Obama’s dangerously heroic view of the Fed

By Felix Salmon
August 13, 2013

The trial balloon, it seems, has floated: Albert Hunt, today, puts Larry Summers’s chances of getting nominated as Fed Chair at 65%, saying that he has the support of just about everybody in the Obama administration not named Valerie Jarrett.

The Summers camp includes several top Obama economic advisers: director of the National Economic Council Gene Sperling, chairman of the president’s Council of Economic Advisers Jason Furman, director of the White House Office of Management and Budget Sylvia Burwell and Treasury Secretary Jack Lew…

When Obama discusses the choice, in private as well as public, he stresses the importance of selecting a chairman who can handle a financial crisis similar to 2008-09. Insiders believe that’s code for Summers.

This argument is of utmost importance: it is pretty much the only argument that Summers has going in his favor, and as such, if Summers does end up getting Obama’s nod, it will be thanks to this particular piece of logic.

So, how compelling is Obama’s argument here? The answer is, not very.

It is worth applauding Obama’s decision to concentrate on potential fat tails — such things are notoriously easy to ignore. That said, the chances of the next Fed chair encountering a financial crisis similar to 2008-9 are pretty slim: realistically, Obama’s appointee will not have to deal with such a crisis. In order for this argument to carry water, then, you need to believe either that the job of Fed chairman is essentially a firefighter role, which has very little importance when there isn’t a crisis, or else that it is so easy enough to do the right thing as Fed chair when there isn’t a crisis that it doesn’t really matter, most of the time, whom you appoint.

This is actually the exact opposite of the truth. The actions of the Fed chair during normal times are of paramount importance: they determine how much growth there is in the economy, how much unemployment there is in the economy, how much the country’s bonds and stocks are worth, and even how likely it is that we might encounter another crisis. The Fed chair is one of the two most important offices in the USA, the other one being the presidency.

That said, however, there’s one time that it doesn’t really matter who the Fed chair is — and that’s when you’re in the midst of a fully-blown financial crisis. At that point, the Fed just moves straight in to Global Firefighter mode, turning on the liquidity taps to full blast and lending as freely as possible to as many counterparties as possible against just about any collateral conceivable. It’s the correct response, it’s an automatic response, and there isn’t a central banker in the world who won’t do it.

Look, indeed, at what happened in 2008-9: the world’s major central banks all responded in pretty much the same way, and indeed coordinated their actions very effectively. They easily agreed on a system of unlimited swap lines, which provided abundant liquidity, in any currency, in any affected country. Certainly there were stupid decisions made during the crisis, but those stupid decisions were made by finance ministers, not by central bankers. There was Ireland’s decision to guarantee all of its banks’ debts, for instance — a decision made by the finance minister, not the central banker. Or there was the US Treasury’s determination that it had no legal authority to bail out Lehman Brothers, along with its failure to effectively communicate that decision to UK authorities.

The world’s central bankers, by contrast, pretty much batted 1,000 through the crisis: while it’s possible to criticize their actions during the recovery, they all did exactly what they needed to do when the credit crunch was at its height and there was a serious risk that the entire global flow of money could come to a screeching halt.

In other words, when there’s a crisis, it really doesn’t matter whether you’re Ben Bernanke or Mervyn King or Jean-Claude Trichet — or Janet Yellen or Larry Summers or pretty much anybody else bar Rand Paul. The central banker’s crisis playbook is a thin document, and easy enough for anyone to master. It’s what central bankers do when there isn’t a crisis that matters, since they’re all going to do exactly the same thing when there is one.

More importantly, financial crises aren’t things which just happen, like asteroids or earthquakes. They have causes — which means that they can also be prevented. Crisis management is an important skill, and it’s one where Larry Summers has a lot of experience. But crisis prevention is the thing which really matters. Summers has demonstrated essentially zero crisis-prevention skills: his deregulatory instincts helped make the financial crisis more likely and more severe when it happened. Mark Carney, to take one obvious example, is a better central banker than Larry Summers will ever be, because he did something vastly more praiseworthy than managing a crisis: he prevented a crisis from ever happening in the first place.

As a result, Obama should be bending over backwards to appoint not the candidate who can best manage a financial crisis, but rather the candidate who is most likely to stop a crisis from happening in the first place. That candidate is Janet Yellen. (Or maybe Mark Carney, but he’s taken.)

