Ever since COVID pandemic shut down most in-person news conferences, Federal Reserve Chairman Jerome “Jay” Powell has become a figure something like the Wizard of Oz. He appears mostly as the disembodied head on a screen, delivering solemn pronouncements about America’s money supply and the economy. During one of these appearances in September, Powell appeared to be particularly stoic. He was forced to address something rare in the world of central banking—an insider trading scandal among his top lieutenants. Two senior Fed officials reported in ethical disclosure forms that they personally traded millions of dollars in stock shares at the very time that they were making decisions that ended up stoking stock prices. Powell let the world know that he was displeased with this situation.

“I think no one is happy,” he said sternly. “It’s something we take very, very seriously. This is an important moment for the Fed, and I’m determined that we will rise to the moment and handle it in ways that will stand up over time.”

In more normal times, a Fed Chairman might have been expected to offer at least a modicum of support for other Fed officials in public—the institution prizes consensus and collegiality. But Powell, 68, is chairman of the world’s most powerful central bank at a moment when the old rules don’t matter. Nothing is predictable, and profound danger looms on the horizon. The Fed is improvising as it goes, and in process it is rewriting some of the rules of the U.S. economy.

Now scrutiny is intensifying on the Fed, and on Powell personally. Rising inflation is putting pressure on the Federal Reserve to scale back its extraordinary stimulus programs and possibly raise interest rates next year. Meanwhile, Powell’s term as Fed chairman will expire in February. The White House announced Monday that President Joe Biden has renominated Powell to serve another term as chairman. But Powell must now face confirmation by a bitterly divided Senate, where anxiety about the economy and inflation has added fuel to a surprisingly contentious debate about the Fed and Powell’s tenure. The debate over Powell’s reappointment seemed pro-forma just months ago. But left-leaning politicians such as Senator Elizabeth Warren have raised concerns about Powell’s friendliness toward Wall Street. Warren went so far as to say Powell would be a “dangerous man” to lead the bank because of his preference for a lighter touch on bank regulation.

The Federal Reserve is a uniquely powerful institution: It is the only entity in the world that can create new U.S. dollars out of thin air. And the Fed has exercised this power on an unprecedented scale over the past decade or so. Between 2008 and 2014, the Federal Reserve created roughly three times as much money as it had created between 1913 and 2007. In other words, it crammed about 300 years’ worth of money growth into a few short years. And then when COVID hit in 2020, the Fed printed about another 300 more years’ worth of money in a period of months—some $3 trillion.

The Fed doesn’t create dollars in the bank accounts of ordinary Americans. Rather, it can only create dollars inside the bank vaults of 24 elite institutions on Wall Street, called “primary dealers,” which include banks like J.P. Morgan and Citigroup. When the Fed prints money, it essentially engages in an extreme form of trickle-down economics by giving new cash to the biggest banks in America in hopes that they will eventually create jobs and boost wages. The Fed’s expansionist policy has become a key component of U.S. economic growth over the past decade—with consequences that may only be taking hold now.

Powell’s critics have drawn attention to his stances on climate change, racial inequality, and bank rules. But what has gotten less attention is Powell’s career inside the Wall Street debt machine that is at the center of the Fed’s most controversial policies. Powell spent years as a private equity dealmaker, creating and selling the kinds of debt instruments that he later bailed out as Fed chairman. Powell’s radical actions to pump more money into markets, credited by many with keeping the economy afloat throughout the pandemic, have also greatly benefitted his former peers in the private equity business. To be clear, there is no indication that Powell has taken any actions at the Fed to directly enrich himself or his former employers. But Powell’s career illuminates the deeper realities about the Federal Reserve and the American economy. The Fed’s policies are not just the realm of technocrat PhD economists who are solving math equations. The Fed is enacting programs that create winners and losers. And the winners, time and again, are people like Jay Powell and the investment firms that made him rich.

Powell has been sensitive to the growing questions about the Fed’s role in U.S. affairs. This might help explain why he was uncompromising, even brutal, when it came to the recent insider trading scandal. The Fed officials in question—Robert Kaplan, president of the Fed’s regional bank in Dallas, and Eric Rosengren, president of the Boston bank—sat on the Fed’s powerful Federal Open Markets Committee, or FOMC, which is best known as the body that raises or lowers interest rates. They were accused of enriching themselves by abusing their access to inside information as the bank deliberated about major financial bailouts last year. During his press conference in September, Powell made clear that the bank presidents’ actions had made his job harder.

