In this clip, Alison Southwick, Robert Brokamp, and Morgan Housel share five Fed fun facts to tell your friends, and they address some of the most common misunderstandings about the organization.
Do you know how the Fed adjusts interest rates? Who actually creates money in the economy (hint: it's not the Fed)? Did you know that the Fed is a bank, and actually makes huge profits? Want to know what Alan Greenspan used to do in the bath? Listen to this clip to find out all that and more!
A transcript follows the video.
This podcast was recorded on Dec. 15, 2015.
Alison Southwick: So, that sets the table for what we're going to call "5 Fun Facts About the Federal Reserve to Fascinate your Friends." Yeah?
Robert Brokamp: That's good, I like that.
Southwick: Because, like we said, we want you to sound like an intelligent person when you're at those cocktail parties that we don't get invited to, and someone happens to be like, "Well, you know what the Fed did? Blah blah blah blah." And you can just like, BOOM, own that conversation. I'm excited. Alright, the first fun fact is -- you touched on this already -- the Fed doesn't actually set your interest rate on your car loan or mortgage.
Morgan Housel: No. The interest rate that you would pay on your car loan or credit card or mortgage is set by the bank that is lending you that money. But the bank is going to be influenced by what rates the Fed is moving around, because the banks are borrowing money from each other on an interest rate that is set by the Fed. So, the money that the bank gets money at is influenced by the Fed, and that's going to influence the rate that you lend at or borrow at.
Brokamp: Right, it's increasing the bank's cost of business, so they're going to try to pass that on. But all those rates are influenced by other factors. The market, for mortgages. And if you're going to get an individual loan, your credit score will play a big part of that, too. So, people will start to panic about, "Oh no, I'd better go buy a house now, because the Fed will raise rates!" But very few people expect that mortgage rates are going to skyrocket because of this.
Southwick: Alright. Here's the next fun and fascinating fact: the Fed doesn't create money, usually. I'm still unclear about this one.
Housel: So, it's a big misconception, and it's put up there a lot, that the Fed is injecting money into the economy, that the Fed is printing money and just throwing it around the economy.
Southwick: Literal money? Like they literally print dollars and throw them in?
Housel: Some people would think that. But even if you think it's just digital money, there's still an impression that the Fed is making money and sloshing it around the economy. And that's not really how it works. New money is created when a bank, a private bank like Citigroup or JP Morgan makes a loan. That's how new money is created. And the Fed doesn't really have any control on that. They can try to influence that with lower interest rates and changing the amount of what's called bank reserves, which is the amount of money banks hold at the Fed. So, they can try to influence it, but they really don't have any power over it.
And when the economy is weak and banks aren't lending that much, which has been the case for the past seven years, you're not going to really ignite a lot of inflation. You're not really injecting a lot of new cash into the economy, no matter what the Fed does. And that's why, I think, there's this big disconnect over the last seven years. People saying, "Look, the Fed printed $4T of new money, but we haven't had a big burst of inflation, why did that happen?"
It's because the Fed didn't print $4T and put it in the economy. They printed $4T with the hope that it would increase bank lending, but it didn't. And that's why there's this disconnect between the two. So, the Fed can try to create new money, but it's really up to private banks to do it. If they're not going to do it, it's not going to inject more money into the economy.
Southwick: Except in cases of extreme emergency like the bailouts?
Housel: Yeah, there are always little technicalities. Back in 2008, the Fed was loaning money directly to AIG and some other large banks. So, that's a little different. But those loans were paid off as well, so even that, the cash didn't really start flowing into Main Street.
Southwick: Yeah. That leads into the next part, the other fun fascinating fact is that the Fed is actually a bank, and it's extremely profitable.
Housel: That's right, yeah. The Fed makes profit, just like any other bank. It has assets that it owns, and those assets pay interest, and the Fed has expenses, and after you subtract those, you get profit. And in the Fed's case, almost all of the profit, about 98%, goes back to the U.S. Treasury, which means it goes back to taxpayers. And over the last seven years, when the Fed's balance sheet has been really big from buying all those Treasury bonds, that profit has been hundreds of billions of dollars that has benefited taxpayers to reduce the deficit.
Brokamp: It was particularly great during the recession when it went and bought all kinds of distressed debt, mortgage-backed securities and things that, eventually, often did recover in price. And they made huge profits, and it all got sent back to the U.S. Treasury.
Southwick: Alright. The next one, banks all have preferred stock in the Fed. They are all part owners in the Fed.
Housel: This is a point that I think is not that big of a deal, but it's great if you are a conspiracy theorist and want to think that the Fed is out to get you. The Fed is owned, in fact, by banks in America. Big banks like Bank of America and Citigroup, they all own stock in the Fed that pays a dividend. It's really just a technical point, though, because for one, they can't sell that stock, they can't trade it.
So it really doesn't have that much practical value. And, the banks don't control what the Fed is going to do, either. So it's really a technical point. But a lot of people will bring that up as proof of, "Of course the Fed is bailing out the banks, the banks own the Fed." It's kind of like this public-private partnership. So, it's great for conspiracy theorists.
Southwick: Right. So, if you get cornered by a conspiracy theorist at a party, good luck.
Housel: 98% of the Fed's profits go to the Treasury, where's the other 2% go?
Southwick: The dividends?
Housel: Yeah. Dividends paid to the bank. So, if you're a conspiracy theorist out there, chew on that.
Southwick: Alright, last fun fascinating fact about the Fed: Alan Greenspan, former very famous Fed chair, was an arrogant jerk.
Housel: Well. Maybe? Let's end it at that.
Southwick: No, you have a story! You have a story for this.
Housel: Ben Bernanke just wrote his biography, his memoir. It's really good, and he talks a lot about how the Fed works and operates, and he talks about, there's this private door from the chairman's office into the Fed board room, where the board meets to make all the big decisions. And Greenspan would wait until everyone else was seated, and then make this grand entrance into the board room through his private door.
Southwick: No one else could use that door!
Housel: It was his door. And Bernanke said, for the most part, he tried not to use it, he tried to be a little more humble in his job.
Southwick: Oh, that's nice.
Brokamp: I don't know if that makes Greenspan an arrogant jerk, by the way.
Housel: If you were the Fed chairman, would you have a big ego?
Brokamp: I think anyone in that room has a big ego. Any of them.
Southwick: So, you think Greenspan deserve that door, and he wasn't being hubristic to tell people they couldn't use that door?
Brokamp: I just think "arrogant jerk" is pretty strong.
Housel: Bro actually has his own door to the Motley Fool cafeteria that only he uses, and he waits until all other employees are seated first, and then he makes a grand entrance.
Southwick: What else should we call him, then?
Brokamp: I don't know. That obviously has a certain amount of self-importance about your job. I don't know if it makes you an arrogant jerk. I do know where he would write his speeches. Anyone know the answer to that one?
Southwick: I don't know.
Brokamp: Bathtub. The phrase "irrational exuberance" and other great Greenspan-isms were written in a bathtub.
Southwick: On pen and paper? How do you do that?
Brokamp: I hope so. I hope it wasn't on his laptop.
Housel: Lots of Warren Buffett's best investment ideas came to him in the bathtub as well.
Brokamp: He was not with Alan Greenspan at the time.
Housel: A couple of them, though, you never know.
Southwick: That's an adorable picture, though. Two little heads sticking up on either side of the bathtub, typing away. "What do you think of this?" So many bubbles!