good for the obligations that their currency issuances amount to. So what we had happen then in the 19th century, in the US, by the mid to later 19th century, was a proliferation of what were at the time called “wildcat currencies” issued by so-called wildcat banks.

And basically there wasn’t any particular currency that was issued by any public instrumentality. They were all privately issued. And so some of them were good, but only if they were issued by good private-sector banks, well-operated or well-regulated, or both private-sector banks. And then lots of nasty bad currencies, unreliable currencies, were issued by poorly-regulated banks or badly-regulated banks or badly-run banks.

And it was hard to sift out what were the good ones or what were the bad ones. And indeed, you or I, if we were to walk into a general store to make a payment for something, we might have a lot of different banks, wildcat currencies in our pocket, and we might have to hand over a whole bunch of it. And then the merchant who was selling us the stuff at the general store would have to pull up a little schedule of discount rates that attach our…

[00:22:06.950] – Grumbine

Foreign exchange within the domestic economy!

[00:22:10.230] – Hockett

Exactly, foreign exchange within the domestic economy. And so the Pecos Bill or the Wild Bill Hickcock bank notes are actually worth 20% of stated par. But the Puritan bank from Puritan, Massachusetts or whatever, that counts at 90% or 100% of stated par. And then they’d have to add up all of these discounted values to come up with the total value that you had laid out on the counter.

That’s not a particularly efficiently-running system. And by the time the Civil War broke out, it was just downright intolerable because the union, the federal government, had to requisition things and had to pay for supplies and had to pay troops and so forth in order to send them down to put down the rebellion in the south.

And if the federal government had to spend all this wildcat currency and didn’t have a currency of its own that was of reliable value to spend, it couldn’t prosecute the war. So a series of enactments by congress, all then signed by president Abraham Lincoln in 1862, 63 and 64, essentially revolutionized the paper currency system.

And what they did is they established a whole system of federally chartered national banks to operate in parallel with the state banks, all of which issued the same note, the same bank note. Now, no matter where they were in the country, it was called the greenback. And of course that’s the source of our current paper dollar bill. It was green and it was the same everywhere.

And so these enactments essentially gave us a single unified national currency. It did not have to be tied to gold or precious metals. And so the treasury department could actually to some extent modulate the quantity. It could issue more when more was needed and more could be absorbed by the productive sectors of the economy and it could issue less when not so much was needed or when there was too much to be absorbed by the productive sectors of the economy.

And, at the same time that we did this, we also then began to prohibit the issuance of private-sector bank notes. So we basically, on the one hand, phased out the inadequate and the problematic and dysfunctional private sector currencies and at the same time we offered a reliable, stable public sector alternative that was issued by banks that were very carefully regulated by a new regime of federal bank regulation.

Now, my own view, for what it’s worth, is essentially we’re going through the same evolution in the crypto space right now. And we are in effect in the wildcat-bank equivalent of the crypto sector right now. We’ve got private-sector crypto issuers of varying reliability and we’ve got a sector that’s essentially unregulated at this point.

Although the SEC and the CFTC are two primary regulators who have the most plausible claims to being able to exercise jurisdiction over this space, are making moves to move in and try to regulate, but are having a little difficulty sorting out who gets jurisdiction over what. Which uncertainty, by the way, is itself a source of the allowance of the continued chaos in these particular markets.

So what I’ve been arguing, and what the book is doing, is essentially providing for the equivalent of that very evolution, that very move forward in the way of, on the one hand, offering a public-sector version of digital currency that is uniform across the country, and that is able to retain value through time and across space, while at the same time, then, phasing out and regulating out the private-sector crypto that is essentially trying to do what we can do much better if we do it publicly.

[00:26:01.490] – Intermission

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[00:26:52.450] – Grumbine

So what I would say coming back at you as the libertarian strain which is largely advancing these things, a lot of the stuff comes from a significantly right-wing perspective.

[00:27:04.480] – Hockett

Yeah.

[00:27:04.860] – Grumbine

And one of their chief problems is they don’t want the government to be the currency issuer. It’s like solving a problem that they purposely went out of their way to solve differently.

[00:27:17.170] – Hockett

Right.