“We understand very well that the trust of the American people is essential for us to effectively carry out our mission,” Powell said. After it became clear that Powell would not defend them publicly, both bank presidents resigned. Kaplan released a statement saying that during his tenure at the central bank, he “adhered to all Federal Reserve ethical standards and policies.” Rosengren’s letter of resignation explained that he was stepping down due to health reasons, and he also released a statement saying that he had complied with all Fed ethics rules. (When asked for comment, both the Dallas and Boston Fed banks referred to earlier statements from Rosengren and Kaplan on the matter.)

Powell knows better than anyone that the dual resignations will not put to rest the biggest question about the Fed. Stock prices are soaring, private equity firms are booking record profits, but the real American economy is plagued by dysfunction. Millions of employees are refusing to return to the labor market, even as the unemployment rate falls, and prices are rising for everything from hamburger to gasoline. It seems that the Fed has been able to rescue Wall Street, but the benefit it provides everyone else seem less clear.

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Powell is often referred to as a “lawyer,” but that’s sort of like calling JP Morgan CEO Jamie Dimon an “economist” because of some classes he took in college. It’s true that Jay Powell has a law degree. But almost immediately after law school he abandoned the world of corporate law for the world of corporate deal-making. Powell’s ascent within this world was unbroken—a slow and steady upward rotation between jobs on Wall Street and in Washington—which ultimately made him among the wealthiest Fed chairmen in history. In the early 2000s, Powell was a partner at the Carlyle Group, a private equity firm that specialized in hiring former government officials and cashing in on their connections. At Carlyle, Powell learned firsthand about the debt-driven business model of the private equity business, which delivered hundreds of millions of dollars of profit to senior partners while saddling the companies they bought and sold with debt and downsizing. As it happened, this is exactly the kind of economic activity that the Fed has been relentlessly encouraging over the past decade. Many years of easy money policies have been rocket fuel for private equity firms like Carlyle Group because cheap debt is their lifeblood. It funds their ambitious takeover plans and even funds their paychecks directly. (Powell was provided with detailed questions about his private equity career and key elements of his tenure at the Fed through Federal Reserve spokeswoman Michelle Smith, but did not provide responses and he was not made available for an on-the-record interview for this story.)

When he joined the Fed in 2012, Powell argued against the bank’s easy money policies, in part he said because he’d seen firsthand how risky the market could become. But he later came to embrace them. This was characteristic of his career. Powell has always been a fixer, with a deft hand, who has helped accommodate the needs of big money and big government.

Powell was born and raised in a wealthy suburb of Washington, D.C. He went to Princeton, then came back home to learn about the world of law at Georgetown University. Shortly after, he plunged into the world of money on Wall Street when he joined the financial firm Dillon Read & Co. The company had been around, in one form or another, since the 1800s. Partners at Dillon Read were relentlessly effective servants of big money. For decades, when two big companies were plotting a merger, Dillon Read often got the call to handle the details. Legal training prepared someone like Jay Powell in a key skill set necessary for success at Dillon Read: discretion.

“The corporate culture was very private,” recalled Catherine Austin Fitts, a managing director at the firm during Powell’s tenure there. Fitts says that the partners at Dillon Read were like members of the Hanseatic League, a guild of merchants who operated in northern Europe during the 1300s. “Their tagline was ‘Serious business with long-term partners,’ which is a perfect description of Dillon, Read,” Fitts says. “They went about their things very quietly. Discretion was everything. And relationships. They really prized long-term relationships.”

One relationship was especially important for Powell. He became close with Dillon Read’s chairman, Nicholas F. Brady, who moved to Washington in 1988 to become the Secretary of the Treasury under Ronald Reagan. After George H. W. Bush was elected, Powell left Dillon Read to join Brady at Treasury. There is no more telling sign of Powell’s success during his early years in private equity. “He clearly had Brady’s trust, if he went to Treasury,” Fitts says. “Brady was no fool.”

Brady’s trust in Powell was validated almost immediately.

