Deciding Who Pulls the Strings Now

No one quite understands what the Federal Reserve does – or even what it is – and girls can’t do math. That’s a deadly combination, even if neither is quite true. It’s just that the Federal Reserve has been the one institution that kept America afloat ever since the collapse of the economy in the final months of the Bush administration’s second term, even if it’s not exactly a branch of the government. At the time, almost all the politicians were completely useless, but then they are generalists, interested in broad public policy, or in power over the life of the country, or power in the abstract, or in fame, or sex, or Jesus, or something. They were not economists. Most of those in Congress are actually lawyers, although some had once been doctors, and a few had been war heroes, like John McCain. At least John McCain was honest about it – he once openly admitted he didn’t really understand economics at all, but he’d brought along a friend who did. That was refreshing – everyone else fakes it, and successful businessmen don’t run for public office. They have far more power where they are, and the pay’s several thousand times better, and in that circumstance fame isn’t much of an issue. It’s quite unnecessary. As for shaping public policy, they have their lobbyists take care of that, as a business expense.

In short, when the massive superstructure of interlocking debt obligations based on millions of worthless home mortgages collapsed, when investment banks went under one after the other, when big-name major commercial banks failed, when credit dried up and the economy seized-up, politicians were useless. There was that one Friday night when Hank Paulson, the Treasury Secretary who had run Goldman Sachs for years and made himself more than a half a billion dollars along the way, and Ben Bernanke, the Chairman of the Federal Reserve who had spent his entire academic career studying the Great Depression, sat down with key leaders of the House and Senate and told them that the nation’s economy, and the world’s, would collapse on Monday morning if they didn’t do something, immediately. The story of that meeting has been told well by others – all the parties at the table were flabbergasted. How could this have happened? Exactly what was happening anyway? Paulson and Bernanke tried to explain, but that was beside the point, and the others at the table might not understand anyway. The point was that the Treasury Department needed seven hundred billion dollars, immediately, to prop up the financial system, or there’d be no economy on Monday.

This was politically impossible. There was no way to explain that seven-hundred-billion-dollar immediate expenditure to any voter, and it was all for the banks, not for the little guy, who was getting clobbered out there – but it had to be done. What did they know? They weren’t economists, or businessmen.

The next week, as the real collapse began, they voted on this new Troubled Assets Relief Program, even if they didn’t quite understand any of it, and it failed in the House. It was too big a lift – but the Dow dropped another thousand or more points, more banks went under, and then Congress finally passed it on a second try. The ongoing disaster merely slowed – in fact it’s still with us – but there was no total collapse. We only came close, and note that George Bush didn’t sit them down and tell them they had to do this. He may have not understood any of it either, which is a clear indication that the president and Congress are not the ones who keep things humming along in America. Someone else, someone almost invisible, pulls the strings. They weren’t elected by anyone, and the only time you’ll hear from them is when total collapse is happening and they need money, lots of it. Give it to them. Don’t ask questions. You wouldn’t understand anyway. Just make yourself useful. Hand over the cash. Sit down. Shut up. Hang on.

Since then the Federal Reserve has been less invisible. Everyone has figured it out. The Federal Reserve runs the economy, as Congress is split into those who urge austerity – spending cuts – spend less on everything so we have no debt – and those who urge stimulus – get people back to work, on anything, even government work, so folks will be buying again, and selling. They’ll never agree and their arguments are broad and uninformed. They make general points, while the Federal Reserve actually does something useful. They set interest rates, and manipulate the money supply by buying what no one else will, adding cash to the system when liquidity is an issue. It’s far more complicated than that – but the Federal Reserve System is the central banking system of the United States. It wasn’t mentioned in the Constitution. It was created on December 23, 1913, with the Federal Reserve Act – politicians finally realized they couldn’t handle financial panic after financial panic through the political process, run by amateurs. If you want maximum employment, stable prices, and moderate long-term interest rates, you don’t want politicians arguing – you want technical experts, in a central banking system, with a bit of congressional oversight if you can figure out what they’re talking about. Let them determine banking practices, and set monetary policy, so tell them their mandate is maximum employment and stable prices, and preventing either too much inflation or too much deflation – and stand back. They’ll figure it out.

