Which Candidate Has What it Takes to Fill Bernanke’s Shoes?

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Ben Bernanke’s tenure as Chairman of the U.S. Federal Reserve has been — to put it lightly — controversial. When he assumed office in February of 2006 — appointed by President George W. Bush — the mechanism of catastrophic financial collapse was already in motion, and his response to the ensuing crisis will likely dominate his legacy as the nation’s top monetary policymaker and financial regulator.

As the financial sector toppled like a Jenga tower between 2007 and 2009, Bernanke helped orchestrate a new paradigm for financial regulation and set new precedent for the use of unconventional monetary policy. The details of his decision-making have earned him a mixed reputation. Advocates argue that the accomodative policy championed by Bernanke over the past half-decade has been critical for U.S. economic growth, and without it the nation might still be stuck in the ditch of recession. On the other hand, critics have argued that the Fed’s easy money has actually led to financial instability, incentivized risk-taking, and provided fuel for asset bubbles.

But whatever the case — whether history lionizes or demonizes him — Bernanke will leave the next Fed chairman with the keys to a car that has been totally retrofitted and souped up to deal with the unique challenges of a financially dense global economy. The new Fed has a lot more horsepower than it did in 2006 and comes with a $3.5 trillion balance sheet in tow.

So who will get to drive this sweet new machine? Word on the street is that President Barack Obama has narrowed the field of candidates to three people: former economic policy adviser Lawrence Summers, current Fed Vice Chair Janet Yellen, and former Fed Vice Chair Donald Kohn.

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Donald Kohn

Kohn, born in 1942, is a Democrat. He received a B.A. in economics from the College of Wooster in 1964 and a Ph.D. in the subject from the University of Michigan in 1971. He began his long central banking career at the Federal Reserve Bank of Kansas City in 1970 as a financial economist, and moved through the system over the next few decades until President George W. Bush nominated him Vice Chairman of the Federal Reserve in 2006, a position he held until 2010.

Monetary Policy

Kohn is considered by most to be a moderate dove, and as such could be a chairman who champions employment-focused policy at a time when America desperately needs to heal its labor market.

However, monetary policy has been accomodative for much of the post-crisis era and policymakers have suggested that the short-term nature of monetary stimulus has run its course. Monetary action can do little, if any more, to help the employment situation in America. After years of having a dove at the helm (Bernanke), many market participants seem keen on getting a hawk in office.

Financial Regulation

Kohn took office just before the financial crisis knocked the American economy to its knees. The effect of the crisis on Fed thinking in general has been visceral, and economic historians can read the evolution of the Fed’s posture toward financial regulation from Kohn’s comments the same way a dendrochronologist can read changes in environment from tree rings.

Speaking in 2005, shortly before he assumed the position of vice chair, Kohn articulated a posture toward financial regulation championed by then-chairman Alan Greenspan.

“Private parties, left entirely to their own devices, do not always produce a market structure and market relationships consistent with adequate protection of financial stability. However, the actions of private parties to protect themselves–what Chairman Greenspan has called private regulation–are generally quite effective. Government regulation risks undermining private regulation and financial stability itself by distorting incentives through moral hazard and by promising a more effective role in promoting financial stability than it can deliver.”

In hindsight it’s easy to call his comment on the general effectiveness of private regulation into question. But his position — guarded, though ultimately trusting — was widely held by many, if not most, prominent economists at the time. The late 2000s financial crisis edited, but did not obliterate, this type of thinking.

Commenting in 2009 while still vice chair, Kohn pointed out that the financial crisis was a global phenomenon.

“Although financial institutions in some countries seemed to be more resilient to the growing turmoil than in other countries, all were affected to a degree, and no particular type of regulatory or supervisory system proved itself clearly superior to other designs–either in the buildup or the crisis-response phase. Problems afflicted both the fragmented system of the United States and the unified systems of other countries. They cropped up where the central bank was deeply involved in regulation and where it played only a consultative role. And it occurred both in systems that were principles-based and those that had thick rule books. Clearly, the deficiencies in both private behavior and public oversight were widespread, and both needed to be addressed.”

And address these deficiencies he did. Kohn served as Bernanke’s right hand in the wake of the financial crisis and has helped define the Fed’s renewed focus on financial regulation. His experience suggests that while he understands the need for enhanced prudential standards, he also understands the natural efficiency of a certain degree of self-regulation.

Janet Yellen

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Janet Yellen

Yellen, born in 1946, is a Democrat. She received a degree in economics from Brown University in 1967, and in 1971 received a Ph.D. in the subject from Yale University. She taught at Harvard for about five years before her first engagement with the Federal Reserve in 1977 and 1978.

She spent the next two decades in various positions at the Haas School of Business, the London School of Economics, and UC Berkeley before really aligning herself toward the Federal Reserve System. She served as President of the San Francisco Federal Reserve Bank for six years before becoming Fed Vice Chair.

Monetary Policy

Like Kohn, Yellen is considered by many to be something of a dove. However, more than anything, Yellen is a diligent economist and has demonstrated during her time in the Fed system that she pursues ideas based on facts, and not ideology. While current policy is more accomodative than hawks would like, and Yellen has had a strong hand in helping develop the framework and direction of that policy, she seems unlikely to fail to address inflation concerns.

However, a comment from Yellen’s past — 1995, when she was a member of the Board of Governors — has come back as a sort of ghost recently.

During a policy discussion meeting held by then-Chairman Alan Greenspan, Yellen argued against inflation targeting as a policy tool and made this now-infamous statement:

“Fortunately, the goals of price stability and output stability are often in harmony, but when the goals conflict and it comes to calling for tough trade-offs, to me, a wise and humane policy is occasionally to let inflation rise even when inflation is running above target…

When I look at the behavior of the FOMC and other central banks, I simply can’t find a lot of cases in which monetary policy has ever been driven by an exclusive focus on inflation performance.”