A scandal erupted inside the Treasury Department involving criminal fraud, risky derivatives contracts, and a too-big-to-fail Wall Street investment house. Powell was called upon to help fix the mess, in part because it had happened right under his nose. Powell was the assistant Treasury secretary for domestic finance, a job that put him in charge of issuing the government’s debt. In 1991, the Treasury department discovered that the trading firm Salomon Brothers, which was a primary dealer, had been defrauding the government. A trader at Solomon named Paul Mozer was using shell companies to buy up an illegally high proportion of Treasury bonds in a scheme to corner the market. In May 1991, Salomon used the scam to buy so many Treasury bills that it controlled 94% of the supply.

When the bid-rigging was exposed, Nicholas Brady moved to revoke Salomon Brothers’ special status as a “primary dealer,” which is what allowed the company to directly purchase Treasury Bills from the Fed, which auctions them on behalf of Treasury. Senior officials at Salomon believed Brady’s move might kill the company.

According to Steven Bell, who was managing director of Salomon Brothers’ Washington office, the firm started fighting to get a lifeline from the Treasury department. Bell’s team set up an emergency office in the company’s kitchen, where they worked the phones. The Treasury official on the other end of the phone line was Jay Powell, Bell recalled.

Bell believed that allowing Salomon to go broke would take down other Wall Street firms. “What if you knock down the biggest tree, and it collapses, and knocks down a lot of other trees in the forest?” Bell says in an interview. Powell would have understood this argument because of his background on Wall Street.

“Jay knew markets well. He had been with Brady earlier. He had the trust of the secretary,” Bell recalls. The Treasury Department eventually decided that Salomon could keep its designation as a primary dealer. Bell would always credit Powell with the victory, and with keeping Salomon alive. “I know that Jay was critical in informing Secretary Brady’s decision,” Bell says.

Powell’s reputation in Washington was enhanced by his high-level government service. In 1997, Powell was able to leverage this reputation when he became a partner at the Carlyle Group.

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Carlyle Group was cofounded in 1987 by David Rubenstein, a former staffer to Jimmy Carter, who said the company’s location in the nation’s capital was what gave it an advantage over private equity firms in New York. Carlyle specialized in buying and selling businesses that relied on government spending, and it hired former government officials to help it. Carlyle partners included James Baker III, a former Treasury secretary, and Frank Carlucci, a former defense secretary. President emeritus George H. W. Bush was an advisor to the firm.

Powell was in his mid-forties when he joined Carlyle. His office was on the second floor of the company’s headquarters building on Pennsylvania Avenue, not too far from the White House. The Carlyle offices were hardly lavish by the standards of private equity. The aesthetic at Carlyle was utilitarian. The company hung prints instead of original paintings, and the partners met in stripped-down conference rooms that could have been found in any law firm or insurance office. “Our offices were so boring and plain that it was a joke,” recalled Christopher Ullman, a former Carlyle partner and managing director. The partners kept their focus on the marketplace. And the marketplace returned the favor. A parade of banks came to Carlyle to advertise deals to its partners. Powell’s job was to sift through these offerings, like flipping through the pages of a catalog, seeking out deals with the most potential.

The Carlyle Group, like other private equity firms, went out and raised money from wealthy people and institutional investors, like pension funds, that put big chunks of money into a pool of cash that Carlyle would use to buy companies. The basic goal was to “invest, improve, and sell” those smaller companies. Carlyle typically held on to a company for about five years and then sold it, ideally for a profit.

Debt was key to Carlyle’s model. Carlyle bought companies using some of its own cash, which it super-charged by borrowing much more to fund the deal. Importantly, this debt was loaded onto the company that Carlyle bought. Then that company had to work hard to pay off the loan. It was like being able to buy a house that earned cash and paid off its own mortgage.

In 2002, one deal caught Powell’s attention. An industrial conglomerate called Rexnord, based in Milwaukee, was looking for a new owner. Rexnord made expensive high-precision equipment that was used in heavy industry, like specialty ball bearings and conveyor belts. It produced the thing that private equity partners valued above all—a steady cash flow. This meant the company was in a good position to pay down the debt that would be loaded on to it.

The Rexnord deal was Powell’s shining moment in the private equity world, according to two people familiar with Carlyle’s operations. It was also a turning point for Rexnord itself, ushering in a period of crushing debt, layoffs, pay cuts and offshoring.

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Rexnord’s headquarters were located in an unremarkable two-story brick building next to a big parking lot in west-central Milwaukee, surrounded by working-class neighborhoods of modest houses. The building was modest, but Rexnord made serious money. The company specialized in making highly engineered conveyor belts and specialized ball bearings used in airplanes.