That may seem undemocratic, or sensible, depending on your confidence in those we actually elect to office. These guys aren’t elected to office. The members of their Board of Governors, including its chairman and vice-chairman, are chosen by the president and confirmed by the Senate – and turned loose. They have, by law, staggered fourteen-year terms, and don’t actually report to either the president or congress. The chairman, now Ben Bernanke, serves a four-year term and can be re-nominated as many times as the President chooses, until his fourteen-year term on the Board of Governors expires – and Ben Bernanke’s fourteen years are up. He has to leave at the end of the year.

That’s the problem. Bernanke has managed the slow recovery from the Bush disaster carefully and reasonable well. The markets have certainly recovered, and banks are now making money hand over fist again, even if they’re still not lending out much of it, and inflation has been incredibly low – prices have been stable. Some have argued that Bernanke ignored that mandate on maximum employment, but that’s a trade-off he chose to make. You can’t have everything, and maybe that will come around, as a secondary effect of all the rest. He’s pulled the strings well enough, or as well as could be expected given the mess he had to clean up. He’s the man who sort of saved the economy. No politicians and no president could do that. It takes a total wonk to do that, running the central banking system, outside the democratic system, or in parallel to it.

This leaves Obama with a serious problem. He now needs to nominate someone new to really run the country, insofar as the economy is the country, and someone the Senate will confirm. The latter should be no problem – few in the Senate even know what questions to ask in the confirmation hearings. They’re neither economists nor bankers – they’re politicians. Still, this person will be pulling all the strings. This person could make or break America. It’s a puzzle.

The choice seems to have come down to two options for the new Chairman of the Federal Reserve – Bernanke’s current second in command, Janet Yellen, and that guy who’s been around forever, Larry Summers, and Hans Nichols of Bloomberg covers the dynamics at play:

When President Barack Obama dropped by Lawrence Summers’s going-away party in 2010, he presented his National Economic Council director with a pair of suspenders, a gag gift to help Summers hold up his perpetually sagging trousers.

The gesture was meant to tease Summers – known inside the West Wing for a mix of awkwardness, abrasiveness and brilliance, according to current and former administration officials – who say Obama regards him with both affection and exasperation.

As Obama ponders a potential successor to Federal Reserve Chairman Ben S. Bernanke, his familiarity with Summers, 58, may give his onetime adviser an edge over Fed Vice Chairman Janet Yellen, whom Obama has scarcely met, the officials say.

Obama considers whether he “has a relationship with the person he’s about to name,” said former Chief of Staff Rahm Emanuel. “I wouldn’t call it the factor, but it’s a factor.”

That’s it? That’s a problem:

Weighing against that advantage for Summers is a backlash within the Democratic Party against his role in President Bill Clinton’s Treasury Department in financial deregulation, which some say contributed to the 2008 market crisis. Those misgivings were underlined last week by a letter that Senate Democrats sent to Obama urging him to choose Yellen.

Summers’s record from those days clashes with Obama’s own argument that deregulation efforts by past administrations helped trigger the worst slump since the Great Depression – and has exacerbated income inequality.

Here’s a refresher on the man:

On May 7, 1998, the Commodity Futures Trading Commission (CFTC) issued a Concept Release soliciting input from regulators, academics, and practitioners to determine “how best to maintain adequate regulatory safeguards without impairing the ability of the OTC (Over-the-counter) derivatives market to grow and the ability of U.S. entities to remain competitive in the global financial marketplace.” On July 30, 1998, then-Deputy Secretary of the Treasury Summers testified before the U.S. Congress that “the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.” Summers, like Greenspan and Rubin who also opposed the concept release, offered no proof that the contracts would not be misused by financial institutions. Instead, Summers stated that “to date there has been no clear evidence of a need for additional regulation of the institutional OTC derivatives market, and we would submit that proponents of such regulation must bear the burden of demonstrating that need.” In 1999 Summers endorsed the Gramm-Leach-Bliley Act which removed the separation between investment and commercial banks, saying “With this bill, the American financial system takes a major step forward towards the 21st Century.”