Obama, it seems, has a dangerously heroic view of what the Fed chair does. There’s the day-to-day managing-the-economy thing, which, meh, there’s no difference between the candidates. And then there’s the swing-into-action thing when a crisis hits, and you want to be able to call upon the great Larry Summers to reprise his role as a key member of the Committee to Save the World.

The reality, by contrast, is that the day-to-day actions of the Fed chair, both in terms of monetary policy and in terms of bank regulation, are all that really matters. If a crisis hits, we already know what the Fed will do, whoever is in charge. And, of course, if the president (or the Fed chair, for that matter) ever wants Larry’s advice, I’m sure that Larry will be right there, willing to give it. In the mean time, Summers should simply continue to make gazillions of dollars consulting for Citigroup. And should take his name out of the running.

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Comments
15 comments so far

I assume Bernanke is leaving the board of governors, not just its chairmanship, which leaves a vacancy on the board if Yellen becomes chairman. To exactly the extent to which I think Summers is psychologically capable of being a non-disruptive back-bencher, I would be a strong supporter of his filling that vacancy, possibly even as vice-chair. I’m not sure that’s a very far extent, though.

Posted by dWj | Report as abusive

His crisis experience is like Inspector Clouseau’s, the master detective who always seems to be at the scene of the crime.

You have to ask yourself, how much were his policies of fostering TBTF banks and an unstable shadow banking system to blame for the biggest financial crisis in 80+ years.

You want a Fed chair committed to building a simpler, more resilient financial system, not one who is going to foster more moral hazard by promising to ‘handle’ them as they arrive (with liquidity, bailouts, and bank subsidies).

There’s a time for a steady hand, and a time for a reformer, and the ‘steady hand’ who built the system that proved disastrous isn’t the right guy to fix it.

Posted by druce | Report as abusive

dWj, knowing, albeit only by reports that appear in the media, the extent of Larry Summers’ ego (i.e., it’s huge), I’d doubt seriously the possibility of Summers accepting an appointment to the board of governors if he was passed over for Chairman.

And I hope, for the sake of this nation, that Mr. Summers isn’t offered an appointment to be chairman.

Posted by Strych09 | Report as abusive

This is a really poor column frankly. OK, Felix might hate Summers, and I’m not convinced he’s necessarily the best candidate at this stage but it is truly terrible and utterly misguided to think that the personality and character of the key central bankers do not matter in a crisis. For starters, Mervin King had a terrible record at the beginning of the crisis eg when the Rock blew up in Sept 2007, a full year before Lehmans. Credit markets had seized up, and instead of looking into it, the Boe thought it was an isolated incident. Sure northern rock overextended, but when in spring 08, Bradford bingley went bust too, and then bear in the Us, surely somehow has to think – hold on, something’s not right. But no, they just didn’t. At least not until Trichet acted in August 2008. (BTW, what the F was the Fed doing? Shown the way by the ECB?)
Exhibit b is so clearly the great depression, where central bankers utterly failed in their role – or rather did what was expected of them, which was not what was needed.

Anyway, we ought to want someone able and willing to take on politicos, media etc – if the conditions require it. It is not easy to assess, as by definition, this may be someone not able or willing to brown nose. This BTW seems to be the only way to get the job. If Summers gets it, regardless on whether it makes sense, that would definitely say: “stick your nose as far up the bottom of your boss, that’s the way to get promoted.”
And frankly they are too many signs showing that already.

Posted by fxtrader7 | Report as abusive

I think the next Fed chairs toughest task will be maintaining the independence of the bank from the executive and legislative branches. You see, Paul Krugman has been right for years while all the hawks have been wrong… and that will continue to be true right up until it isn’t. Just like GE was the safest corporate credit in the world levered 40/1… until it wasn’t.

If we get inflation from a doubling of debt to GDP or a quadrupling of the monetary base in just a dozen years it will take a tough and unpopular customer to administer the antidote.

It would seem to me that we would want to remove (or lower) the fiscal stimulus of the 5-6% of GDP generated by deficit spending before we remove the stimulus provided by zero interest rate policy. The next Fed chair will have to help make that case.

