Dammit Janet, I love you!*

I am very pleased with the president’s nomination of Janet Yellen to be the next Federal Reserve Chair. Ms. Yellen has impeccable credentials, the best economic forecasting record of any recent Fed official, and appears to take the regulator part of the Fed Chair job seriously.

This last part is important. Larry Summers, the original front-runner for the job, helped push through the key deregulation of the late Clinton years, has dismissed the idea that it contributed to the bubble or crash, and has basically never admitted a mistake in this area. Alan Greenspan was essentially hostile to financial regulation, and bears as much responsibility as anyone for the housing bubble of the 2000s. Ben Bernanke has acknowledged that the Fed failed as a regulator during the housing bubble, but he was a Fed governor for most of that bubble and Chair for the last two years of it. Economist Bill Black finds Bernanke to have been sorely lacking as a regulator. The Fed’s main regulatory task is to try to detect and reduce systemic risk, i.e., risky activities that threaten the larger financial system and economy. Granted, Yellen told the Financial Crisis Inquiry Commission in 2010 that she failed to see several of those risks (securitization, credit rating agencies, Special Investment Vehicles) when she was San Francisco Fed President in 2004-2010, but on the other hand she was among the first at the Fed to publicly call attention to the housing bubble

Granted, monetary policy, not financial regulation, is the main part of the job. I agree with those who have said she will probably be very similar to Bernanke as far as that goes, and I’d call that a good thing. The Fed needs to do what it can to pull us out of this Little Depression, and since interest rates cannot fall below zero, additional measures like buying long-term bonds and mortgage-backed securities (i.e., quantitative easing, or QE) make sense, as long as they work. Yellen is often stereotyped as a “dove” because in recent years she favored expansionary policy and did not state that inflation was an imminent risk, but those recent years were the Little Depression that began in 2008. When unemployment is not the nation’s biggest problem, Yellen is more concerned about inflation. Such as in the roaring 1990s, when Yellen was Clinton’s Chair of the Council of Economic Advisers and then a Fed governor. With unemployment down to its lowest levels in decades, Yellen was an inflation “hawk,” as Matthew O’Brien details.

Whether the Senate is capable of that much nuance as it considers her nomination remains to be seen. I expect she’ll win majority support, including a handful of Republicans, and that Republicans will resist the temptation to filibuster her nomination. The right-leaning American Enterprise Institute offers several reasons why an anti-Yellen filibuster would be a disaster. Then again, flirting with disaster seems to be the Congressional Republicans’ game plan of late.

PS Here is a recent (Nov 2012) interview with Janet Yellen.

* Title stolen from EconoMonitor, who of course got it from Rocky Horror:

Monetary policy IS currency manipulation

Everyone from the Chinese to Alan Greenspan is slamming the Fed’s new round of longer-term bond purchases (QE2) as a back-door plot to weaken the dollar. The logic is that the bond purchases should lower interest rates, thereby lowering the demand for dollars and causing the dollar’s price to fall, thereby raising U.S. net exports. That much is true, but it leaves one thing out:

That’s exactly how expansionary monetary policy is supposed to work!

It’s even in a lot of macroeconomics principles textbooks:  When the Fed lowers interest rates, the lower rates are supposed to raise GDP by spurring household consumption and business investment (that much is in every principles textbook) and secondarily by lowering the demand for U.S. bonds, thus lowering the demand for dollars and weakening the dollar, thus raising U.S. exports and lowering our imports.  This effect is sketchier than the effects on consumption and investment, since net exports are very volatile and do not respond quickly to changes in exchange rates, but it is there.

So why exactly is it currency manipulation when it’s part of QE2 (which is only expected to reduce interest rates by about 20 basis points and so far has actually seemed to raise them a bit, due to inflationary expectations and the Fed’s surprise decision to concentrate its purchases on medium- rather than long-term bonds) but not when it’s part of the Fed’s zero-federal-funds-rate policy?  I’m thinking the selective outrage might have something to do with President Obama’s meetings with Asian and G-20 leaders this week.  The Chinese are happy to grasp at this new straw in order to deflect attention from their more blatant attempts to keep the yuan low, the Europeans are seeking some company for their draconian budget-slashing misery, and Greenspan is bandwagon-jumping as usual.

P.S.  Although I think this particular criticism of QE2 is bogus, I am against QE2 for a host of other reasons, which I’ll get to in another post sometime.

Too big, too bad, too late: Greenspan speaks

Simon Johnson has yet another fine post on the need to break up the biggest banks, for the sake of financial stability.  Unfortunately, he notes, it looks like it ain’t gonna happen, that the SAFE Banking Act sponsored by Sens. Sherrod Brown (D-OH) and Ted Kaufman (D-DE) won’t make it anywhere near the Senate floor.*

The post includes a remarkable quote by Alan Greenspan, who now seems to get it:

“For years the Federal Reserve had been concerned about the ever larger size of our financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. A decade ago, citing such evidence, I noted that ‘megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.’ Regrettably, we did little to address the problem.”

