Bernanke

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The Federal Reserve Board

The central role of the Fed has put it top of many people’s agenda’s as either a heroic bastion against the disasters wrought by the big private banks, or as the epicenter of all that is evil in the tangled world of oligopolistic big money.

The truth is somewhere in the middle.

I don’t want to re-hash my views on the Fed too much, but allow me to call attention to an awful article in the Huffington Post by way of demonstrating how difficult it must be to be a central banker – no one likes you.

The central argument of the HuffPo piece is that the Fed, by virtue of its patronage and power has effectively captured and molded the economics profession in its own ‘big money’ image. This is supposed, I think, to be a commentary to elaborate on Paul Krugman’s excellent New York Times article over the weekend. Krugman asks rhetorically: what happened to economics? And this very thin piece by the HuffPo is supposed – presumably – to further the discussion.

Except it fails miserably.

The truth is exactly the other way around. Which is what any sensible reading of Krugman would have led you to conclude.

Still I imagine it is always more easy to roll out yet more populist anti-establishment drivel than it is to think through and come up with a constructive comment.

The fact as I see it is this: economics as a serious academic body of thought has wandered way off track. Most of the major work of the past few decades, including much of that for which Nobel prizes have been awarded, is lamentably irrelevant to the furtherance of our understanding of real world economies. That we have known this for some time, and that a debate has been simmering within the profession for decades was largely and understandably unknown to the public at large.

Who knew? Well economists knew. Or at least some of them.

The point is that we have known for years that the models used to shape economic policy are so abstracted from reality that their usefulness has been eroded practically to zero. Unfortunately they are also what is taught in all the major universities. It is simply not possible to build a solid reputation within economics unless you subscribe to the central dogma. And it is this dogma that the HuffPo article argues flows from the Fed. It does not. It flows from academia into the Fed. The causation is reversed from that described in HuffPo.

That this is so makes for a much different article. In fact it makes for the kind of article Krugman wrote.

The key public policy issues we face in finance and economics are not driven by an attempt by the Fed to dictate economic thinking; but by the fact that our central economic theories are screwed up.

None of this exonerates the Fed. As a center for applying economics it should have been more open to non-traditional ideas. It, like Wall Street, was captured by ‘free market’ theories. This was most evident in Greenspan’s era, but it carried over under Bernanke’s rule too. It took the crisis to highlight to the economics elite that they were off track – they would still be adhering to a deregulatory free market viewpoint were it not for the recession. In many ways they still subscribe to the old theories. Why? Because, as Krugman tells us, there are no fully formed alternatives. We are learning on the fly.

The good news is that the Fed staff is sufficiently intelligent that they were able to kluge together a response to the crisis that has worked so far. We are not done yet – we need a good exit strategy – but the signs so far give me confidence that the Fed can perform that task as well.

Now, I don’t want to go too far in defending the Fed. I think they have been deplorable in the commitment of their regulatory duties. They are so steeped in central banking that the details of regulation sometimes [always?] take a secondary place on the agenda. People like Bernanke understand, roughly, how an economy works at the high level of macroeconomic policy, but they are far less certain about the organization and governance issues that affect the day-to-day execution of banking. This is the only plausible explanation I can give for the mess the banks were allowed to make of the derivatives market. There seems to be little or no public purpose served by much of the fancy finance that goes on in the Wall Street trading rooms: big profits are made, big bonuses are generated, but at enormous risk and in, ultimately, anti-social ways. So why was it permitted?

If we assume, as I think it is safe to do, that the objective of the banking system is to allocate capital across the economy in efficient ways such that growth is encouraged and supported, then the primary purpose of regulation is to ensure that task occurs as flawlessly and at as low a social cost as possible. Financial innovation is meant to help this allocation of capital become even more efficient. And by efficient I think we mean less expensive and at lower risk. If these are the two primary markers of success, then modern finance, economics, and thus the regulatory framework has failed as about as abysmally as it could. We have just plunged the entire world into a near depression, tens of millions of people worldwide have lost their jobs, and we have burdened ourselves with trillions of dollars of debt precisely because Wall Street and its regulators fouled up. Someone should be accountable for that. I think the Fed is right at the heart of the problem.

