A Chance to Remake the Fed
Janet Yellen has only chaired the Federal Reserve for a few months, but you could forgive her if she feels like the new kid in school that nobody wants to sit with at lunchtime. With the resignation of Jeremy Stein earlier this month, there are only two confirmed members of the seven-member Board of Governors: Yellen and Daniel Tarullo. Three nominees—Stan Fischer, Lael Brainard and Jerome Powell, (whose term expired but has been re-nominated)—await confirmation from the Senate. Another two slots are vacant, awaiting nominations. One consequence of the shortage of Fed governors is that regional Federal Reserve Bank presidents, chosen by private banks, now outnumber Board members at monetary policy meetings, allowing the private sector to effectively dictate monetary policy from the inside, and creating what some call a constitutional crisis.
The need for two more nominees, however, provides an opportunity to reunite the progressive coalition that prevented Larry Summers from getting nominated as Fed Chair last year. By pursuing a nominee dedicated to tougher oversight of the financial industry, reformers can make their mark on the central bank for years to come. But it was much easier to reject a known quantity like Summers, especially with an obvious, historic alternative in Yellen. Who will progressives demand this time to represent their interests at the Fed?
An odd tradition has sprung up organically at the Fed, in which open seats are unofficially earmarked for certain coalitions and interest groups. Elizabeth Duke’s resignation last year created an opportunity to fill the “community banker seat,” for example, and senators in both parties have asked for someone with community banking experience to replace her. There are seats traditionally designated for academic economists and international banking experts, and seats for people with Wall Street experience, all so the Board can cover its bases and have a go-to expert for each of its various responsibilities. Maybe the Fed, with such a powerful role to play in the economy, shouldn’t get assembled like the Super Friends, but that’s how it’s traditionally been done.
Since 2010, progressives could take heart in a public interest/consumer protection seat, held by Sarah Bloom Raskin, Maryland’s former chief banking regulator. But the White House basically made that seat disappear in the aftermath of the Yellen-Summers brouhaha. President Barack Obama nominated Raskin to the number two job at the Treasury Department, and replaced her with Lael Brainard, a Treasury official from the Tim Geithner era and a loyal soldier for the Administration’s viewpoint, which has tended to be more moderate on financial reform issues. Stan Fischer fulfilled the academic and international banking monetary policy roles (in addition to bringing Wall Street cred to the table, thanks to his former position as a senior executive at Citigroup). Neither nominee carries the same understanding of the relationship between financial markets and ordinary people as Raskin does. The Stein resignation offers a chance to revive the “Main Street seat,” and install somebody focused on protecting the public.
Raskin’s absence can be felt in recent regulatory decisions. Since Yellen’s term as chair began, the Fed has certainly focused more on financial regulation than it did in previous years, taking control of decision-making from the staff level and giving it regulation the status of an unofficial third mandate, behind full employment and price stability. But so far, that focus has mostly amounted to rhetoric; the actions have been a mixed bag.
On the positive side, the Fed rejected Citigroup’s plan to increase its shareholder dividend after the financial giant failed a stress test. And last week, the Fed released rules for the “supplementary leverage ratio,” which limits how much the eight largest banks can borrow, a way to reduce risk and ensure that Wall Street can pay for its own losses, rather than taxpayers.
However, the leverage rules are modest; they really only limit big bank borrowing to $95 for every $100 it lends out, instead of $97. Plus, the rule doesn’t take effect until 2018, giving lobbyists ample opportunity to weaken it further. On the same day as the leverage ratio announcement, the Fed delayed part of the Volcker rule, giving banks two more years to divest themselves of collateralized loan obligations, packaged securities of risky loans which have become all too prevalent of late.
Yellen herself has said that more stringent rules may be needed to limit the conditions that triggered the 2008 financial crisis, but the middling approach she has taken thus far suggests she doesn’t have the right colleagues with the courage to face down Wall Street and make it happen. While Daniel Tarullo is the point person for financial regulation, he needs allies that can nudge him toward deeper reforms and shift the center of gravity on these issues.
Progressives had enough power to stop Summers, but moving from opposition to proposition forces them to coalesce around a specific individual to replace Stein, which hasn’t yet happened. There are some obvious names available. Sheila Bair, former head of the Federal Deposit Insurance Corporation (FDIC), would serve nicely in a reform role, as would Simon Johnson, the previous chief economist for the International Monetary Fund (IMF), a stalwart on the need to effectively regulate the financial system. Both of these prospects have enemies inside the White House, but they are also eminently qualified for the job and would give ordinary Americans a voice inside a powerful institution.
Other alternatives would be easier to get past the White House. Jared Bernstein, the former chief economist to Vice President Joe Biden, has been floated, though he focuses more on full employment than financial regulation. Andrew Green, legislative counsel to Sen. Jeff Merkley (D-OR), is another possibility; during the Dodd-Frank debate, he helped write the Volcker rule.
One possible name who could get widespread support is Elise Bean, the chief counsel on the Senate Permanent Subcommittee on Investigations chaired by Sen. Carl Levin (D-MI), which has churned out several aggressive reports detailing the perfidy of banks like Goldman Sachs and JPMorgan Chase. Bean has respect on both sides of the aisle and a wealth of knowledge about how the financial system works in the real world. Many reformers, who preferred to remain anonymous amid ongoing discussions on the matter, consider Bean the leading choice.
Even the “community banker seat” could result in a strong financial regulator. Thomas Honeig, currently vice-chair of the FDIC, is an outspoken proponent of tighter regulation, and has been instrumental in the few stronger reforms that have taken place. He has the support of the Independent Community Bankers Association, stemming from his past as a community bank examiner and the president of the Kansas City Federal Reserve, the only district composed entirely of community banks.
Hoenig, an old-line Republican, has a reputation as a hawk on monetary policy and inflation, but he would be outnumbered in that perspective on the Fed board, and some believe his strength and influence on financial regulation outweigh the monetary policy issues. He would force Tarullo to consider more radical measures, and give a community bank perspective on industry consolidation and the resulting abuses to consumers.
Appointments such as these could have a major impact well into the future, especially if the nominees pledge to serve full 14-year terms. Lately, Fed governors have served fewer years, with Jeremy Stein’s tenure one of the shortest on record. (Stein likely saw he would have less influence without his Harvard colleague Summers as Chair, and quickly departed.) But with a longer commitment, financial reformers could establish a long-standing presence at the central bank, well into the next few presidential terms.
This will require consensus among progressives, who found it easy to oppose Summers for Yellen, but must now determine who exactly to support, and how to force agreement from an Administration that got its way on the last set of nominees. The Administration knows control of the Senate is in peril, and the window of opportunity to make its mark on the Federal Reserve is closing fast. Progressives can leverage this, and restore the Main Street seat.
This would establish the principle that the Fed has a responsibility not only to use monetary policy to keep the economy moving, but to use regulatory policy to keep a lid on the capital markets. Ironically, it was Stein who tried to merge these two, suggesting that the Fed raise interest rates to depress asset bubbles. That choice to deliberately decelerate the economy would harm ordinary people, and reveals the Fed’s blind spots toward Main Street. There’s an opportunity to reverse that; progressives simply need to flex their muscles again.
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