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Robert Prasch: The Next Chair of the Federal Reserve Must be a Regulator

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By Robert E. Prasch, Professor of Economics at Middlebury College. Cross posted from New Economic Perspectives

If we go by the rumors circulating in the financial press, the Obama Administration is on the verge of selecting a proven failure – Lawrence Summers – to be the next Chair of the Federal Reserve System. This is the man, let us recall, whose greatest success in office was to work for the repeal of Glass-Steagall in 1999 and the nudge along the passage of the Commodity Futures Modernization Act of 2000 (which forbade any agency from regulating Credit Default Swaps). These profoundly mistaken decisions provided the nation’s largest and most irresponsible financial institutions with the bulk of the permission they needed to leverage up their balance sheets, hide the risks inherent in the mortgage-backed securities they were pushing onto unsuspecting investors, all while enabling them to become Too Big To Fail (and, as no less than the Attorney General of the United States has affirmed, Too Big To Prosecute).

Few people enjoy criticizing others, but our democracy can only function if office-holders are held accountable (a reality that the NSA is clearly resisting), and the evidence fairly shouts out that Lawrence Summers failed America during his stint as Treasury Secretary. That this failure was not a “one-off mistake” is evident from the fact that he also failed the people of a close ally – South Korea – during their financial crisis. His poor decision-making as President of Harvard University also cost that institution a good deal of money.

Of course, Summers was far from solely responsible for the failure of our financial system in 2007-09. Similarly, he was not solely responsible for the failure of the Obama Administration to even consider disciplining or shrinking the nation’s largest financial institutions. But no one can doubt that Summers played a critical role in the mania for financial deregulation that was characteristic of the Clinton-Gore Administration. Let us recall that today, years after the crash, most American families are poorer as a consequence of his “service to the nation.” By contrast, many bankers are richer. It should be obvious why bankers and their lobbyists wish to see Summers elevated to Chair of the Federal Reserve. It is less obvious why a Democratic President would want to see him at the Fed, or in any other office that even remotely touches on matters of economic policy.

By contrast to Summers, the Federal Reserve needs to be led by someone who understands that Too Big To Fail remains one of our nation’s most significant and unresolved problems. We need someone who understands that the Dodd-Frank Act was a woefully inadequate response to what ails the American financial system. But overall, and of most importance, the Fed must be led by someone who understands that instituting tough and effective regulation and supervision over the nation’s financial institutions is our first line of defense against a repeat of the disaster that just occurred. In short, if Jamie Dimon, Lloyd Blankfein, or Brian Moynihan are not alarmed by the person selected to run the Fed, then we are not doing it right.

Again, by contrast to Summers, or any other alum of the Robert Rubin school of financial deregulation & big bank coddling (which includes Timothy Geithner, Jack Lew, Peter Orszag and Jason Furman), the next Chair of the Federal Reserve needs to be someone who understands that organized irresponsibility, gross misrepresentation, and outright criminality – and I am not using these words casually – have become central to how the our largest financial institutions conduct their businesses today.

The evidence for this misconduct is now ubiquitous. No thanks to the Fed, over the last five years we have witnessed revelation after revelation of wide-ranging and expensive financial scandals from rigging the critically-important LIBOR rate of interest, to massive and ongoing money laundering at HSBC and other banks, the rampant and unchecked issue of fraudulent mortgages and the equally fraudulent securities constructed out of those mortgages, and the systemic and ongoing conduct of financial fraud and perjury conducted by several large banks in the course of dealings with literally thousands of American homeowners. And yet throughout, little was done and nothing was learned.

Bank regulators of even average ability, had they been on the job, would have alerted their superiors and the American public about these goings on long before they evolved into a full-blown crisis. That this did not occur demonstrates a catastrophic failure of leadership, which brings us directly back to the choice for the nation’s premier bank regulator – the Federal Reserve (astute readers may know that the Office of the Comptroller of the Currency is supposed to be the lead regulator of the largest federally-chartered banks, but as it has been so long since they have even tried to do their job we can expect nothing from them but misdirection and obstruction).

Who, then, should run the Fed? Thus far, the conversation has focused on the pros and cons of Quantitative Easing and so forth, but the truth is that monetary policy did not cause the crisis and, sadly, it can do little to hasten its resolution. So, let’s not allow such issues to become a distraction. If, then, we begin our selection process with the assumption that the choice must be someone with national stature and extensive experience in policy-making, whom should we propose or support?