“It made things that people needed to make the world move,” explained the company’s former Chief Financial Officer, Tom Jansen. The company’s annual sales were reliable, at about $755 million a year. Jansen had been working at Rexnord since the 1980s. He was impressed when Jay Powell and the Carlyle Group team arrived. “Their pitch was—we want to help you. We want to help you grow,” Jansen recalled.

Carlyle bought Rexnord in September 2002, funded mostly by corporate debt that was loaded onto Rexnord’s balance sheet. Rexnord’s debt level instantly jumped from $413 million to $581 million and its annual interest payments on debt rose from $24 million in 2002 to $45 million in 2004. Rexnord would pay more money on interest costs than it earned in profit during every full year that Carlyle owned it.

The debt put pressure on Rexnord. In early 2003, Rexnord employees in Milwaukee agreed to take an average pay cut of $3 an hour, along with other concessions, to convince the management team not to move seventy jobs to North Carolina. The Milwaukee employees were unionized, and so moving those jobs to a nonunionized southern state might have saved Rexnord money. But Jansen says the Carlyle team was sensitive about the headlines such an action might create. “They were very, very aware that if cuts had to be made, we had to make them with respect. Treat people with respect. They did not want any bad publicity at all over this stuff,” he recalled.

By early 2005, Rexnord still carried more than $507 million in debt and paid twice as much money on interest costs than it earned in profit. But Jay Powell, and the company’s board of directors, decided that there was room for Rexnord to borrow more. A corporate takeover target caught their eye—it was another old-line manufacturing firm based in Milwaukee, called Falk Corporation, which made industrial components like gear drives and couplings. Rexnord’s executive team engineered a deal to borrow $312 million in the form of a leveraged loan, which was loaded onto Rexnord’s balance sheet, pushing the company’s annual interest payments from $44 million to $62 million. Rexnord’s total debt jumped from $507 million to $754 million. Still, this acquisition made Rexnord more attractive to an outside buyer. The company had diversified its product line, expanded its footprint, and still enjoyed a steady flow of cash from operations.

It was time for the Carlyle Group to cash out its position.

Carlyle found a buyer for Rexnord in the form of another private equity firm, called Apollo Management. Apollo devised a plan to purchase Rexnord just as Carlyle had done, by syndicating new leveraged loans and loading them onto Rexnord itself. Apollo’s ambition on this front was remarkable. Apollo raised $1.825 billion, more than twice what Carlyle had paid just four years earlier.

The payoff to Powell and his team was immense. It is difficult to determine just how much profit Powell earned from the sale, because Carlyle does not disclose such figures. But Apollo’s purchase price was more than $900 million higher than Carlyle’s. Under Carlyle’s investment rules, 80% of the profits would have gone to the limited partner investors who put up money for the buyouts and 20% to Carlyle, according to one person familiar with Carlyle’s operations. Of the Carlyle money, 45% went to the corporate “mothership,” as they called it, and 55% would go to Jay Powell’s team. Government disclosure forms from 2018 indicate that Powell’s personal wealth was worth between $20 million and $55 million by 2018.

Powell left Carlyle after the Rexnord deal. He dabbled in private equity for a few years and then he joined a think tank in Washington, D.C., before President Barack Obama nominated him to be a Fed governor in 2012.

Rexnord itself didn’t fare as well. The company Powell left behind was crippled with debt. Its total debt burden rose from $753 million to $2 billion in one year. Its annual interest-rate payments rose from $44 million in 2005 to $105 million in 2007. The company would pay more money in interest than it earned in profit every year for more than a decade. Rexnord became a company that was emblematic of the private equity world. It was no longer a company that used debt to pursue its goals. It was now a company whose goal was to service its debt.

Between 2011 and 2020, the debt-heavy world of Rexnord would intersect with the Fed’s easy money policies. And Jay Powell was in the middle of it.

*****

Jay Powell was something of an agitator when he arrived at the Fed. At the time, in 2012, Fed Chairman Ben Bernanke was pushing FOMC members to commit to another round of quantitative easing, the experimental program first used in 2008 and then used again in 2010.

