Tom Hoenig, the longtime president the Federal Reserve Bank of Kansas City, recently enjoyed a first. On April 18, The New York Times printed an op-ed that he had written.
Hoenig wrote about his belief that the government should not come to the rescue of every large financial institution that gets into trouble.
Hoenig has spent the last year staking out this ground. On March 6, 2009, he gave a speech in Omaha titled "Too Big Has Failed." After that, he got invitations to testify before Congress, to opine in the Financial Times and to appear on CNBC.
Hoenig became chief executive of the Kansas City Fed in 1991, but his celebrity has never been greater than it is now. A recent edition of The Wall Street Journal called him the Fed's "rebel with a cause." The Kansas City Star's business section has become a Hoenig fanzine. In an interview with the Star earlier this year, a chesty Hoenig challenged the thinking of Fed Chairman Ben Bernanke and New York Times columnist Paul Krugman, the two best known economists in the country.
All of the strutting is a little peculiar because Hoenig is one of the guys who missed road signs when the U.S. economy was gunning its engine at the edge of a cliff.
In spring 2006, Hoenig said he did not think there was "much risk of a housing price collapse on a nationwide basis." Later that year, as housing prices began to fall, Hoenig said the adjustment seemed to be happening in an "orderly way."
The future, of course, took a much darker turn. Problems in the housing market swamped the whole economy. By fall 2008, Wall Street faced its biggest crisis since the Great Depression.
Hoenig did not see the storm coming. In fact, deep into the summer of 2008, he was predicting that the United States would avoid a recession.
Misjudgment ran rampant at the Federal Reserve, Hoenig's employer since 1973. The nation's central bank provided the easy money that helped inflate the housing bubble. It also fell down in its role as a regulator of banks. Just last week, an inspector general faulted the Chicago Fed for missing opportunities to rein in subprime lenders.
To be sure, Hoenig will not go down as one of the great recession's master villains. He runs one of 12 banks in the Federal Reserve system. Only part of the time does he get to cast a vote on the direction of interest rates. He's known as an inflation "hawk," a guy who likes to keep the money supply on the tight side.
Hoenig was not oblivious to the cracks in the U.S. financial system, either. He gave a speech in 2006 warning against overoptimism. In it, he remembered how bankers felt invincible before the savings-and-loan crisis of the 1980s. "[G]reed, pride, arrogance and other human frailties are often at the root of bad banking decisions, and those qualities remain with us today," he said.
Still, as Hoenig emerges from the wreckage with his oxford shirt looking crisp, not a sandy-brown hair out of place, his newfound role of reformer has a cloying, revisionist aspect to it.
He began his New York Times op-ed by describing a recent visit that he'd made to Santa Fe, New Mexico. Much like a candidate running for office, he could not get through the first sentence without wielding the words "Main streets." Hoenig wanted to make it clear that he stood with the shop owners, not some derivative traders.
State-fair imagery aside, Hoenig made a good case. He wrote that the government undermines the financial system when it deigns that a megabank or investment company is too big to fail. The guarantee of financial support, Hoenig argued, provides the big boys with a competitive advantage over smaller banks. "And in the end, they are a burden on taxpayers," he wrote.
Hoenig's piece went on to provide a little history about the Federal Reserve. The 12-bank system, he said, was designed to counterbalance the influence of Washington and Wall Street. The Fed has banks in places such as St. Louis and Kansas City, the thinking goes, so that policymakers understand the conditions out where the regular people live.
Hoenig likes to play up the solidity of middle America and his own modest origins. He grew up in Iowa and served in Vietnam. "My father was a plumbing contractor," he said at a recent talk at the Metropolitan Community College's Penn Valley campus.
That's all very nice. But Hoenig shouldn't assume that his audience is naïve enough to think that greed and stupidity are unique to the coasts. In the recent crackup of the financial system, the heartland provided more than just a population of dupes.
The Big Short, which is the No. 1 nonfiction book in the United States as I'm writing this column, tells the story of the investors who placed bets against the mortgage bonds created from subprime home loans. Those investors correctly identified the bonds to be the financial equivalent of clown shoes.
The Big Short was written by Michael Lewis (Moneyball, The Blind Side). Two Kansas City companies figure into his narrative.
Lewis highlights an investor named Michael Burry, whom he describes as a "one-eyed money manager with Asperger's syndrome." For a time, Burry just sat in his office in Northern California and read the fine print in the mortgage bonds' owner's manuals.
One of the subprime-loan originators that Burry studied was NovaStar, a company that started in Westwood and later moved into an office building off Ward Parkway. NovaStar specialized in making home loans to people with shaky credit.
Burry noticed when NovaStar began issuing loans of increasingly crappy quality. From early 2004 to late 2005, the number of NovaStar borrowers taking out interest-only loans — no money down! — nearly quintupled.
The charade lasted until home prices stopped growing at an unprecedented clip and sketchy borrowers began to default on their tricked-out loans. The guys Lewis writes about in The Big Short saw the doom on the horizon that Hoenig and so many others did not. Burry's clients got rich.
Lewis also describes a subprime conference in Las Vegas where the chief executive of Option One Mortgage — a home-loan originator owned by H&R Block — gave a speech. Several months earlier, Option One had announced losses on its subprime portfolio. Option One had been forced to buy back a bundle of mortgages because the borrowers had missed the initial payments.
The loans were that bad. "Who the fuck lends money to people who can't make the first payment?" asks Steve Eisman, one of Lewis' smart investors.
In Lewis' telling, the Option One executive — he goes unnamed — tried to assure the conference attendees that he had everything under control. Eisman, who was sitting in the audience, taunted the executive. He shaped his fingers into a zero to indicate the chance that he gave Option One to keep its loss rate below 5 percent.
Eisman was right. Option One's business model was a joke. H&R Block eventually sold the company and replaced Block CEO Mark Ernst.
NovaStar, a company that the New York Times labeled labeled Exhibit A for anyone interested in the goofy lending practices which precipitated the housing collapse, was eventually delisted from the New York Stock Exchange. Today, it operates an appraisal service and provides banking services for people with low and moderate incomes.
The Federal Reserve Bank of Kansas City was not in charge of regulating either Option One or NovaStar. Still, the hometown companies provide a lesson that Hoenig should keep in mind as he makes the rounds: We folks in the Midwest are just as full of shit as anyone.