It is one thing to be applauded for taking the steps needed to right the ship, it is another to avoid owning up to the fact that it was you who nearly sank it to start with.

So as we look forward to financial reform – which is now bubbling to the surface again as a top agenda item – I, for one, would feel a lot safer and better about the future were the Fed to be restricted to banking and left out of a revamped regulatory structure.

The entire banking industry is operating, still, a failed business model. That will change as the clean up proceeds and regulators enforce higher and better quality capital standards. We need a regulatory system untainted by rotten theory and distanced from the banks. Right now the Fed is neither of these things.

Which brings me back to that awful HuffPo article: it argues the Fed has too much clout in economics. My take is that the Fed caved too easily to the fanciful dreamlike theories peddled by the likes of Lucas, Fama, and Prescott. Had it been a bastion of practical banking, the way I envisage it should be, it could have pushed back against those utopian models and injected a sense of reality. In other words it would have been good for the Fed to dictate economic thinking as long as it wasn’t what was being taught out there in Chicago!

If we are to break the stranglehold of mythical free market economics a good place to start would be the Fed. Will we see that? I doubt it. As Krugman indicates, economic theory is now in crisis. We have exposed the ‘flat earthers’ as clinging to a foolish argument, but have yet to discover a good alternative. Meanwhile the Fed needs to act. So what does it use? Whatever ad hoc stuff it can lay its hands on. That doesn’t give me much confidence, but it would have provided a much better story than the nonsense HuffPo posted this morning.

My solution? Get the Fed to focus on central banking and monetary policy. Recent experience tells me it has a lot to learn and an equally large task ahead to steer us clear of any new bubbles that may be forming on the back of our massively re-liquified economy. Leave bashing the banks – and I mean bashing in the harshest sense – to someone better equipped.

And ignore HuffPo.

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Bernanke Part 2?

Obama’s decision to re-appoint Ben Bernanke as Federal Reserve Board Chairman has stirred up the dust on Wall Street. Opinions vary wildly over whether it is a sound choice. The single point of agreement appears to be the unanimous idea that this is a very significant moment in the history of the Fed and the economy, so whoever gets the job is an equally significant player on the world stage.

My view?

Mediocre decision. I would have preferred a change, but my problem has been to think of a solid alternative acceptable to a wide audience. There are a few names tat spring to mind -Yellen and Geithner being amongst them – but each has potential issues that could marshall opposition. I don’t like it, but Bernanke is going to get a second shot at the job.

He wins by default.

That’s not a good position to find ourselves in.

The central problem is that academic economists are , by and large, incapable of doing practical things like running central banks. Plus most, if not all, of them are tainted by their adherence to the theories that got us into this mess. Bernanke himself, of course, was an academic, which is one reason why he failed so obviously at the task of spotting and proactively dealing with the housing bubble.

Let’s take a look more closely at how to evaluate Bernanke.

It seems to me that there are three major criteria to look at:

  1. His performance in the run up to the crisis.
  2. His performance during the crisis.
  3. His performance as a regulator.

The first two are central banker type issues and obviously the third is regulatory.

In terms of the run up:

I just don’t see how that Bernanke gets a high grade here. He was absolutely part of the problem. He is ideologically committed to the libertarian ‘market-knows-best’ philosophy that led both he and Alan Greenspan to ignore the build up in asset prices. He failed lamentably to control the excesses of the American economy in the face of the glut of money flowing in from abroad. On the contrary he became a leading advocate of the ‘savings glut’ theory that the bubble was a result of ‘excess’ foreign savings coming to America to find a happy and risk free home. Consequently he saw that inflow of speculative cash as a sign of America’s strength not as a signal to rein in profligate debt riddled habits. A worse decision could not have been made.

So in the run up to crisis Bernanke failed at every test. He is schooled in, and continues to advocate, the very theory that failed us. I have yet to see his admission of this failure. I doubt whether we will ever see it. He remains a committed bubble denier. Better yet we should think of him as a bubble blower.

Next, the crisis itself.