[00:27:18.120] – Grumbine

How would you affect their confidence in the CBDC? I feel like when I read stuff about the CBDCs, that I’m reading stuff about 5G wireless causing seven legs to come out of the back of your neck. Over-the-top wrong mindedness. It makes me think that an education is very necessary here. The entire crypto space survives by disinformation.

They talk about “they’re printing so much money, they’re debasing.” How do you debase a free flooding currency? “They’re debasing the currency!” Once they say that, you know they’re lying. But then, the next part of that comes back to something you said a little bit earlier. You talked about the 90s and the initial foray into the “dotcom bubble” and a lot of companies realizing revenue that hadn’t even left their warehouse.

And I think back to Cisco and some of their accounting practices in the early two thousands, and MCI doing faulty accounting, taking leased lines and making them part of their internal assets. Enron. So what I keep seeing, and I want to make sure I’m seeing this correctly, because I’m pulling from our friend Bill Black as I think through this, multiple chapters of the same novel.

We build it up. We become too big to fail. And we have high-speed transactions, lots of bad people involved, a lot of ignorance, and lots of really cool mystique around it. And you end up with massive corruption. We saw this in the savings and loan crisis. We saw this in the housing crisis with Fanny and Freddie and Countrywide. By the way, those people are still doing their business.

They didn’t go away. Nobody got prosecuted. And so now we’re dealing with a whole new wave of these folks. What is going on to stop that corruption now, bob? You’re working on a CBDC, these things are going on to stabilize, but publicly, not privately. What other legislation is out there? What is some of the talk behind the scenes as to regulatory environments that may curtail more of these frauds cropping up and then stealing everyone’s money?

[00:29:40.000] – Hockett

Sure. So I think again there are two things that will be done ultimately because there are two things that always are done when we actually get a handle on these things after they’ve gotten out of hand and become dysfunctional to the point where they actually harm lots of innocent third parties and unsuspecting fraud victims and the like.

So the two things I think that will happen and are already beginning to happen are, in effect, further developments of the general type that I just mentioned. So the first thing you do is, as a public, as a country, as a polity, as a nation-state, as a community, you recognize explicitly the legitimate value-add that is offered by the new technology in question.

So the technology of paper currency was a legitimate financial and monetary advance as a modality. Similarly the issuance of stocks by firms and the issuance of bonds by firms and then ultimately the issuance of derivative securities by various firms or derivatives underwriters were legitimate financial advances that enabled the financial system, at least in potential, to function more efficiently, to function much more effectively and to channel credit to lots of places where it belonged.

Productive places, in other words, that previously hadn’t had access. But as always, because there’s a legitimate advance posed by these new technologies, there is the potential for fraudsters to come in and overhype the potential or to pretend to be themselves realizing the potential when they themselves really are not.

And so the way you deal with this then is, first, we as the public seize on the actual value-add of the new technology and offer it publicly as something that is universally available to everybody on a non-profit-seeking basis. And then, complementary to that offering of the safe version of this new technology, stamping out the unsafe or fraudulent versions, the pseudo versions, let’s call them.

Because really most cryptocurrencies that are out there right now are crypto pseudocurrencies. They’re not real currencies. They’re not real stores of value. They’re not real technologies as packaged and used by the purveyors of them that will in any way aid economic growth or aid the actual growth and the prosperity of the real economy or the citizenry.

So on the one hand we establish and provide the public version and then on the other hand, you stamp out all of the fraudulent and inadequate private versions. Now, what are we doing right now along those two lines?Well, for one thing, as you know, the various regional Federal Reserve banks, the New York Fed, for example, the Boston Fed, the San Francisco Fed, are working on prototypes of a legitimate CBDC, a legitimate, in other words, digital dollar.

And they’re essentially doing so largely along the lines that are described in the book that I wrote recently that you raised up. And I promise this isn’t meant to be a plug, but they’re doing it along the lines described in that book, by and large. And indeed I’m working with several of these initiatives to try to make sure that the form that it ultimately takes, and the digital dollar ultimately takes, is in fact a legitimate, publicly-issued currency, essentially the digital equivalent of the paper dollar or the greenback.