Quantitative easing has a complicated name, but a simple goal. It was a way to pump hundreds of billions of dollars into the bank vaults of the 24 primary dealers during a time when the Fed was keeping short-term interest rates pegged at zero. This strategy—pumping money into the banking system while removing the incentive to earn interest by saving it—created an all-powerful force in financial markets called a “search for yield.” Anyone with lots of money, like pension funds or insurance companies, were frantically searching for investments that would provide even a small yield. This is why quantitative easing drives up the price of assets, like the stock market. Billions of new dollars are all chasing the same assets, which boosts the price of those assets.

One type of asset that gained popularity was the kind of corporate debt that Companies like Carlyle Group used for buyout deals, like leveraged loans and corporate junk bonds. Companies like Carlyle could package and sell this debt to investors who were searching for yield.

Jay Powell thought that this was dangerous, according to the statements he made inside of FOMC meetings, the transcripts of which are released after a five-year delay. The Fed was pushing too much money into the leveraged loan market and was driving up prices to unsustainable levels.

“While financial conditions are a net positive, there’s also reason to be concerned about the growing market distortions created by our continuing asset purchases,” Powell had said at the January FOMC meeting (the “asset purchases” he referred to were the result of quantitative easing. The way the Fed moved money to Wall Street was by purchasing assets, like Treasury bonds, with newly created dollars). Powell warned that the Fed was wrong to presume that it could clean up the mess after a bubble burst.

“In any case, we ought to have a low level of confidence that we can regulate or manage our way around the kind of large, dynamic market event that becomes increasingly likely, thanks to our policy,” he said.

Another critic of easy money was Richard Fisher, who was the then-president of the Dallas regional bank. During one meeting, Fisher pointed out that quantitative easing primarily helped primary equity firms and banks.

Quantitative easing “has, I believe, had a wealth effect, but principally for the rich and the quick—the Buffetts, the KKRs, the Carlyles, the Goldman Sachses, the Powells, maybe the Fishers—those who can borrow money for nothing and drive bonds and stocks and property higher in price, and profit goes to their pocket,” Fisher said during one meeting. He argued that this would not create jobs, or boost wages, to nearly the degree the Fed hoped it would.

Bernanke prevailed with the argument that the Fed needed to do something. Congress seemed incapable of managing America’s economic affairs during the 2010s, and the Fed had the ability to act. During 2013, the Fed operated its biggest round of quantitative easing yet, creating roughly $1.6 trillion.

As Powell gained stature within the Federal Reserve, he changed his outlook on quantitative easing. A review of Powell’s comments during meetings show that his warnings softened and then seemed to disappear.

As late as June 2014, Powell seemed wary of the Fed’s easy money stance. “After almost six years of highly accommodative policy, the risks are out there and continue to build,” Powell said during one meeting. What worried him more was the prospect of “a sharp correction amplified by the liquidity mismatch in the markets that would damage or halt the progress of what is still a weak economy.” He was saying that a lot of traders and hedge funds had built up risky positions using a lot of debt. If markets fell—because inflated asset prices started to reflect their real value—then traders might dump their assets and cause prices to crater.

But just seven months later, Jay Powell gave a speech at Catholic University in Washington, D.C., aimed at disarming the central bank’s critics, such as libertarian figures like former congressman Ron Paul, who was calling for more oversight of the Fed. Powell said that the increasingly vocal criticisms of the Fed were misguided.

“In fact, the Fed’s actions were effective, necessary, appropriate, and very much in keeping with the traditional role of the Fed and other central banks,” he said. He went out of his way, during that speech, to defend the very policies that he had been warning about internally since he had become a Fed governor. He said that “unconventional policies,” such as quantitative easing, were largely responsible for America’s economic growth, and that the critics of those programs had been proven wrong. “After I joined the Federal Reserve Board in May 2012, I too expressed doubts about the efficacy and risks of further asset purchases,” Powell said. “But let’s let the data speak: The evidence so far is clear that the benefits of these policies have been substantial, and that the risks have not materialized.”

His reversal was noted by his colleagues at the FOMC who had previously argued alongside him about the risks of quantitative easing.

“There was a shift, and I think it’s noteworthy,” Fisher, the former Dallas Fed president, says in an interview. Fisher was not aware of any study or new data set released between June and February that would justify a reversal of Powell’s judgment about quantitative easing or zero-percent interest rates.

