Lecherous Democrats Bill Clinton, Anthony Weiner, Bob Filner and Elliott Spitzer have given a whole new meaning to the phrase “hands-on management.” But nearly as indefensible is Obama’s desire to name Larry Summers, rather than Janet Yellen, to replace Ben Bernanke as head of the Federal Reserve. If Obama does make that mistake Republicans should denounce it as an egregious example of Wall Street crony capitalism and the “old boy network” picking the best man rather than the best person to fill a crucial post.
To gain some perspective, consider this hypothetical. Barry is Chairman and CEO of XYZ Corp., and the head of the company’s biggest division, FOMC, is about to retire. Over the past few years, FOMC has successfully grappled with tough industry conditions under the leadership of the Division Head, Ben, and his second in command, Janet. FOMC’s future success depends not only on the smarts of its senior managers but on their collegial cooperation in responding to constantly changing market conditions. Maintaining comity in the ranks is particularly crucial now, because FOMC is about to roll out a new product that has been under development for four years. This is no time to “change horses in the middle of the stream.” So Janet is the obvious choice to replace Ben. But wait. Barry has an associate (and tennis partner), Larry, whom he’d really like to give the job to. Admittedly there are pros and cons. Pros: Larry is very smart, and Barry has worked with him before; he will be a team player. Cons: Larry has never worked in FOMC’s industry, and he is unfamiliar with FOMC’s distinctive organizational structure and culture of collegiality. Worse still, he is famously abrasive and arrogant, and his inflated regard for his own intelligence has led to imprudent decisions on more than one occasion.
Whom should Barry select? The answer is obvious. Except to Barry, who really, really wants Larry. Stay tuned.
Seven Reasons to Be Leery of Larry
No Fed Experience Although he has ample experience formulating economic policy and addressing economic crises, Summers has never conducted monetary policy. He has never participated in an FOMC meeting, trying to persuade colleagues to follow a cohesive policy, and then communicating that policy in a market-friendly way. Even if he were not notoriously abrasive, Larry would have, at the very least, a challenging transition period. And it would be disastrous if global financial markets sensed there was discord and “bad blood” within the FOMC. Yellen, by contrast, has been at the Fed for many years as a Governor, President of the San Francisco Fed, and Vice Chairwoman. She is widely respected, skilled at building consensus internally and communicating her views to market participants.
Yet Another Citi Crony Capitalist. As I have shown in previous posts, Citigroup has for decades been mismanaged and periodically running to Washington for favors and bailouts (two during the 2008 financial crisis). It skillfully cultivates powerful Beltway Buddies such as Robert Rubin, who after helping dismantle Glass Steagall as Treasury Secretary (making possible the merger of Citi and Travellers) just happened to land a lucrative sinecure at Citi. Now it turns out that Larry Summers has been doing consulting work for Citi; after a stint at the Fed, he could join the bank, just as his mentor Bob Rubin did. With Citi Alum Jack Lew already serving as Treasury Secretary, U.S. macro policy would virtually become a Citi subsidiary.
A Divisive, Disruptive Confirmation A third of Senate Democrats and 62 female House Democrats signed letters to Obama supporting Janet Yellen. Given his close ties to Citigroup and to Obama’s failed stimulus plan, nearly all Republicans will oppose Summers. A Democrat operative told The Washington Post, “Given the level of opposition to Larry Summers within our caucus, confirming him would be a huge challenge and probably a pretty ugly process.”
Tapering Raises the Risks Putting Larry in charge would be particularly risky now, when the Fed is undertaking the delicate operation of reducing “Quantitative Easing,” or monthly $85 billion purchases of bonds. The mere suggestion of “tapering” these purchases has boosted Treasury bond yields dramatically, in turn driving down the currencies and stock markets of developing nations.
White House Experience Is Irrelevant: Because the Fed is supposed to be totally separate from the White House, Summers’ experience as economic advisor to Obama in 2009 and 2010 is largely irrelevant. Arguably it is negative because it reduces the perceived independence of the Fed.
Hubristic Imprudence Summers is prone to ahistorical analytical hubris leading to imprudent decisions and judgments. At Harvard he reportedly battled the head of Harvard’s endowment, Jack Meyer, because Summers wanted to take the fund’s entire transactional cash balance and invest it in illiquid long-term investments. Bad call. The “Checkbook Fund” lost $1.8 billion in a single year. And Harvard was rocked by a severe liquidity crisis in 2008 when it had to post collateral with Wall Street banks for interest rate swaps, entered into while Summers was President. Harvard literally had to borrow in the middle of a financial panic to meet payroll. Summers also naively underestimated the financial risks created by derivatives, hedge funds, over-levered banks, and skewed incentives for Wall Street executives. Commenting in 2005 on a prescient paper by Raghuram Rajan highlighting these risks, Summers called the paper “slightly luddite.”
Great Call, Janet In contrast to Summers, Janet Yellen was quite early in recognizing the huge economic risks posed by sub-prime mortgages. By the Spring of 2007 her staff was already studying the problem. In late June, 2007, she told the FOMC:
“In terms of the growth outlook, I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst. Indeed, the repercussions of falling house prices are already playing out in some areas where past price rises were especially rapid and subprime lending soared. For example, in the Sacramento metropolitan area east of San Francisco. . . . Research by my staff examining metropolitan areas across the country indicates that the experience of Sacramento reflects a more general pattern. They found that low rates of house price appreciation, and especially house price decelerations, are associated with increases in delinquency rates even after controlling for local economic conditions such as employment growth and the unemployment rate. One possible explanation for these findings is that subprime borrowers, especially those with very low equity stakes, have less incentive to keep their mortgages current when housing no longer seems an attractive investment, either because prices have decelerated sharply or interest rates have risen. These results highlight the potential risks that rising defaults in subprime could spread to other sectors of the mortgage market and could trigger a vicious cycle in which a further deceleration in house prices increases foreclosures, in turn exacerbating downside price movements.
Copyright Thomas Doerflinger 2013. All Rights Reserved.