Now, Greenspan is a bit like the Bible, Shakespeare, or Adam Smith — comb through all his words and you can probably find something to support your position, whatever it is.  But it is striking that he acknowledges the lack of economies of scale brought by big banks and their potential for systemic damage.  His regret at not addressing the problem would be more constructive if he could find a concrete proposal to support, like Sen. Kaufman’s bill, for example.  (I’m reminded of the old quote A little knowledge that acts is worth infinitely more than much knowledge that is idle.)

* Update:  The Brown-Kaufman SAFE Banking Amendment did make it to the Senate floor on May 6, but it was voted down, 33-61.  The roll call vote is here.  About two-thirds of Democrats voted for it, along with three Republicans.  Among the Democrats voting No were Senate Banking Committee Chairman Christopher Dodd and New York’s Chuck Schumer and Kirsten Gillibrand.

Big swinging deregulators

” ‘As Treasury secretary starting in 1999, [Larry Summers] shepherded a couple of bills that helped deregulate financial markets, and he has made it clear that he doesn’t buy the notion that these laws caused the financial crisis.” — David Leonhardt, New York Times, 25 November 2008 (more here)

In this weekend’s NYT Magazine, Summers’ old boss, Bill Clinton, takes full responsibility for the failure to regulate credit derivatives, those most opaque and easily abused of financial instruments.  We already knew that Summers, his predecessor Robert Rubin, and Fed Chairman Alan Greenspan backed the blanket exemption of credit derivatives from regulation.  What we did not know until this week, however, was just how much they regarded financial deregulation as a holy sacrament.  (OK, so we did know that about “Alan Shrugged” Greenspan.)

A Washington Post feature on Brooksley Born, the head of the Commodity Futures Trading Commission at the time, makes this plain.  In 1998 Born wrote a “concept paper” pondering the possible merits of derivatives regulation, prompting a circling of the wagons by Summers, Rubin, Greenspan, and Securities and Exchange Commission chairman Arthur Levitt:

‘In early 1998, Born’s plan to release her concept paper was turning into a showdown. Financial industry executives howled, streaming into her office to try to talk her out of it. Summers, then the deputy Treasury secretary, mounted a campaign against it, CFTC officials recalled.

‘”Larry Summers expressed himself several times, very strongly, that this was something we should back down from,” [Born aide Daniel] Waldman recalled.

‘In one call, Summers said, “I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II,” recounted [Michael] Greenberger, a University of Maryland law school professor who was Born’s director of the Division of Trading and Markets.’

Cognitive capture, anyone?

The paper was released, and it didn’t cause a crisis.  Unregulated credit default swaps, on the other hand . . .

Mark Thoma has a synopsis of the Post story on Economist’s View.  (Hat tip: Baseline Scenario.)

(For a helpful primer on the rise and fall of the original BSDs, see Daniel Gross’s Slate column of 25 September 2008.)

Bill Clinton accepts some blame for the crisis

It’s part of a lengthy cover story in Sunday’s New York Times Magazine.  There’s a good synopsis of it here in The New Republic online, and another one by NYT economics writer David Leonhardt, with annotations, here on the Times‘s Economix blog.  Some highlights:

Clinton says he totally blew it in acceding to Greenspan’s call that derivatives should be unregulated.

He also says that his backing of Gramm-Leach-Bliley (i.e., allowing banks and investment banks and insurance companies to merge) would have been wise only if, as he expected, there was going to be appropriate regulation and oversight of the new financial supermarkets.  Had he known there would be none in the next two presidential terms, he would have opposed it.

Very interesting.  He’s a lot more open about his administration’s shortcomings in this department than, say, Larry Summers has been.  Just in the little bits I saw, Clinton is thoughtful and persuasive.

He also touches on the important distinction between regulations/prohibitions and oversight, with financial supermarkets as a case in point.  When you can count on having good regulators who provide adequate oversight, then you can allow certain activities that might otherwise better be prohibited.  Then again, is “deregulation with proper oversight” too clever by half (not to mention oxymoronic)?  We shouldn’t be learning about this policy approach a decade after these deregulatory policies were put in place.  Who was speaking up for proper oversight during the Bush years?

Much ado about nationalization

The word “nationalize” has at least one great use, in the punchline of a hilarious Winston Churchill story.

But in the current media firestorm over bank nationalization, maybe it’s time to abolish the word as harmful to thought.  (David Paul seems to agree.)

I’ve used the term myself and like the idea of the government temporarily seizing control of the big zombie banks, but “nationalization” has been bandied about so loosely that it’s lost its meaning.  Many people described the Bush-Paulson capital injections (via purchases of preferred stock that gave the government small nonvoting stakes in some banks) as nationalization, when they were really just crude subsidies (as Willem Buiter pointed out).  And if it’s nationalization for the government to temporarily take over a failing bank so as to help depositors and creditors,  avoid systemic risk and arrange for the orderly sale of its assets, then we’ve been doing it for over 75 years, ever since the creation of the FDIC.  In fact, by some compelling accounts, Sheila Bair’s FDIC has been the one shining light in this crisis.