Having helped create the mess it was only fitting that Bernanke found himself at the epicenter of the crisis not just in having to deal with extreme monetary policy problems, but also as a regulator and central banker. The Lehman and AIG crises stressed the capability of the Fed to the extreme. That they appear to have been shambolic, to put it mildly, when viewed with hindsight is not exclusively Bernanke’s fault. The US has a fractured and deliberately antiquated regulatory system that has its roots in the 1930’s and still reflects the state of finance back then. One of the great legacies of the Reagan/Bush era is the deliberate underfunding and near abandonment of our regulatory framework – we should be grateful that it worked at all, which I think is due far more to the lower level functionaries than to its leadership. Nonetheless work it did. And the world’s financial markets did not implode totally. Bernanke sat at the table during most of those essential decision making moments, so we have to give him due credit for that.

But: his de-regulatory predilection surely cannot go unblamed. The fact that the regulatory system is so rickety is because influential people like Bernanke believe profoundly in the efficacy of market solutions. Regulation was seen as a hinderance. Perhaps he still harbors those ideological beliefs. If so he is completely disqualified from the job. Obama seems to be willing to take the chance that the worm has turned.

In terms of pure monetary policy I tip my hat to him. The Fed has employed an arsenal of monetary weapons never before deployed. The entire range of conventional and unconventional weapons has been used. The Fed’s balance sheet has been expanded to levels never seen before; the money base has been bloated beyond recognition; and interest rates – the ‘normal’ tool has been held extraordinarily low for a very long time. All this has created a fear of inflation down the road – which as you know I disregard as a current worry – and so Bernanke has sensibly started to lay the groundwork for a safe exit from these crisis driven measures. The Fed’s monetary policy response has been excellent, even though at times it seemed to be a follower rather than leader in innovation – The Bank of England gets the laurels in innovation, although that is a dubious honor – it managed to introduce enough measures on sufficient scale to stave off disaster.

Finally as to his regulatory credentials.

I have already signaled my objections here. Bernanke at heart is a de-regulatory person. His core ideas are all built around opening the financial world up to competition and thus innovation. He is blind both to the use and value of regulation. His record is terrible. The Fed stood idly by as the derivative market exploded into an other-worldly mess of intricate and valueless obscurely constructed deals that ultimately tore the economy down. That was on his watch. His continued view is that deregulation produces benefits that strengthen the economy by shifting or mitigating risk, or by adding value and opportunity for wealth creation. I would endorse that only in so far as the wealth being created was exclusively channeled to the pockets of bankers. The economy at large saw no benefit. On the contrary taxpayers are going to be paying off the debts of the ‘innovators’ for a very long time. All that innovation produced no substantial social benefit, and it came a huge and very real cost to the millions of people who are now unemployed because of the lax regulatory regime Bernanke presided over.

To cap this all off: in the proposed ‘reform’ of financial regulation the administration intends to hand the Fed even greater power, especially in its role as overseer of ‘systemic risk’. Bernanke is not capable of taking on this job. His education and predilection indicate that he is too far embedded in the system to understand it or to be able to withstand the inevitable pressure from the big bankers who will want to water down anything that might restrict their ability to amass personal fortunes. Bernanke is too weak for the role. He is too close to the big banks. So is practically everyone at the Fed, which is why I advocate the construction of an entirely new regulatory body to take on the systemic role.

Lastly: Bernanke actually is campaigning against the creation of a Consumer Protection Agency for finance. This is driven in part by turf wars – the Fed has done a very poor job at overseeing consumer protection so far; and by his ideological objection to all regulation. Neither of these sources of opposition give great comfort that Bernanke is equipped to be a regulator.

Having said all this I am forced to admit that there are few alternatives. Obama may simply be making the ‘best worst’ choice. It would be impossible, though a lot of fun, to appoint a consumer advocate like Robert Reich, but I imagine the bond market would melt down instantaneously. Krugman is intellectually superior but is enjoying life as it is and would be objected to by the big banks [which is a positive credential in my book]. And the rest are all colorless replicas of Bernanke himself: all schooled in the same ideas; all all deeply wedded to Wall Street; and all too immersed in macroeconomics to give the time of day to consumer advocacy.

So we end up making the safe play. Keeping the guy in the seat already. The markets will love that since they crave stability and the devil they know already. Monetary policy will be safe. Regulation will be a shambles. And the risk of another bubble will remain large on the horizon.

This is what comes from group think: lack of choice.

And group think is one of the main reasons we ruined our economy.

At least let’s all hope that Bernanke Part 2 is a lot more dull than Part 1 was. That will be a triumph.