In contrast to the current conversation pitting Fed Vice-Chair Janet Yellen against Lawrence Summers, I would like to suggest that we select an economist who has already shaken up the powers-that-be with his public stance on Too Big To Fail, who understands the need for substantially enhanced capital requirements along with more robust bank regulation and supervision, who has experience as a regulator, who was the long-time President of the Federal Reserve Bank of Kansas City, and who has never been through the revolving door that has spun so lucratively for Robert Rubin and his acolytes. FDIC Vice-Chair Thomas Hoenig is my choice to run the Fed, and I believe that the record clearly indicates that he is far and away the person best positioned to manage the institution while reigning in the Too Big To Fail banks. I know that he is now retired from the Fed and may not want the headaches that would come with the job, so let’s remember to say “please” when we ask him to serve.

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28 comments

  1. C

    Lest we forget Summers also bears some responsibility for the Shleifer affair in which Harvard Economist Andrei Shleifer along with the Harvard Institute for International Development were given control over U.S. efforts to privatize the russian economy and to setup the russian stock market among others.

    The affair, endorsed by Summers, was structured around no-bid contracts, mired in fraud, some of it by Schleifer, and led to multiple lawsuits in the U.S. and economic damage in russia.

    Summers’ role in all this was initially to “oversee” the contract when he was in the Clinton White House, and then later to oversee (some say protect) Schleifer as president of Harvard.

    Somehow I feel this argues against his qualifications as a “regulator.”

  2. paul

    I opened with a question: “Larry, what’s wrong with the
    budget deficit?” He replied: “It takes away savings that could
    be used for investment.” I then objected: “No it doesn’t, all
    Treasury securities do is offset operating factors at the Fed. It
    has nothing to do with savings and investment.” To which he
    retorted: “Well, I really don’t understand reserve accounting,
    so I can’t discuss it at that level.”

    Mosler 2009

  3. mcgee

    Do ‘they’ exist? The boy/girl scout who are civic minded and buy into the American Dream and will be protectors of the citizenry and not the corporatocracy? Are we still believers of a system that will miraculously change if we can just get the right people in the right positions? How many lessons have to be forced down our throats about the ‘new normal’ before a group epiphany occurs that maybe, just maybe, reveals it is the system that needs changed and not a few titular heads?

    Gah. Forgive my bilious response to who may or may not be the best head of the Federal Reserve. I no longer care or believe it matters.

  4. psychohistorian

    I highly approve of this textual white noise.

    Of course that means that it bears little connection to the reality of our current plutocratic led class system in the Wester Bloc of countries.

    Where is the sea change in our world that is ready to throw a monkey wrench into the management of the Fed/World Bank/IMF, etc.? Did I miss that coup?

    All this money for propaganda and none for the public commons.

    And don’t ever, ever, ever talk about curtailing the inheritance of the folks that own these “public” institutions.

  5. Hayek's Heelbiter

    “Finance ministers soon became expert swindlers, cheating and extorting on a grand scale. The peasants worked till they dropped and citizens were forced to pay huge taxes.”

    E. H. Gombrich (2005). A Little History of the World. Yale U.P. p. 216.

    Re pre-revolutionary France.

  6. Hugh

    The next chair of the Fed must be a regulator? Perhaps we should wish for a pony as well. We live in a kleptocracy. The next chair of the Fed will be chosen by Obama who serves the interests of the kleptocrats and the person he chooses will serve those interests as well.

    I’m not sure what the author means by saying that the Fed’s monetary policy did not cause the financial crisis. Greenspan and Bernanke’s easy money policies fueled the housing bubble. Both Greenspan and Bernanke viewed markets as self-regulating and self-correcting and so turned a blind eye to the most massive frauds in human history. The Fed may not have been the primary instigator of this criminality but it certainly was an indispensable abettor and facilitator of it.

    Remember too that Geithner who in the run up to the housing bust and meltdown was president of the New York Fed, which is as large as the rest of the regional banks combined. He thought all the exotic financial “innovations” were just great and continued to defend them even after they blew up the world financial system. So the Fed was deeply involved in this rotten festering mess throughout. I say this because Hoenig headed the Kansas City Fed for 20 years from 1991 to 2011. He may not have had a ringside seat like Geithner to everything that was going on but he certainly had a good view from one of the sky boxes.

    If recent history and the knowledge that we live in a kleptocracy should have taught us anything, it is that we can not expect our elites to fix the problems they created or fundamentally change the system from which they derive their power, position, and wealth. It is, nevertheless, the hallmark of the Establishment liberal to suggest some marginally less tainted member of the elite, someone who has criticized aspects of the system but never the system itself and to hold out the possibility of a reformist program which is never going to happen. Even if Hoenig is a reformer (which I doubt) he would never be chosen precisely for that reason.

    And as Beard and others will no doubt also point out, none of this addresses the unconstitutionality and illegitimacy of the Fed itself. What does it mean to be the reformist head of a banking cartel? I mean as long as we are putting forth our wishes, why not wish for the end of the Fed, for its functions to be folded back into the Treasury, and for an end to kleptocracy?