For those who want a hawk at the head of the Fed, this comment was punctuated by the sound of nails being hammered into a coffin.

On a side note, The Wall Street Journal recently examined economic predictions made by Fed policymakers between 2009 and 2012 and ranked them based on accuracy. True to her reputation as a level-headed economist, Yellen took the top spot for overall accuracy.

Financial Regulation

As vice chair since 2010, Yellen has played an instrumental role in the evolution of the Fed’s role as a financial regulator. She has helped create a framework for financial regulation — much of which is tied up in advancing the Fed’s capacity to gather information, as with the establishment of the Office of Financial Stability Policy and Research — and has helped oversee the implementation of the Dodd-Frank Act.

Speaking in June 2013 at the International Monetary Conference in Shanghai, Yellen offered a “brief retrospective on financial regulatory progress” since 2008. In it, she outlined the new framework she helped build and identified where there was work to be done.

“Although we have made the financial system safer, important work remains in each of the three areas I have highlighted: the basic bank regulatory apparatus, addressing the problems posed by SIFIs, and limiting risks in shadow banking and financial markets,” she commented.

Lawrence SummersLARRY SUMMERS

Summers, born in 1954, is a Democrat. He earned a degree in economics from the Massachusetts Institute of Technology in 1975 and earned a Ph.D. from Harvard University in 1982. That Summers is one of the mad geniuses trolling the upper echelons of the government is something that even critics admit — he became a tenured Harvard professor at 28 and has a thick portfolio of compelling academic papers.

Those who have worked with Summers have lauded him for his brilliance, but not for his personality. Reports from nearly every position Summers has held indicate that he is hard to work with, sometimes dismissive of ideas and people, and can be rhetorically combative.

As an economist, he is perhaps most well known for serving as the Treasury Secretary under President Bill Clinton from July 1999 to January 2001. He also served as Director of President Obama’s Economic Council in 2009-10, where he quickly earned the respect of the president.

Monetary Policy

Understandably, Summers’s thinking on monetary policy is more opaque than that of Kohn or Yellen, who both have had careers as central bankers. This alone — the fact that Summers would pretty much be a Fed ‘newbie’ — has been a major part of the conversation surrounding his candidacy for chairman. While there’s little doubt that he could bring fresh ideas, sharp thinking, and a certain “can do” attitude to the position, the Fed chairmanship is not necessarily a position for a maverick.

Summers wrote an article for Reuters in 2012 that touched on both monetary and fiscal policy, a type of thinking that is more consistent with his experience than strictly monetary concerns.

“There is also an oddity in this renewed emphasis on quantitative easing. The essential aim of such policies is to shorten the debt held by the public or issued by the consolidated public sector comprising both the government and central bank. Any rational chief financial officer in the private sector would see this as a moment to extend debt maturities and lock in low rates – exactly the opposite of what central banks are doing. In the U.S. Treasury, for example, discussions of debt-management policy have had exactly this emphasis. But the Treasury does not alone control the maturity of debt when the central bank is active in all debt markets.”

He went on to suggest that, “Any rational business leader would use a moment like this to term out its debt. Governments in the industrialized world should do so too.”

Financial Regulation

Like Kohn — and pretty much everybody else, for that matter — Summers’s stance on the regulation of the financial industry has evolved over the course of the late 2000s financial crisis. But with this in mind, one of Summers’s most iconic encounters with the world of financial regulation had to do with the Gramm-Leach-Bliley, which many argue was a contributor to the financial crisis.

Commenting on the issue in 2009, Arianna Huffington described Summers as “one of the top economic minds of his generation,” but added that “his core beliefs and assumptions helped lay the groundwork for the current crisis.”

Huffington explained:

“As Treasury Secretary under Clinton, Summers played an important role in convincing Congress in 1999 to pass the Gramm-Leach-Bliley Act, which repealed key portions of the Glass-Steagall Act and allowed commercial banks to get into the mortgage-backed securities and collateralized debt obligations game. The measure also created an oversight disaster, with supervision of banking conglomerates split among a host of different government agencies — agencies that often failed to let each other know what they were doing and what they were uncovering.”

The Glass-Steagall Act refers to provisions in the Banking Act of 1933 that put a wall between commercial and investment banking. This limited securities trading activity and ostensibly barred banks from trading the types of financial products that were instrumental in the financial collapse. The repeal of these provisions has been cited a a direct contributor to the crisis.

But Summers also has a reputation for calling it like he sees it. During his time working for the Obama Administration he earned a reputation for being extremely tough on big banks during regulatory discussions. He reportedly suggested that the accounting methods at big banks was borderline fraudulent — something he knew, perhaps, because he is a consultant for Citigroup (NYSE:C). This last fact has some critics claiming he is in the pocket of Wall Street.

So, who is it?

Summers has emerged as the apparent favorite of President Obama himself. Summers has earned the president’s respect despite his thorny personality and many regard him as the type of person who could respond well to any new crisis, should one emerge. The downside of this pick is that Summers has pretty much no central banking experience.

On the other hand, Yellen seems to be a crowd favorite because of her extensive experience at the Fed and her reputation as a rigorous — although sometimes soft-spoken — economist. A number of congressional Democrats have signed a petition advocating on her behalf.

Kohn seems to have fallen into the background against the celebrity of Yellen and Summers. Although he is by all means a strong candidate, he appears to be outgunned by Yellen’s reputation and Summers’s personality.

Obama could make an announcement about his choice as early as August, but Bernanke is not due to leave office until January 31, 2014. If Obama neglects to make an announcement before then, then Yellen automatically assumes the office.

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