And the rest is history, from Enron to the economic collapse as the Bush administration ended, and there’s also this:

Lawrence Henry “Larry” Summers (born November 30, 1954) is an American economist. He served as the 71st United States Secretary of the Treasury from 1999 to 2001 under President Bill Clinton. He was Director of the White House United States National Economic Council for President Barack Obama until November 2010. Summers is the Charles W. Eliot University Professor at Harvard University’s Kennedy School of Government. He is the 1993 recipient of the John Bates Clark Medal for his work in several fields of economics.

Summers also served as the 27th President of Harvard University from 2001 to 2006. Summers resigned as Harvard’s president in the wake of a no-confidence vote by Harvard faculty that resulted in large part from Summers’s conflict with Cornel West, financial conflict of interest questions regarding his relationship with Andrei Shleifer, and a 2005 speech in which he suggested that the under-representation of women in science and engineering could be due to a “different availability of aptitude at the high end,” and less to patterns of discrimination and socialization.

Yeah, yeah – girls can’t do math – but Janet Yellen can:

Yellen was an assistant professor at Harvard in 1971–76 and an economist with the Federal Reserve Board of Governors in 1977–78.

Beginning in 1980, Yellen has been conducting research at the Haas School and teaching macroeconomics to full-time and part-time MBA students. She is now a Professor Emeritus at the University of California, Berkeley’s Haas School of Business, where she was named Eugene E. and Catherine M. Trefethen Professor of Business and Professor of Economics. Twice she has been awarded the Haas School’s outstanding teaching award.

Yellen served as chair of President Bill Clinton’s Council of Economic Advisers from February 13, 1997 to 1999, and was appointed as a member of the Federal Reserve System’s Board of Governors from 1994 to 1997. She has taught at Harvard University and at the London School of Economics. Yellen serves as president of the Western Economic Association International and is a former vice president of the American Economic Association. She was a fellow of the Yale Corporation.

From June 14, 2004 until 2010 Yellen was the President and Chief Executive Officer of the Federal Reserve Bank of San Francisco. She was a voting member of the Federal Open Market Committee (FOMC) in 2009.

One wonders how Obama would explain choosing Summers over Yellen to his daughters. The guy has been wrong a lot, on really major issues, but I know him well and don’t know Yellen, and she’s a girl anyway? He can’t say that. Does he say that to the Senate Democrats who sent him that letter saying Yellen was their choice, given that Summers was a key player in what ruined the economy?

Hans Nichols provides the contrast:

Yellen, as president of the San Francisco Fed, was one of the only members of the Federal Open Market Committee to warn about the fallout from a collapse in housing. At a 2007 Fed meeting, she said the biggest risk to economic growth was housing, which she called the “600-pound gorilla in the room.”

Yellen was never swept up in the deregulatory fervor of the 1990s, according to Fed staff who worked with her.

“She cared about supervision and regulation at a time when a lot of economists, even at the Fed, had the view that the financial system, subject to market discipline, would take care of itself,” said Rich Spillenkothen, who served as the Fed’s top regulator from 1991 to 2006.

She was right and Larry Summers was wrong, as if it matters, and Jonathan Chait takes it from there:

The hard-money cranks of the right have spent the Obama years nurturing fears of incipient inflation that never seems to arrive, yet whose non-arrival never dents their airtight worldview. The current jostling between Larry Summers and Janet Yellen to become the next head of the Federal Reserve has introduced a new and even more primal fear into the minds of the hard-money cranks: the trepidation that their monetary essence will be drained by a woman.

The hard-money cranks don’t frame it this way. In their own minds, they are the upholders not only of firm currency standards but also firm intellectual standards. They insist Federal Reserve appointments be dictated solely by merit and are beset by liberal gender police insisting on compromising their standards in the name of diversity. “Are we entering the era of the gender-backed dollar?” asks the right-wing New York Sun. The Sun cares only about the soundness of the currency, which it defines as its value relative to gold, not of gender. But the whiff of masculine gender panic is not hard to detect.