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Astrological Economics: Just What is Bernanke’s Sign?

For a subject as dry and mathematically inclined as economics, at least in its orthodox version, the linkage between the real world an the merely imaginary is more tenuous than most laypeople would think.

This occurred to me today when I read an excellent letter in the Financial Times. In it an MIT lecturer talks about how limited the average person’s grasp of rational choice is. We are mostly quite irrational even though we often try to be very sensible in our decision making.

“Star charts are as useful in predicting asset price bubbles as orthodox theory. Why? Because at least an astrologer doesn’t doubt their existence.”

This is, of course, not news to any of us. That’s why many of us find it quite difficult to make decisions about even trivial aspects of life.

The so-called ‘Paradox of Choice’ is a good example. [See Barry Schwartz’s book] Economists theorize that giving consumers a myriad choices will, inevitably, produce the best result: the more choice, the more likely that a consumer will find something that exactly matches what they want.

But this flies in the face of our evolutionary roots. We are not cognitively equipped to get into finely grained decision making, where we are required to evaluate nuanced differences. We are it bit brutish in our thinking. We are equipped for simple and often binary decision making: the kind of on-the-fly type of thinking that primitive animals have to make in order to survive to live another day. So when confronted by a plethora of choices most of us simply freeze up and avoid making any choice at all.

A practical example of this is the supermarket. Researchers have shown that someone going to the supermarket with a specific purchase in mind – say toothpaste – will often turn around and leave if there are too many varieties, flavors and brands on the shelf. It is better, in other words, for the shelf to sport a quite limited choice. Sales will be higher and consumers happier.

Contrast this real world research finding with the assumption within free market economic theory that consumers are ‘perfectly rational’, and we can start to comprehend why economics is such a mess. It is more astrology than science.

The entire edifice of free market theory rests on the notion that you and I are supreme calculators. That we are not defeated by shelf loads of products, but that we are capable of feats of analysis, consciously or not, that allow us to arrive at extraordinarily precise decisions that inevitably lead us to maximize our welfare. We never make mistakes. Never.

Sound familiar?

No, I didn’t think so.

I realize it seems very dull, but I want to reiterate the importance of of this small example: our economic lives have been run for years by people who’s outlook on life is conditioned by, and depends upon, on exactly the theory derived from assumptions like that of ‘perfect rationality’.

Take away perfect rationality, and the superiority of markets, as opposed to, say, governments, as allocators of scarce resources crumbles. That means no one can ‘prove’ that markets left to their own devices will always outperform the government.

So the debate reverts to a political one.

Which is why it is urgent that economics recovers itself from the dead end it was driven into seventy years ago and abandons most of the thinking accumulated since then. It simply isn’t true. Worse: it leads to severely handicapped public policy making. It allows ideologues like Reagan and Bush to slam the government – which is their right from an ideological perspective – from within an aura of scientific discipline.

There are times when markets are terrible – sub-prime mortgages anyone?

Bubbles are common structure within capitalist economies. So are business firms. But both bubbles and firms cannot exist within the purity of orthodox economics. Perfection has no room for the messiness of either.

The Nobel prize winner Ronald Coase pointed out to his economics colleagues in 1937 that since business firms seem to be quite common the profession ought to re-consider its allegiance to perfection. Instead he was ignored for decades and only much later did a subculture sprang up inside the profession studying firms. But the textbooks remain pristine. Indeed the firm as an economic entity remains a curiosity and is ignored by most academics.

So too with bubbles. Visit most academic economist websites and you will find all sorts of opinions as to why bubbles cannot be predicted. Many will deny they exist – even now. This is because they are all so inculcated with the perfectionist view that they fail to see the real world. And rather than admit their subject has a big hole in it, they attempt to explain away the Emperor’s nakedness by resorting to all sorts of arcane and highly jargon laden reasoning.

Economists have even begun to argue that their inability to reject a negative argument against their own theory is sufficient to justify its continued existence. Think about that: they take the fact that they have nothing to say as support for a theory. This is hardly Popperian refutation. It is vacuous.

The fact remains that economists are faced with a choice: either their subject is failing to explain many very common economic structures; or it is akin to astrology.