    1. profoundlogic

      Well said.

      Wishing for the chair of the Fed to be a “regulator” is just about as productive as waiting for Obama to provide the “hope and change” he promised to deliver…It ain’t going to happen!

      At what point do we as Americans come to grips with the realization that a kleptocracy is a kleptocracy, that a failed, corrupt institution is precisely that? My son might wish for a unicorn for Christmas, but wishing won’t make it so. The history and structure of the Fed speak for itself. Common Yves, do you really think one of the most secretive, obscure financial institutions in U.S. history is going to regulate the very same activities which validate its existence? For God’s sake, just re-read the FOMC transcripts leading up to the crisis. It’s pretty damn apparent these guys are clueless as a collective body, and that’s before you even get into the conflicts of interest in the structure of the Fed itself.

      My own personal belief is that we have already approached the precipice and missed the opportunity to correct the imbalances in the system. Not that there isn’t a brighter future for or country, I believe there is. Unfortunately, I find it difficult to see how we’ll arrive there while we cling to failed systems and failed institutions. The warning signs are all around us. The office of the President, Congress, the Fed, the financial system in general…each of these institutions have failed the American people in epic fashion in recent decades. This has been no accident. It’s a direct result years of decadence and complacency as a society, and the opportunistic efforts of a corrupt establishment to solidify their control.

      They say that the definition of insanity is doing the same thing over and over again and expecting a different result. As a regular reader of this fabulous blog, I would suggest that we all look beyond the institutions that have failed us, and look for ways in which those institutions can be restructured or eliminated. Until we become the change we want to see, the change will not happen. Placing our hope in failed leaders or institutions will just beget more of the same, and recent history suggests that the bar will be continually lowered in terms of the quality that is received.

    2. Dan Kervick

      Hugh, given your criticism that the Fed operates a cartel, I take it that you support a free market in banking?

      1. Hugh

        I don’t believe there has ever been such a thing as a free market. The only questions that need to be asked about any market are who’s running it and for whose benefit. I think that banking should be plain vanilla and endlessly dull. This kind of banking could be done equally well by government or the private sector. I really don’t care which.

      1. Susan the other

        Hugh, Dan Kervick just confused me. I’m for a national central bank without under-the-table benefits for private banksters; I’m for the Central Bank of the United States, but I am not for the private Federal Reserve fake national bank. And for a national central bank to spend wisely it cannot squander its money on private corporations (including banks) dedicated to privatized profits and socialized losses.

        1. Hugh

          Yes, as I said in my original comment, I want the Fed’s functions returned to the Treasury and used for the benefit of the people, not the rich and the elites. Of course, this would only work if the current kleptocracy is rooted out of our politics. The ending of the Fed would be part of rooting kleptocracy out of our economy.

    3. Montanamaven

      Right on, as always, Hugh. Fold Fed under Treasury so only the public can create money. This money should be spent on the general welfare of its people such as health services and education and physical infrastructure. That creates real wealth as opposed to spending it on bombs and bubbles. That is what a monetary system if for: the good of its society. Banks should just be vanilla intermediaries for people who want to borrow at interest or deposit and get some interest. As I understand it we need to nationalize the monetary system not nationalize the banks.

  7. gold price

    Yellen has a clear edge on experience, having served as president of the San Francisco Fed and vice-chair of the Fed system; in that role she has had particularly responsibility for overseeing “reserve bank affairs,” such as reviewing and approving the banks’ budgets.

    1. Paul Niemi

      The last time I looked, the Chairman of the Federal Reserve could only be nominated by the President from among the seven sitting on the Board of Governors. Same with the Vice-Chair, and Janet Yellen has already been nominated and confirmed for that. Lawrence Summers is not a sitting Governor, and Thomas Hoenig is retired, so each would have to be nominated and confirmed to fill a vacancy before being eligible to be nominated for Chair. The way I see it, the fact that Yellen has already been confirmed by the Senate for Vice-Chairman gives her a leg up over the other names floated. Her nomination would be the path of least resistance, least likely to be derailed in the Senate despite the hotly political nature of the decision. Senators who now say the confirmation will be easy are just blowing smoke.

  8. profoundlogic

    How many economics PhDs does it take to predict a recession?

    Please use your creativity.

  9. edmondo

    Meh. The Larry Summers trial balloon is just a smokescreen to make Janet Yellin look like an inspired pick in comparison. She’s more of the same but Summers is just being put out there to show you that it could have been much worse.