And indeed, for that reason, earlier versions of this proposal that I put out before the book, various articles and essays that I put out several years ago, actually starting about five or six years ago, are named things like “the digital greenback.” Because I’m trying explicitly to draw the analogy to the paper greenback. So that’s on the positive side, on the public offering side or the public alternative side, we are, at this point, finally working on developing CBDCs in various regional Federal Reserve banks.

In so doing, we’re following the lead of other countries that got there first. Sweden is probably the most advanced right now, with the E-krona being a purely publicly-issued digital currency that is replacing, almost entirely, paper currency. Not by law in the sense of outlawing paper currency, but just essentially people in Sweden seem to prefer to use their phones as a means of payment and so they are using, or they’re going to be making payments in, e-krona.

On the other side, the regulatory side, as I mentioned before, both the SEC and the CFTC have tried to make moves in the way of regulating the digital currency markets, in the way they regulate the securities markets and the derivatives markets respectively. And I think the best thing that Congress could do right now is first, to essentially answer the regulatory turf question.

For as long as the SEC remains uncertain whether the CFTC is going to have ultimate jurisdiction, and for as long as the CFTC remains uncertain as to whether the SEC is going to have definitive regulatory jurisdiction, neither of them is able to advance as far as we need them to advance in developing or crafting full-on cryptocurrency regulatory regimes.

Now, of course, all of the scammers and scoundrels out there, the fraudsters, who of course our friend Bill Black would describe as the “control fraudsters,” they’re thrilled with that. They want there to be uncertainty as to who, as between the SEC and the CFTC, will have jurisdiction to continue, because for as long as that uncertainty continues, nothing gets regulated and they can keep doing what Sam Bankman-Fried did and scam the hell out of everybody.

So the first thing I think we ought to do, or that Congress could do, would be essentially to settle that boundary dispute, so to speak, between the SEC and the CFTC once and for all in the crypto space. And then, secondly, charge whichever agency is given that jurisdiction with the task of crafting a full-on regulatory regime.

That part is not really going to be that difficult because basically regulating this sphere is going ultimately to have to look a lot like what we do in regulating the securities sphere, in regulating the commodities sphere, in regulating the derivatives sphere, and even for that matter, the stocks and bonds spheres.

Essentially the pyramid structure is the problem in all of these distinct spheres, or at least originally is the problem before regulation in all of these spheres. The form that regulation will take in the currently under-regulated sphere is going to look a lot like the form that regulation now takes in all of these previously unregulated but now regulated spheres, which again includes securities, commodities, and derivatives.

[00:36:34.270] – Grumbine

I got to ask, in terms of the institutionalized knowledge of the Fed and central banks in general, we see clearly that they have depoliticized things that really shouldn’t be considered settled science. Like, we raise interest rates to solve inflation, we lay people off to stave off inflation, we’ve cut federal spending to stave off inflation. These are all things that are killing the host so that they can somehow or another resuscitate it later.

[00:37:05.830] – Hockett

Right.

[00:37:06.300] – Grumbine

These are ridiculous, but this is the Bible by which they operate from. I find it interesting to see archaic folks that are stuck in institutions like this and the more I learn, and I recently spoke with Clara Mattei. We talked about “The Capital Order,” and she talks about the role of the trinity of austerity which is interest rate hikes, the fiscal space reduction, eliminating public spending, and then the layoffs.

I find it intriguing to think about crypto. Rightly or wrongly, it has been seen as a path out of this cage that we’ve been put in through the tools of austerity, and people are finding a way around that. And in their mind, freedom, the desire for that, is laudable. However, that’s not how it worked out. And the Fed and all central banks have shown us that they’re technocrats.

In the end, they’re going to do what the Bible tells them to do and that’s that. How does a new technology like this get fitted into their institutionalized, beyond-the-debate methods and procedures?

[00:38:17.470] – Hockett

Yeah, that’s a really poignant question from my point of view, Steven, because I wish there were a nice algorithmic answer that could be given to it or a nice simple, straightforward solution to it. I think, however, that the solution is inherently multipart. So in some of the parts are parts that really are part of the answer to the problem in those other spheres, too.

And then other parts of the answer, I think, are to some extent at least unique to the new technology or the new sphere being opened up. So to start with the former, the answers that are, I think, relevant in the other subsectors as well. It’s helpful, I think, or it’s at least somewhat helpful or potentially helpful to have a central monetary authority that has some degree of insulation from the immediate political pressures.