“There was no condition in 2015 that would have indicated, or necessitated, easing off that argument,” Fisher says. More likely, he believed, was the effect of being a Fed governor. “The evolution may well have come from being there longer, being surrounded by brilliant staff that has a very academic side to them and bias,” Fisher says. “You’re living in a cloistered atmosphere. It’s a different environment when you’re in that hallway. You conform more. I don’t think there’s anything nefarious about it. I just think it’s the social dynamic.”

In closed-door meetings, Powell continued to cast doubt on the efficacy of quantitative easing. “I think we’ve never looked at asset purchases as other than a second-best tool,” he said during the FOMC meeting in September 2015. “I think that’s been the way it’s been talked about since the very beginning—uncertain as to its effect, uncertain as to bad effects, and certainly uncertain as to political economy characteristics,” he said. But a review of his comments, which are available only through the end of 2015, indicate that Powell was softening his arguments and his warnings. The language became less vivid and less focused on “large and dynamic” market crashes.

As Powell’s rhetoric appeared to cool, the markets for leveraged loans and risky debt were heating up. No company better illustrated what was happening than the company that made Jay Powell rich: Rexnord.

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Robert Hetu, a managing director at Credit Suisse, helped create and sell leverage loans that funded Rexnord’s operations during the 2010s. Hetu’s office overlooked Madison Square Park, but everyone on his team was working too hard to enjoy the view. The corporate debt business was a seven-days-a-week endeavor. Hetu took a vacation once, to a luxury resort in Shangri-La, China, where he joined his family in a tour van to see the countryside and ended up on his cell phone in meetings with a lawyer; he remembered the van stopping to let a bunch of pigs cross the road while he negotiated over the phone. “That’s the lifestyle. You get rewarded for it, but there’s a price to it,” Hetu recalled.

Hetu helped Rexnord refinance $1 billion in debt in March 2012, and the contract for the deal was 344 pages long. Virtually all of the paragraphs in those 344 pages were produced under heavy scrutiny, negotiation, and anxiety. A successful debt contract contained a multitude of components that had to fit together snugly, immune from legal challenge, in such a way that it would entice outside investors to buy the debt. Selling the debt was crucial for the business model to work. Credit Suisse arranged the leveraged loans, but never meant to keep a lot of them. “They’re not in the storage business, they’re in the moving business,” says Hetu.

The moving business was brisk. As the tidal wave of quantitative easing cash arrived on Wall Street, it created a new chance for banks like Credit Suisse to expand their leveraged loan business to an unprecedented scale. They did this through the creation of something called the collateralized loan obligation, or CLO for short. A CLO was essentially a package of leveraged loans that were grouped together and sold to investors.

Credit Suisse was a leading producer of CLOs, issuing eleven between 2010 and the first half of 2014, worth a total of $6.7 billion, making it the third-largest CLO dealer in the country. This opened a new pipeline for Robert Hetu and his team of leveraged loan makers. The buyers came storming into Credit Suisse’s CLO shop, desperately searching for yield. Rexnord’s debt was chopped up and distributed into a wide variety of funds that were offered by Credit Suisse.

Hetu described this situation as being caught in a vise. On the one side, there was pressure from investors, like pension funds, clamoring to buy loans. On the other side there were the private equity companies, like the Carlyle Group, which were the best source for these new loans. The private equity firms had leverage, and they began to use it to their benefit. They started to offer leveraged loans for sale that had very loose covenants, meaning the contract terms that protected investors. But private equity firms started insisting that they be cut. This became so common that Wall Street came up with a nickname for loans with the covenants stripped out, calling them Cov-lite loans.

It was Hetu’s job to take the Cov-lite loans out to the market and see if anyone would buy them, which didn’t turn out to be a problem. There was always a buyer. A $1 billion loan would have $2 billion worth of takers. The demand for Cov-lite loans was intense, which only encouraged the deal sponsors to insist upon them more. There was just too much money looking for yield for investors to demand high standards. The Cov-lite loan, once an exotic debt instrument, became the industry standard. In 2010, they accounted for less than 10% of the leveraged loan market. By 2013, they were over 50%, and by 2019 they accounted for 85% of all leveraged loans.

“It’s tough. You see what people agree to and you’re like: ‘Oh my god. Do you realize what you’re agreeing to?’” Hetu says. “These deals get more and more aggressive by the day because the market, again, is supplied with a lot of cash. The CLOs have to put money to work. There’s a limited number of deals that are coming to market. They all love it. They buy it.”