    1. killben

      I also get the feeling that we are being set up to receive Yellen with open arms. As if she is any better than the Big Ben. Anybody can be made to look more beautiful on a relative basis by placing a more ugly person beside that person. Tricks these propangadists play might have made even Goebbels feel like a novice. Did you notice… no mention of the deserving ones like Thomas Hoenig, Paul Volcker who can tackle the menance of TBTFs.

  10. killben

    “By contrast to Summers, the Federal Reserve needs to be led by someone who understands that Too Big To Fail remains one of our nation’s most significant and unresolved problems.”

    If this were the criterion the best fit would be Thomas Hoenig. WILL NOT HAPPEN.

    My next choice on this criterion will be Paul Volcker. Warren’s choice too! WILL NOT HAPPEN.

  11. jfleni

    It may just be a straw in the wind, but maybe, just maybe, after the Awash vote, Congress is starting to find their backbones (not to mention other parts too).

    Therefore when Babbling Barry seriously proposes “Professor Larry the Misogynist Destroyer” or even Timmy(!!) for Fed chairman (totally posible considering how Barry worships those clowns), they might find enough moxie to just shoot it down hard, and make it plain it will never happen.

    Stranger things (like the Awash vote) have happened; unexpected change can happen surprisingly fast sometimes.

  12. washunate

    “Bank regulators of even average ability, had they been on the job, would have alerted their superiors and the American public about these goings on long before they evolved into a full-blown crisis.”

    What? The superiors are the problem. A lack of alerts is a laughable explanation of what went wrong over the past decade and a half or so. Yes, I am purposefully linking a CNN article first – this was so broadly understood that it even appeared in the mainstream corporate media.

    http://www.cnn.com/2004/LAW/09/17/mortgage.fraud/
    http://www.nakedcapitalism.com/2010/09/william-white-getting-tough-on-banks-may-not-hurt-economy.html
    http://www.bankrate.com/brm/news/mortgages/BakerFamily.asp
    http://www.naomiklein.org/shock-doctrine
    http://online.wsj.com/article/SB123086154114948151.html
    http://online.barrons.com/article/SB122246742997580395.html

    etc.

  13. Lauren Taylor

    I agree, a regulator would be most qualified than almost anybody to run the Federal Reserve. Recently, Canada made a similar appointment, by naming Poloz as successor of Mark Carney. Poloz is a domestically trained PhD economist. I believe he is the first non-US trained economist to be named Bank of Canada governor. Moreover, he is deeply acquainted with financial institutions of the government. After the recent criticisms of how Goldman Sachs and Citibank alumni have obtained key government posts, the argument has been strengthened to name a regulator as Governor of the Federal Reserve.

  14. Worden Report

    Given former US Sen. Ted Kaufman’s conclusion that the Dodd-Frank Act has failed to reduce “too big to fail” systemic risk of the big banks (see http://thewordenreport.blogspot.com/2013/07/did-wall-street-write-dodd-frank.html), the need is greater for the Fed to keep a watchful eye on the megabanks, which are still engaging in high-risk trades. (on this point, see http://thewordenreport.blogspot.com/2013/05/can-federal-reserve-handle-banks-too.html) Paul Volcker would not pull any punches. He took care of inflation in the early 1980s and pushed the “Volcker Rule” even as lawmakers and regulators have weakened it in line with the interests of Wall Street. In contrast, Larry Summer pushed for the repeal of the law that had kept commercial and investment banking separate (the Glass-Steagall Act) and lobbied Congress to keep financial derivatives unregulated in the late 1990s. (See http://thewordenreport.blogspot.com/2012/07/foe-of-glass-steagall-break-up-big-banks.html) Is there a learning curve here or is history bound to repeat itself?

  15. Lafayette

    EXCEPTIONAL

    As one-half of the Gruesome Twosome that laid to rest the Glass-Steagal Act, which has wrought undescribable harm upon the economy with the Toxic Waste Mess, I don’t see how Summers has any standing whatsoever in LaLaLand on the Potomac.

    Unless, of course, there is a skewed Honor Amongst Thieves that prevails in that quarter.

    Summers is an exceptionally intelligent man. He is also proof-positive that exceptionally intelligent men can make exceptionally bad mistakes.

    He lets his ego cloud his judgement and cannot be trusted for such a high office that, in fact, has little oversight by a higher authority. (I.e., the PotUS, because the head of the Fed is not a cabinet position.)

    However, there is the more informal Kitchen Cabinet, of which the Fed head is indeed invited to meeting. So, what’s the difference.

    It is possible that Obama sees someone who he can manipulate. And he DID manipulate Summers when he worked for Obama in the White House.

    That is shrewd thinking, but what the board needs, as others have said on this thread, is a regulator and neither a manipulator (which Summers is when he wants to be) nor a manipulee of the PotUS.

    Methinks …

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