There are hopeful signs: people like Robert Thaler, mentioned in the letter I referenced at the beginning of this post, are slowly chipping away at the outmoded and mechanistic thinking that supports the orthodox theory. But they have a very long way to go.

Meanwhile ideologues still latch onto the orthodox theory in order to justify their politically motivated views. Which affects all of us. The current debate about health care reform would be so much more sensible were it rooted in real world claims about the efficacy of markets rather than being supported by an orthodoxy that resembles the reading of star charts.

So too would the re-regulation of banking.

The relevance of economic theory has never been greater. That’s why it is fun to get involved in the debate. In large part, the crisis we are living through is a creation of orthodox theory. Which is why it’s protagonists are so vocal in their attempts to misdirect our attention: Robert Lucas, Martin Feldstein, Robert Barro, John Taylor, and many others are constantly popping up in the media to pull the wool over our eyes. Their common theme is that it is the government’s fault. Or, failing that, they throw their hands up and claim that no one, absolutely no one, could possibly have seen the crisis arising.

They protest too much.

Their economics is beautiful. Intricate. Intense. Intellectually fascinating. Difficult to master. Brilliantly conceived. And about as scientific as astrology.

Star charts are as useful in predicting asset price bubbles as orthodox theory. Why? Because at least an astrologer doesn’t doubt their existence.

So with respect to the discussion over whether Bernanke should be re-appointed as Fed chairman: only if he was born under a propitious sign. Turns out he’s either Sagittarius or Capricorn. It is quite obvious that the Fed has far too many of those already. Time for one of us more solid, some would say dull, Taureans?

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Muddle Over The Fed [Or How John Taylor Can’t Think Straight]

Today’s Financial Times has a couple of articles in it concerning the Federal Reserve Board and Ben Bernanke. The general thrust of each is to diffuse criticism of the Fed and to advocate it’s independence and the overall record of Bernanke himself. One piece is an editorial favoring Bernanke’s re-appointment as Fed chairman. The other is an op-ed by the well known economist John Taylor – he of the ‘Taylor Rule’ – arguing against expanding the Fed’s role as a regulator, and defending it’s role as ‘independent’ overseer of monetary policy.

It is this second piece that I want to address.

I was originally going to entitle this post something like: ‘John Taylor’s an Idiot’, but thought better of itbothout of deference to him, he has that rule named after him, and he teaches at Stanford, and because I didn’t think anyone reading my blog would know who he was.

Should you all care?

Yes: he is influential, and his views are a good reflection of the muddle that neo-classical economists can get themselves into when they want to defend their rotten theories from attack and, at the same time, deflect blame for the economic crisis away from those theories. Taylor often pops up with a right wing viewpoint, so he’s worth listening to in order to understand why our economic elite has so little to offer as we fumble our way out of the crisis.

So let’s get to his article.

He begins with a very ordinary argument against expanding the Fed’s powers as a regulator. I find myself in agreement with Taylor that the Fed should be highly limited. But when he slips into his patronizing justification that the government department’s are best forced to focus on limited objectives he let’s his orthodox slip show a tad too much. I get the feeling he’s thinking that those government employees are just too dumb to handle several tasks at once, unlike the heroes over at Citigroup, for instance. Hmmm. A bit of bias creeping in there Professor Taylor?

Then he goes on to argue for the Fed to be limited because extending its oversight remit would raise the risk – gasp – of political interference. And in neo-classical ideology nothing – and I mean nothing – can be worse than political interference. this is because we all absolutely ‘know’ that the government is always inefficient when compared with the smooth operation of the free market – right Professor Taylor?

So we want to remove politics from the Fed so as to sanitize it from the taint of government. That way it can take those hard decisions raise interest rates and prevent bubbles without having to worry about what the politicians think, or what would happen to those big banks it regulates.

Taylor is right: a Fed that has big ‘systemically important’ banks as it regulatory target might be more inclined to do things to help those banks avoid trouble – after all it will know what kind of mess they are in and it wouldn’t want to be blamed if one went belly up.

But this raises a conundrum for Taylor and all ideologues like him:

If the Fed is independent of government and thus making decisions based upon purely economic grounds – informed by standard economic theory no less – how do we all account for its recent performance?

Taylor does this by eliding straight into an attack on government.