You can read the whole New York Sun item here – it is a bit odd – but Chait notes there’s more:

The Sun’s point – captured in its headline, “The Female Dollar” – struck the Wall Street Journal’s editors as so clever as to bear repeating in their own editorial today. Yellen, the Journal concedes, “doesn’t lack for professional credentials. But her cause has been taken up by the liberal diversity police as a gender issue because she’d be the first female Fed chairman.”

That is a pretty remarkable passage, especially the “but.” The “gender police” would argue that they support Yellen because she is so highly credentialed, not despite her qualifications. Indeed, the basic breakdown of the debate is that Yellen supporters argue she’s better qualified than Summers, and Summers supporters argue they’re equally qualified. Even if you accept the pro-Summers view, using gender as a tie-breaker in the case of two equally qualified candidates for a job that has never gone to a woman seems like the sort of ultra-modest application of affirmative action that even conservatives tend to endorse, at least rhetorically.

And of course the pro-Yellen argument is that the two candidates are not equally qualified, but that Yellen is more qualified, and only her gender is causing some critics not to see that. The Journal processes this argument as the slow destruction of our standards. The Journal frets that “Nancy Pelosi has bellowed her support.”

Oh, the humanity! No, wait. That was the Hindenburg and this isn’t:

As it happens, the Journal’s news writers, who frequently infuriate and embarrass their editorial-page colleagues by reporting facts, published a report today measuring which members of the Federal Reserve board have made the most accurate predictions since the crisis. The Journal-style inflation hawks who have predicted rising prices around every corner have scored terribly. The highest scoring member – that is, the one whose predictions were most frequently borne out correctly by events – is none other than Janet Yellen.

Given this record, “the female dollar” looks awfully appealing. But it puts a fine point on the gender panic that is now infusing the hard-money cranks. They have constructed a fantasy world in which they sit in their plush leather chairs, calmly defending the rigors of tough-minded empiricism while feminists bellow from the street below. Yellen keeps analyzing the world in a sound and clear-minded way while they bay at the moon.

The economist Paul Krugman adds this:

I’ve spent five years and more watching the inflationphobes, who weren’t particularly sensible to begin with, descend into shrill unholy madness. They could have reacted to the failure of their predictions – the continued absence of the runaway inflation they insisted was just around the corner – by stepping back and reconsidering both their model and their recommendations. But no! At best, we see a proliferation of new reasons to raise interest rates in a depressed economy, with nary an acknowledgment that previous predictions were dead wrong. At worst, we see conspiracy theories – we actually have double-digit inflation, but the Bureau of Labor Statistics is spiriting the evidence away in its black helicopters and burying it in Area 51.

So at this point I thought I’d seen everything. But no: the prospect that Janet Yellen, a monetary dove, might become the next Fed chair has driven the right into a frenzy of – well, words fail me.

That’s okay. Words didn’t fail Jonathan Chait – but that’s okay. The panic is quite understandable. This person will be the one who is actually pulling the strings, the one who really runs the country, insofar as the economy is the country, and it could be… a girl. After a black president, as much as he has been neutralized, that may be a bit too much for conservatives, who like things as they always were and should be forever. It even may be a bit too much for Obama. He does have his conservative side – he often seems more Eisenhower than FDR – to the dismay of the left. But if we’re going to have an unelected shadow government, having someone who gets things right would be nice.

About Alan

The editor is a former systems manager for a large California-based HMO, and a former senior systems manager for Northrop, Hughes-Raytheon, Computer Sciences Corporation, Perot Systems and other such organizations. One position was managing the financial and payroll systems for a large hospital chain. And somewhere in there was a two-year stint in Canada running the systems shop at a General Motors locomotive factory - in London, Ontario. That explains Canadian matters scattered through these pages. Otherwise, think large-scale HR, payroll, financial and manufacturing systems. A résumé is available if you wish. The editor has a graduate degree in Eighteenth-Century British Literature from Duke University where he was a National Woodrow Wilson Fellow, and taught English and music in upstate New York in the seventies, and then in the early eighties moved to California and left teaching. The editor currently resides in Hollywood California, a block north of the Sunset Strip.
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