Go back to about ten or eleven years to the heyday of John Boehner and Eric Cantor, one of those so-called young Turks, who are now probably fairly grizzled Turks, who were complacently claiming to be the leaders of US economic policy in the House of Representatives. If those people had had control over the Fed, or been able to make the Fed respond immediately to what they were demanding, which, as you’ll remember, was much more austerity even than the disappointment notice Barack Obama was pushing on us, it would have been an even worse disaster.

Things would have been much worse in 2011, 2012, even than they already were. Maybe that would have been a good thing because maybe it would have heightened the pressure on everybody to the degree where we had a revolution. But apart from that, apart from making things so painful that we actually finally had a helpful revolution, if they fell anywhere short of that, they would have made things much worse than they really were.

And happily, Ben Bernanke, who is certainly not a hero by any means, neither a hero of the intellect nor a hero of statesmanship, was at least smart enough to know that these people were idiots and was at least insulated enough not to have to bow to them or kowtow to them or do what they wanted them to do. So on the one hand, that can be an advantage, a certain degree of insulation.

On the other hand, obviously I’m basically going Aristotle here on the golden mean. At the other extreme, there’s the possibility of complete and utter unaccountability and, in effect, a kind of autism, right? A complete shutting off from public understanding and public needs, and also shutting off from alternative voices that are alternative to the orthodoxy that prevails in the American academy generally, and the economics academy more specifically.

So it seems to me the question is: is there some way to, on the one hand, insulate a monetary authority or other finance-regulatory authority from immediate pressures of mob rule (or at least autocratic retrograde right-wing rule, on the one hand) while still having a portal open to it where it can actually take seriously new perspectives, or better perspectives, and can actually learn from sorry experience on the other hand.

Now, one way to do that might be…You mentioned before that I had worked at the New York Fed before. That which occasions that happening is itself, I think, kind of interesting. And it might itself provide a partial model, or the germ of a model, for what we can do going forward. So after the crash of 08, to its credit, one of the things that the New York Fed as an institution did was to ask itself, and by that I mean the people there began to ask themselves: what went wrong?

How did we not see this coming? What did we leave out? What were we blind to that enabled all of this shit to develop right under our noses and then explode, so that we weren’t aware of it until it was too late? And one of the things they decided when they did an internal self-study was that there was too much groupthink around not only the New York Fed, but in the Fed system generally, that basically if Alan Greenspan said something, everybody just accepted it around there.

And then they all repeated it. They mimicked it like myna birds or parrots. And nobody really was encouraged to think for themselves, and nobody was encouraged to question any orthodoxy or any so-called consensus opinion. More like a kind of imposed opinion that had been imposed upon everybody as a party line.

And so they thought maybe one way to guard against that would be to establish within our own midst a contrarian thinking department in effect, what I call a kind of internal asshole department. They need somebody to be an asshole, essentially to say, “are you sure about that? Why do you say that? Isn’t that possibly wrong? Aren’t you being ridiculous here?”

And thinking, basically, somebody to be an annoyance, somebody to pick at the possible flaws in any particular consensus view that had developed within the institution. And what they hired me to do, I guess they heard from somebody that I was an asshole, is they hired me to help establish that internal contrarian thinking department.

And to their credit, they did give me a lot of free rein. They didn’t try to come down on me or shut me down when I suggested various things that ought to be being done that aren’t being done, or suggested that maybe we not say things or do things that everybody assumes that we should do. They were open to this for a brief period. This didn’t last forever, but for a number of years they were open to this and were actually even friendly to me about it.

They would invite me to lunches, invite me to dinners and the president of the New York Fed at the time, Bill Dudley, his administrative assistant, would contact me before various speeches he was to give. And she would say, Mr. Dudley would like you to suggest some sort of out-of-the-box things that he might consider, or include in this forthcoming speech, or in that forthcoming speech.

And they were really friendly to it. And I think the height of this, the apotheosis of this, came with that eminent domain plan that I developed for underwater mortgage loans. You might remember that from back in 2010, 2011, 2012. So I came up with this plan for how to, essentially, bust up or clear out the underwater mortgage problem and essentially to keep people in their homes and to write down their mortgage loans.