The second part of his article talks about how the current crisis stems from a failure of government. He puts it succinctly::

“The financial crisis was caused in large part by government actions such as monetary authority that aggravated the housing boom.”

Let’s think this through rigorously rather than sloppily.

The housing boom was, according to Professor Taylor, abetted by lax government actions. Ergo to avoid future recurrences we need to slap government into shape rather tan extend its role by giving the Fed more oversight.

But Professor: is the Fed not independent of the government? Is it not your fear that the Fed might lose that independence? Have you not just spent half an article arguing that extending the Fed’s role would jeopardize that independence?

I think the Professor has his proverbials in a twist.

He has run plumb into the neo-classicists ideological trap.

Yes the Fed is proudly independent. Yes it would lose that independence were it to take on more regulatory responsibility. That is why I want to strip it of all regulatory responsibility.

But that’s the point Professor: it is and was independent. It has been since 1951, when as the Financial Times editorial points out the heavy hand of Treasury [i.e. government] meddling was cut away.

So: it was not ‘government actions’ that contributed to the financial crisis, was it? No not at all. It was the independent Fed under the leadership of Alan Greenspan and Ben Bernanke.

There you have it.

Taylor is playing the usual right-wing bait and switch game.

He is saying the Fed should remain independent because that suits his anti-government bias. But then he turns around and blames the government for the financial crisis. And the government agency he pins the blame on is the same Fed whose independence he lauded but two sentences previously.

Now the Professor is academically very rigorous no doubt – tainted by his ideology, but so are most academic economists – but he allows himself to be extraordinarily sloppy in this article. He surely wouldn’t give himself a very good grade.

So why does he commit his error?

Because there is something even more sinister than government interference in his mind: criticism of orthodox economic theory.

It turns out that the independent Fed executed flawlessly along the lines expected by textbook theory. And thereby contributed mightily to the crisis.

So the good Professor is trapped into defending the Fed as independent when it works well, and then contradicting himself and labeling it as a government agency when it screws up.

How rigorous!

How non-scientific!

How totally political!

How ideological!

That’s textbook economics for you.

No wonder economists are the subject of ridicule.

A true scientist -something Taylor evidently is not – would look at the evidence and reformulate his hypothesis in the light of revealed facts. Not those neo-classicists! No. They reformulate the facts in order to preserve their hallowed theories.

Elsewhere in the FT another columnist – Tony Jackson – calls out the neo-classicists. He relates the story of Robert Schiller – a renegade in economics – getting a cold reception at an economics seminar when he used the word ‘bubble’. Schiller says that word was received like talk of zodiac signs at a meeting of astronomers. For those of you who don’t realize it: there can be no bubbles in a neo-classical world. The market is always correct in its valuations no matter how erratic or absurd.

It is that level of denial that allows Taylor to double talk in his article.

Back on planet earth, and away from the world Taylor and his ilk inhabit, it is the neo-classicists who are the astrologers.

Ben Bernanke as palm reader-in-chief. Now that has a ring to it.

Addendum:

More bad news for the Professor. Here’s a quote from the Wikipedia entry that describes the ‘Taylor Rule’ – a piece of economic thinking that the Professor is no doubt proud of:

“Although the Fed does not explicitly follow the rule, many analyses show that the rule does a fairly accurate job of describing how US monetary policy actually was conducted earlier under Alan Greenspan“

Hmmmm.

The Fed clearly followed the Taylor Rule during the Greenspan era. Right when the Professor claims that the Fed, qua government agency, was contributing to the financial crisis.

Now we’ve got him.

Apparently it was the Taylor Rule that contributed to the financial crisis.

Ouch!

That’s got to hurt.

No wonder he’s muddled about the Fed. They use his rule, and drive the ship onto the rocks. Oops. No wonder he’s angry at them.

Maybe it’s a different Taylor?

Nope. Sorry Professor: you’re part of the problem.

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Bernanke Watch?

There seems to be quite a cloud of dust being kicked up over a number of concurrent and intertwined themes concerning the Federal Reserve Board: there are matters of its secrecy, its competence, its role in the future of bank regulation and now also its management. Simultaneously as we head into Fall we will be caught up in the debate about how to re-regulate the banking sector.

At the center of all this is Ben Bernanke the Fed Chairman who’s term in that role expires in January.

