Ed Lotterman: Look off Wall Street for Fed nominees

August 16, 2013 

Barack Obama's choice to replace Ben Bernanke as chair of the Federal Reserve Board is important, but key issues as to why it is important are being ignored. That may lead to the wrong person getting the job.

The first issue is that of public trust in the Fed itself. In a democracy, the trust of the general citizenry in the central bank is as important as the trust in the court system, legislative bodies and the chief executive. And to produce sound monetary policies over the long run, it is also important that a central bank enjoy substantial operating autonomy, insulated from political or populistic pressures. That means its governance should not be directly reliant on the outcomes of elections.

However, this insulation from direct accountability carries the danger that the Fed may lose the public trust. Widespread public mistrust in any government institution is corrosive to democracy. So the staff of the Fed itself, career employees together with the presidentially appointed governors, need to give maintenance of legitimacy and public integrity high priority. The president and Senate need to keep these issues in mind in choosing and confirming any new governors, but especially the chairman.

There always has been a lunatic fringe propagating conspiracy theories about the Fed. Cheap political rhetoric about the Fed can gain support from both ends of the political spectrum, even in normal times, and it needs to be ignored.

But still not fully emerged from the most severe global financial crisis in 80 years, we certainly are not in normal times. Moreover, those in the public who think that the Fed bears at least partial responsibility for the crisis itself, failing both as the steward of our nation's money supply and as one of its principal bank regulators, are correct. And yes, in responding to the crisis that began to unfold six years ago, the Fed, together with the Treasury and other government agencies, repeatedly chose to err on the side of keeping financial institutions afloat and paid less attention to the financial problems of Main Street businesses or households.

The rationale for that approach was that if a nation's financial sector collapsed, and we were in danger of that in the fall of 2008, all the rest of the economy gets swept away, too. Witness the Great Depression. So preventing meltdown on Wall Street was indirectly of enormous importance to small businesses and households.

But that doesn't obviate the clear lesson that Wall Street's risk-taking is legal blackmail. The general public is at least to some degree correct in its suspicions that the deck is stacked against them.

That is why at this point it is important that no one be appointed to the Fed board who has gotten rich from Wall Street, either as an executive of a major financial firm or by giving speeches to, consulting for or serving as director of such a firm.

When Harvard economist and now apparent Fed chairman candidate Larry Summers left office as Clinton's Treasury secretary, his financial disclosure forms showed a net worth of less than $500,000. When he joined the Obama administration eight years later, they showed $17 million to $39 million in assets. Being president of Harvard for five of those years certainly brought in some money, but the bulk of it represents the sort of largesse financial mega-firms shower on those expected to have political influence at high levels.

That sort of Wall Street-derived wealth should automatically rule out Summers and anyone else with such ties.

That Obama seems not to give this a thought should worry citizens.

The second undiscussed issue is reform of the institutional mindset of the Board of Governors.

The board has a permanent staff, and the seven governors are virtually the only non-bureaucratic appointees. There is no single "permanent secretary," but there is a small corps of department heads that serve a similar function. Donald Kohn, former governor, Fed staffer for four decades and favored Alan Greenspan protege, was one such official. Now Obama has cited him as a possible alternative to Summers or to Fed vice-chair Janet Yellen, another favored candidate.

By many accounts, Kohn is very bright and extremely knowledgeable about our nation's financial institutions and the execution of monetary policy. He has a Ph.D. in economics. He is a good administrator. He would be a fine choice if the institution did not need a good shaking up.

But the Board of Governors staff needs a searing reorientation. Long before the official 1999 end of the already moribund Glass-Steagall Act, which restricted the financial activities of banks, the Fed staff had actively cooperated with Wall Street in punching it full of holes. And it went along with then-chairman Greenspan's refusal to use the Fed's powers to regulate the shadow banking system organized around risky mortgage origination and securitization that blew up in 2008. Finally, there was much support for the Greenspan-led easy money policies.

Kohn's role in this is not clear. He certainly rejected - along with Summers - prescient criticisms of Greenspan-era Fed policy.

Naming Kohn to head the Fed would be like naming Adm. Husband Kimmel, Pacific Fleet Commander at the time of Pearl Harbor, to be secretary of the Navy. Kimmel was a fine officer. But he presided over a monumental failure. Kohn did not similarly "preside," but he was a high-placed functionary at a time when Fed policies were leading to disaster. Given that there are other good candidates, including Yellen and Roger Ferguson, a former Fed vice-chair with a Harvard law degree and economics Ph.D, Kohn's name should be struck from the list.

Write Ed Lotterman at ed@edlotterman.com.

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