And it involved the exercise of eminent domain either by federal authority or by state authority or by local authority. And you might remember that brought a lot of controversy, to put it sort of politely, a lot of very vehement objection from Wall Street, all over Wall Street. So all sorts of banking institutions and right-wing politicians and so forth were attacking me by name for a while.

This was my 15 minutes of fame, so to speak, where The Wall Street Journal attacked me by name two days in one week on its op ed page. And in the midst of all this, I get an email from the head of research over at the New York Fed, who was himself, by the way, a politically conservative-minded guy. And he said, hey, Bob, would you mind writing up a paper-style description of the plan and its justification for us, comma, the New York Fed, comma, to post on our website?

Can you believe this? Yes. I’d be happy to develop all this on my own in my personal capacity, not in the Fed’s capacity, because of course, without the Fed’s permission to do this, I couldn’t call it a Fed thing. But once I had done it, the Fed says, hey, can you do this? Sure. And so I did it, and they put it up on the website and they responded to criticisms.

And of course then they were duly attacked by The Wall Street Journal as having been taken over by communists or whatever. So, that kind of thing. I don’t want to overplay the importance of that particular moment or that particular project, or even that particular office that they asked me to help start up.

But what I do want to say is that that, it seems to me, is an example of the kind of thing that as a more general practice could be a helpful way of having it both ways, in central banks or in monetary authorities, where you in effect institutionalized self-criticism. You institutionalize self-questioning as a means of inoculating yourself against a dangerous form of groupthink of the kind that had come to dominate the entire Federal Reserve System, thanks largely to Alan Greenspan and all of the crazy Democrats and Republicans alike who worshiped him for two decades in the lead-up to 2008.

Something along those lines I think would be helpful. And in that sense you could almost think of a department like that or a function like that within an institution like the central bank as a counterpart to you, or to the university, or to the entire sphere of social critics within any pluralistic society that welcomes criticism.

So you can think of the Steve Grumbines or you can think of the universities as a means by which a society reflects upon itself and criticizes itself and asks itself whether it might do a better job of what it’s trying to do. And if you were actually to replicate that more macro institution or self-criticism capacity in a more micro way within specific public instrumentalities, that, I think, would be a very helpful step. And then you can have both the partial insulation and the accountability or the self-criticism.

[00:47:54.310] – Grumbine

Very good. Bob, I want to get your closing thoughts on the crypto crisis. Do you foresee more of these things happening?

[00:48:03.610] – Hockett

Yeah, I think we will probably see more of the same across various so-called crypto exchanges. I don’t think that more of the same is going to affect the wider economy in the way the financial crash of 2008 did. Because, happily, there were enough people with enough common sense and there was enough regulatory structure left in place after the Dodd-Frank Act of 2010 that you didn’t see the same quantities of essentially borrowed funds being used to speculate in crypto as you did before.

In other words, financial institutions on which we in the real economy, and in particular the middle and working classes depend, didn’t yet get into all of this nonsense in a big way as they did in the lead-up to 2008. And so the broader economy, I think, is a little bit better insulated this time against these crashes than it was last time in 2008, 2009.

That being said, I think enough money is going to be lost and enough public attention is going to be drawn to these crashes that you will finally see Congress enacting meaningful legislation to, in effect, answer the jurisdictional question to begin with, the turf question, and then lay out a regulatory regime that looks a lot like bank regulation that will then be applied to this space, on the other hand.

And then, as the CBDC finally comes online, as the dollar goes digital and comes to be administered by the Fed in the same way that the paper currency is, we’ll basically have that problem solved. And then you and I can turn to the next crazy Ponzi nonsense that’s going to come along, because there will be a successor.

Just as surely as subprime followed junk bonds and as surely as crypto followed subprime, some shit coin, shit this, shit that is going to come next, too, once we’re done with this one. But we’re not quite done with this one, but I think we’re on the way, though.

[00:49:58.510] – Grumbine

All right, Bob, thank you so much for joining me again. This is Steve Grumbine with my guest, Bob Hockett. From Macro N Cheese saying, we are out of here.

[00:50:14.630] – End Credits

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