Posted by y2kurtus | Report as abusive

The problem with Summers is that he is financially ignorant and has repeatedly demonstrated that whatever job he undertakes, it would have been performed just as well and often better by a doorstop. (Now, it is possible that Summers is not actually stupid, but, in that case, he spends an awful lot of effort trying to appear stupid.)

My main fear is that we’ll get a Fed chairman so scared of economic growth that he’ll slam on the brakes at the first sign of inflation. Hint, you can’t have economic growth without inflation. That’s Economics 101, “What are prices?” We could use a few years of five to ten percent inflation to get the economy moving again after 30 years of stagnation.

Posted by Kaleberg | Report as abusive

I had to laugh when I heard that the Fed might be called in to act if we had another financial crisis. Normally the response is lower interest rates and more liquidity, but the Fed right now has all it’s fire engines outside and all the hoses running full blast dousing us with money and interest rates are still close to zero. Actually the worry should be about how Fed activity now is contributing to tomorrow’s problems. I don’t see Yellen or Summers being particularly vigilant to that concern or sensitive to it. We really need someone who understands markets and regulation and the real economy. Two people who fit that bill are Sheila Bair and Thomas Hoenig. As far as arguments floated to support Summers, they are fake discussions. The real reason Obama wants Summers is that Bob Rubin and his acolytes are orchestrating a campaign to give Summers his dream job. The Obama economic team are all Rubin allies having kicked out anyone not so aligned, and as a result out of touch and insular. Larry Summers is just not that popular or appreciated by the country at large, and for good reason, he helped create today’s problems while in the Clinton administration.

Posted by Sechel | Report as abusive

Indeed, the next Fed chair more likely has the problem of managing the current programs in an economy that is growing but not enough. Which is a serious problem, but not the same sort of problem faced in 2008. And one for which the Fed is not especially well suited–it has little direct impact at the wages-and-jobs level.

Posted by Moopheus | Report as abusive

“More importantly, financial crises aren’t things which just happen, like asteroids or earthquakes.”

Well, The Bernanke seems to think they do. This is the man who thought “subprime is contained.”

“Druce” is asking the critical question. The idea that bubbles can’t be seen and that it is best to deal with them after they pop – do you sign on to that Felix????

Posted by fresnodanhome | Report as abusive

“[W]hen you’re in the midst of a fully-blown financial crisis . . . the Fed just moves straight in to Global Firefighter mode, turning on the liquidity taps to full blast and lending as freely as possible to as many counterparties as possible against just about any collateral conceivable.” I don’t agree that this is what the Fed did in 2008; while they’ve gradually stepped it up since then, they still aren’t going “full blast.”
The Fed Chair in a crisis is not less important than in normal times. We needed a better Fed Chair in 2008; Bernanke batted about .199, far from 1.000!

Posted by Philon | Report as abusive

I think our faith in central bankers globally is mis-placed. We’re asking them to do the job of fiscal stimulus when they only have monetary tools to use. Congress needs to grow up and do their own dirty work so the Fed can focus on what they do best: manage inflation.

It is for these reasons (global abdocation by elected officials) we see monetary purchasing power fall steadily across developed economies. The Carry Trade Index of G7 counties has jumped 30K since the June taper-on mis-speech by Chairman Bernanke (see chart below):
http://make300aday.com/3111/btfd-index-c arries-on-despite-market-drops/

Posted by tradersteve | Report as abusive

None of this blather matters. Valerie has already decided. It’s Yellen. End of discussion.

Posted by nixonfan | Report as abusive

Very big bubble getting ready to pop…

Everyone does realize the Fed is not a government entity – correct?

Posted by StillTired | Report as abusive

Felix,
The fact that Larry Summers is even being considered, and seriously is a bad sign. President Obama’s decisions are unfathomable, though I am concerned and believe there is greater than 50%, say 65% probability, that Summers will be selected.

I am concerned for the same reasons as everyone else. As of three weeks ago, no one wanted Summers as Fed governor, as indicated by online reader polls by the WSJ, Fox, NY Times and yes, Mother Jones.

Posted by EllieK | Report as abusive

Sheila Bair??

She is on record as saying there would be more bank lending and investment if interest rates were HIGHER !!

Posted by Ed62 | Report as abusive
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