Let’s pick this all apart to get some perspective:

  1. I agree with Joe Stiglitz that we should have a healthy debate about whether to re-appoint Bernanke. The point being that among the issues we need most strongly to confront is that the crisis underlined the extraordinary ‘group think’ endemic throughout our financial elite, whether they are in the banks or in the regulators or academia. Bernanke is very representative of this group think – which relies far too much on so-called market forces and not enough on regulation. It would be healthy to open up our thought processes, and having a different Fed chairman would signal that intent.
  2. That raises the obvious problem: given group think is there a candidate of sufficient caliber not cut from the ‘market knows everything’ mould? And therein lies the rub. No one leaps off the page as being qualified, except for Janet Yellen out in San Fransisco. Given some of her recent speeches I am sure she’d cause quite a few raised eyebrows as Fed Chairwoman.
  3. On the contrary side: I would oppose Larry Summers. He’s a very bright guy, but is absolutely and resolutely a Wall Street buddy. He just doesn’t seem able, yet at any rate, to get the point about how dangerous the big banks have become. They own us. That has to stop. They profiteer at our expense. That has to stop. They are behaving in an anti-social manner. That has to stop. They used our money to pay out dividends and bonuses. That has to stop. In all these confrontations Summers hasn’t been able to muster the courage to oppose the big banks. Either he isn’t strong enough, or he is on their side. Both conditions make him a bad Fed chairman.
  4. Geithner would be worse. He’s a Wall Street fan. He seems very vocal about reform, but he is far too aligned with big banking and that group think.
  5. As for the Fed itself. It needs to be reformed. Those who want a close Congressional control are ignoring the value of independence. All the evidence suggests the economy will benefit from an independent central bank. So monetary policy and its market manifestations such as the discount window operations etc need to be kept away from the natural tendency of politicians to favor inflation as a cure all for excess.
  6. Having said that the Fed made a meal of regulation. It should give up its regulatory role in favor of a focus on monetary policy. I doubt this will happen given Bernanke’s and Geithner’s efforts to make the Fed the center of our new ‘systemic’ regulatory regime. There may be organizations less well equipped for that role, but they don’t spring readily to mind.
  7. More broadly: our entire regulatory set up needs an overall to rid it of ‘regulatory capture’. We need to refresh the independence and solidarity of the regulatory system so it cannot be ‘gamed’ by bankers moving themselves from one part of the system to another to get a softer regime. Frankly the rabbit’s warren of regulatory bodies needs total trashing and replacement with a new set – maybe even just one organization – that has to manpower and clout to resist Wall Street. The current set up is antiquated and embarrassing and works only to the advantage of the bankers. The bureaucratic infighting has broken out into the public domain as the various regulators defend their turf. Hey guys: none of you succeeded in preventing the crisis. So let’s have less bashing each other and more conversation about what the new regime will look like.
  8. Going back to Bernanke: I do not see a role for him in such a comprehensive arrangement as a regulator. But his record as a central banker would suggest he could stay at a trimmed down Fed.

Meanwhile: critics of the Fed would be better advised to focus on the arcane and outmoded way the Fed is run, rather than on auditing its success. The current Fed system is skewed towards an economic reality circa 1913: it is comprised of member banks representing areas of the country that were far more important a century – the farm belt is too influential and California is underrepresented. Plus the member banks are run by people well tied to local banking. Which means that the New York Fed is essentially a Wall Street annex: its current boss is a Goldman guy. It is the presence of these banker ties that destroys any vestige of true independence that the Fed may have vis a vis regulation. It is not uncommon for employees to move from the Fed to a bank and then back again during the course a career. That’s acceptable, even to be encouraged, for central bankers. Not so much for regulators.

Finally on auditing the Fed: I think this idea is simply political grandstanding. On what basis would an audit be conducted? and against what criteria would the Fed be ‘scored’? The whole concept seems dumb. We are better off getting a new regulatory regime in place rather than in wasting time chasing down opinions over whether the Fed gets through an audit well.

Meanwhile the Bernanke watch heats up.

My vote?

Kick him out if the Fed stays substantially unaltered. Keep him if it is reduced to more of a central bank and less of a regulator.

Addendum:

Dean Baker chimes in and is much less flattering than I have been.

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