All this corporate debt didn’t benefit Rexnord employees like John Feltner who worked at the company’s ball-bearing plant in Indianapolis. As it labored under so much debt, Rexnord looked for ways to cut costs. In 2016, Rexnord announced that it was shuttering the plant where Feltner worked and sending the production to a new facility in Mexico, cutting 350 jobs in the United States. Feltner eventually found a new job at a local hospital, but the pay didn’t match what he earned as a unionized factory worker. Although it had been painful, expensive, and destabilizing to be laid off from Rexnord, Feltner had grown accustomed to it during his career—he’d been laid off from another good manufacturing job before joining Rexnord. “I call that the new normal. It’s something you get used to,” he says.

By the end of 2018, the U.S. market for CLOs was about $600 billion, double the level a decade earlier. Banks in the United States held about $110 billion. The total amount of corporate debt in America reached new highs in 2019 of about $10 trillion, up from about $6 trillion in 2010, a value that was worth almost half of the total U.S. economy, also a new record. If the price of these leveraged loans and corporate bonds fell dramatically, as Powell had warned they might back in 2013, the broader economic effects could be ruinous.

That’s exactly what started to happen in late February of 2020, when the first cases of COVID-19 were detected in the United States.

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The week of March 16 was when people on Wall Street saw things happen that they didn’t think were possible. Scott Minerd, the chief investment officer at Guggenheim, was amazed when he saw the market for Treasury bills essentially freeze, meaning that buyers and sellers couldn’t on a given price for U.S. government debt. There had been a similar collapse in the mortgage bond market, back in 2008. But to see it happen in the $20 trillion market for ultrasafe Treasurys wasn’t just scary. It was difficult to comprehend.

The market for corporate debt was in a tailspin. “At the height of the thing, the bid/offer spread was, in some cases, 30%” on corporate debt, Minerd says. “That is unthinkable.”

Powell and the Federal Reserve moved aggressively. Powell’s Fed did virtually everything that Ben Bernanke’s had done in 2008 and 2009—slashing rates to zero, offering “swap lines” of dollars to foreign banks, purchasing mortgage bonds and commercial paper—all in a matter of weeks. It still wasn’t enough. The markets for corporate debt continued to fall.

The fragility of the corporate debt markets created an interlocking set of crises, each linked to the next like a chain, that threatened to take down the banking system. The first, immediate crisis arose from the indebted corporations that were scrambling to get cash. In their panic, these companies rapidly drew upon a source of emergency debt called a revolving credit facility, which allowed them to quickly borrow cash up to a certain limit. After markets crashed on March 16, Southwest Airlines drew down a $1 billion revolving credit facility. The hotel operator Hilton drew down $1.75 billion. General Motors, the following week, would draw down $16 billion. This helped explain why bank stocks fell by almost half in a matter of weeks. The revolving credit facilities threatened to bleed the banks dry even as they struggled to cope with the market volatility.

The second link in the chain of failures would happen when companies started to miss debt payments and default on the loans. This would force debt-rating agencies, like Standard & Poor’s and Moody’s, to downgrade companies like Ford, moving many into the realm of junk debt. A wave of such downgrades looked inevitable, and it carried a grave consequence for the big banks. The downgrades would be like a torpedo in the side of the CLO industry. The approaching tide of credit downgrades posed a serious risk to the value of the CLOs. Most CLOs contained a contract clause that allowed them to hold only a certain amount of junk debt. If more of the leveraged loans inside the CLOs were downgraded to junk, this would breach the contracts and force the CLOs to sell off their junk debt and replace it, or write down the value of the whole CLO. If the CLOs dumped their holdings at the same time, the market could plunge. This posed a danger to banks. In 2019 alone, the value of CLOs held by big banks jumped by 12% to $99.5 billion. The vast majority of these CLO investments were held by three big banks: JPMorgan, Wells Fargo, and Citigroup, who together owned about 81% of all CLO bank holdings. Many of the loans inside the CLOs were the kinds of Cov-lite loans that Hetu sold, which shifted more risk to investors.

Over the weekend of March 20, Powell finalized the details of a complex rescue package that would push the Fed into new territory. It would be the largest, most far-reaching, and most consequential intervention in the history of the Federal Reserve. The bailout created three new programs, the first two of which authorized the Fed to directly purchase corporate bonds for the first time. This had a far-reaching impact. Once the Fed bought corporate bonds, it could never undo the action. The eager eyes on Wall Street would always remember what they had seen—every time the Fed intervened, its future intervention was assumed. Now, people who traded corporate bonds and leveraged loans had an assurance that the Fed would save them if the market collapsed.

