New Fed governors may bring new policy solutions

December 29, 2011

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

U.S. President Barack Obama’s new Federal Reserve governors may bring new policy solutions. He may have laid a clever election-year trap by nominating the party-balanced pair of Jeremy Stein and Jerome Powell to the central bank’s vacant posts. Both are well qualified. Moreover, Stein’s views on financial regulation may even help watchdogs like the Fed to prevent future MF Globals from emerging.

Politically, Obama’s move is canny. He apparently balances the political parties, while nominating Powell, the Republican, only until January 2014 and Stein, the Democrat, until 2018. By doing so, he challenges Senate Republicans to block the nominations and show themselves partisan and obstructive, while reserving the right to replace Powell when his term ends shortly after his own re-election.

On substance, both men are highly qualified, and from their record likely to support Fed chairman Ben Bernanke’s loose-money policy. Powell’s connections to Carlyle, the most politically-minded major private equity group, and his donations to GOP candidates Mitt Romney and Jon Huntsman, suggest he won’t rock the boat on policy.

Stein, a Harvard professor, has a monetary policy specialization and a published track record. In particular, in a recent paper he suggested that Fed regulatory policy should address the problem of excessive leverage in the shadow banking system by extending reserve requirements to it. This would, for example, address the problem at MF Global, the failed Wall Street firm whose London subsidiary appears to have created chains of repurchase agreements, using client funds. By having some control over non-bank financial borrowing, the Fed could reduce both overall systemic leverage and the incentive to move assets into the shadow banking system.

Adding Powell and Stein to the Fed board won’t do much to transform the Fed’s current stimulative monetary policy. But Stein’s ideas, if implemented, could mitigate some of that policy’s potentially bubbly side effects. Wall Street might not view that as a positive, but it’s hard to see on what basis legislators could object to giving either man the job.

Predictions: Breakingviews is publishing a series of articles over the holiday that look ahead to 2012. The pieces will be collected together in the annual ’Predictions Book,’ produced in print and electronic form early in the New Year.

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