Powell pushed further. The Fed announced on April 9 it would expand the bailout and buy even riskier bonds, which were rated as junk debt. The junk bond purchases would not be unlimited. The Fed would only buy debt that had been rated as investment-grade before the pandemic.

Also that day, the Fed updated a separate new program (called TALF, for “term asset-backed-securities loan facility”) so that it could directly purchase, for the first time, big chunks of CLO debt. This was a significant extension of the Fed’s safety net, and it played a large role in quelling the anxiety around the hundreds of billions of dollars’ worth of CLOs that faced loan write downs. It also helped the big banks that owned billions in CLO debt.

The full FOMC did not vote on this program because it was an emergency lending effort, only requiring the approval of a handful of members on the board of governors. There are no transcripts available to determine the thinking behind the new initiatives, parts of which were approved by a unanimous, closed-door vote on April 8 (The vote was taken by Powell, his vice chairman Richard Clarida, and Fed Governors Randal Quarles, Lael Brainard, and Michelle Bowman).

This program was shocking to people who traded bonds. It was one of those things that divided history: There was the way things worked before the announcement and the way things worked afterward.

“Fundamentally we have now socialized credit risk. And we have forever changed the nature of how our economy functions,” says Minerd, at Guggenheim Investments, who is also an advisor to the Fed. “The Fed has made it clear that prudent investing will not be tolerated.”

This bailout didn’t just save the corporate debt market. It fueled it. By the end of 2020, companies issued more than $1.9 trillion in new corporate debt, beating the previous record that was set in 2017. The cheap debt has helped deliver record profits to private equity firms like Carlyle Group. In late October, Carlyle reported a record $14 billion in asset sales for the third quarter of the year, helping it pay $730.6 million in earnings to its shareholders, also a record. Carlyle’s stock price has jumped about 86% since the beginning of the year.

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Jay Powell now faces the biggest challenge of his career. He must figure out how to withdraw the Fed’s financial stimulus without crashing markets at the very moment he is fighting for his job. Recently, Powell said that the Fed will begin slowing its flow of new money that has been pouring into Wall Street since March of 2020. The Fed was purchasing $120 billion in assets each month, and plans to slow or “taper” the purchases each month with the goal of ending them by the middle of next year.

The easiest way to reverse quantitative easing, and raise interest rates, is to do so very slowly and with clear communication. That way, financial traders know what’s coming and can position themselves gradually without dumping assets and creating a market panic. But outside events are forcing the Fed’s hand, and eliminating the luxury of time.

Price inflation is running hot and lasting longer than many analysts predicted earlier this year as mass vaccination programs allowed the economy to begin reopening. The supply chain snarls caused by COVID has remained surprisingly consistent, while demand has remained surprisingly strong, pushing inflation higher than it has been in years. This, in turn, has put pressure on the Fed to hike interest rates as early as next summer, after it has stopped its quantitative easing.

Consumer prices aren’t the only kind of inflation. Asset prices are also super-heated thanks to the Fed’s easy money policies. Stock prices have risen so fast and so high that it is raising concern in the most unlikely of corners. In October, Morgan Stanley’s Chief Executive Officer James Gorman acknowledged publicly what so many asset traders say privately—the stock market has become a bubble, and the Fed should do something about it.

“You’ve got to prick this bubble a little bit,” Gorman said during an interview with Bloomberg Television. “Money is a bit too free and available right now.”

If history is any indication the process of raising rates and withdrawing quantitative easing it will be, at the very least, a bumpy ride. And the job is enormous. The last time the Fed tried to withdraw quantitative easing, the central bank owned about $4.5 trillion in assets. Today, it owns about $8.6 trillion. It remains to be seen how stable corporate debt markets once the Fed eases the pressure to search for yield. But private equity firms, hedge funds and Wall Street speculators can take one lesson from the past few years: Jay Powell will be there for them.

Copyright 2022 by Christopher Leonard. From the forthcoming book "THE LORDS OF EASY MONEY: How the Federal Reserve Broke the American Economy" by Christopher Leonard to be published by Simon & Schuster, Inc. Printed by permission.