The Independent Institute


Filling the Federal Reserve Board Vacancies?

(See updates below, 2/13 and 2/24.)

Five of the most important appointments Donald Trump will make during his first year in office will be to fill three vacancies on the Federal Reserve Board, to reappoint or replace Janet Yellen as Federal Reserve Board Chair, and to designate one of the Board members as Vice Chair for Supervision.

Thanks to Senatorial foot-dragging during the last two years of the Obama administration, there are already two vacancies on the 7-member Federal Reserve Board of Governors. The Board has several important monetary and regulatory powers in its own right, and at full strength, constitutes an ex officio majority of the 12-member Federal Open Market Committee that sets key monetary policy instruments. The announcement yesterday by Governor Daniel Tarullo that he plans to step down effective April 5 will open a third seat, thereby guaranteeing Mr. Trump’s nominees a majority of the Board when a fourth seat opens up in 2020, if not before.

The obvious candidate for Chair is John B. Taylor, who is Raymond Professor of Economics at Stanford University, a Senior Fellow of the Hoover Institution, and namesake of the famous “Taylor Rule” for monetary policy. He is a prominent hawk on inflation and budget deficits, generally opposes the Bernanke-Yellen policy of Federal Reserve aggrandizement known as “Quantitative Easing,” and is wary of out-of-control “entitlement” spending. Taylor may come close to 99% name recognition among economists, and is highly respected even by those who disagree with his free-market policies.

His 2012 book, First Principles: Five Keys to Restoring America’s Prosperity, is “fundamentally about rules vs. discretion, commitment vs. shooting from the hip, and more deeply about whether our economy and our society should be governed by rules, laws and institutions vs. trusting in the wisdom of men and women, given great power to run affairs as they see fit,” according to the glowing review by “Grumpy Economist” John Cochrane here.

Although Janet Yellen’s term as Chair does not expire until Jan. 31, 2018, in my opinion Taylor should be appointed to one of the existing vacancies on the Board immediately, in order to get his voice heard as soon as possible.

A stellar candidate for one of the other open positions on the Board, as well as for the long-vacant position of Vice Chair for Supervision, is Sheila Bair, who served as Chair of the Federal Deposit Insurance Corporation during the tumultuous years 2006-2011. Her 2012 book, Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself, is an insider’s scathing indictment of the housing bubble and TARP bailouts.

A Dole Republican, Bair received her J.D. from the University of Kansas Law School. Since leaving the FDIC she has been Chair of the Systemic Risk Council, an effort of the CFA Institute and Pew Charitable Trusts, and since 2015 has been President of Washington College in Chestertown, MD.

Bair would be a natural successor for Tarullo, who has been the Board’s unofficial specialist on bank supervision. Today’s Wall Street Journal identifies David Nason, “an executive at General Electric Company’s financing arm who was an architect of the 2008 bank bailouts during a stint at the Treasury Department,” as a leading alternative candidate. (“Fed Departure Offers Path to Change,” front page, February 11-12, 2017. ) [On Nason, see also Addendum below.]

The two existing vacant seats expire at the ends of January 2018 and 2030. Anyone appointed to one of these vacant seats would be eligible to serve another full 14-year term, so that someone could be appointed to the lame duck 2018 seat with the expectation that that person would be re-appointed in 2018. Tarullo’s seat expires in 2022. If Yellen is not reappointed as Chair in 2018, she would have the option of continuing to serve as one of the seven Governors until her seat expires in 2024, or resigning early, as Richard Nixon appointee Arthur Burns did in 1978 when Jimmy Carter declined to reappoint him as Chair. If she does resign, a fourth opening on the Board would become available within Trump’s first year in office, and Trump would have at least five appointments within his first term.

My suggestion would be to appoint Taylor to the 2018 seat immediately, with the expectation that he would be reappointed to the same seat and as Chair effective February 1, 2018. This would require the Senate to hold hearings on him twice, but the second hearings would be expedited by having already reviewed him in the first hearings. If Taylor were appointed to the 2030 or 2022 seat now, there would still have to be new hearings for him to become Chair in 2018.

Then, Bair should be appointed to the seat expiring in 2030 and as Vice Chair for Supervision immediately, rather than waiting for Tarullo to step down in April. Although Bair would conceptually be replacing Tarullo as the Board’s supervision specialist, there is no reason she couldn’t officially take over this position at once. The President would then have a few months to think about a replacement for the 2022 seat, and until fall to finalize his pick for Chair.

Addendum 2/13/17:

According to CNBC on Jan. 19, the favorite on Wall Street for Vice Chair for Supervision is David Nason, CEO of Energy Financial Services. Nason served 2005-09 as Assistant Treasury Secretary for Financial Institutions under Hank Paulson, and according to Wikipedia, “played a pivotal role in creating, developing and implementing the Treasury’s response to the financial crisis of 2008 and 2009.”

In other words, Nason was a mastermind of the bailouts, and as such, putting him in charge of bank supervision would be like placing the fox in charge of the henhouse. It is small wonder that Wall Street loves him.

Although GE Capital (of which Nason became senior VP in 2010) received no TARP funds per se, it was a major beneficiary of TARP’s sister bailout program, the Temporary Liquidity Guarantee Program, which gave FDIC guarantees to $130.85 billion of GE Capital debt between 2008 and 2012. This was even larger than Bank of America’s draw on the program ($111.1 billion), and second only to Citigroup’s ($179.5 billion).

The FDIC did make $2.3 billion on these guarantees to GE Capital since fortunately it did not default, but the premium charged (about 1.1% per year) was clearly below market, or GE Capital would not have taken advantage of the program. Granting credit default guarantees at below-market rates is equivalent to pumping profits into the receiving institution.

Nason is therefore entirely unsuitable for the position of Vice Chair for Supervision. In case Sheila Bair is not interested, a good alternative would be Thomas Hoenig, former President of the Federal Reserve Bank of Kansas City (1991-2011), and Vice Chair of the FDIC since April 16, 2012. As KC Fed President, he served on the FOMC on a rotating basis, where he earned a reputation as an inflation hawk and critic of “Too Big to Fail.”

Another well-qualified candidate would be Jeffrey Lacker, who has been President of the Richmond Fed since 2004 and therefore also has extensive experience on the FOMC. Like Hoenig he has voted repeatedly for tight money, and vocally opposed the September 2012 vote to purchase Mortgage Backed Securities.

An obscure provision of the Federal Reserve Act requires at least one member of the BOG to have “demonstrated primary experience working in or supervising community banks having less than $10 billion in total assets.” Since to the best of my knowledge none of the existing members has any such experience, my reading of this is that the next nominee must have such experience, or at least that the next group of simultaneous nominations must include at least one such person. Since the FDIC and the regional Federal Reserve Banks are all heavily involved in regulating banks of all sizes, Bair, Hoenig or Lacker would all meet this criterion, while Nason would not.

Another obscure requirement for FR Governors is that there may be no more than one “from any one Federal Reserve District.” I suppose that the Senate has some discretion in interpreting the preposition “from,” but occasionally this requirement has been a concern. Clearly Hoenig, from the Kansas City district, does not overlap any of the existing Governors. Bair is currently from the Richmond district, which is already over-represented, if anything, but she does have strong ties to Kansas as well that the Senate may choose to recognize. Nason’s company is headquartered in Stamford CT in the Boston Fed’s district, which arguably is already represented by Stan Fischer, long of MIT.

Yet another, if often neglected, criterion for the Governors is that they should be selected with “due regard to a fair representation of the financial, industrial, and commercial interests and geographical divisions of the country.” Jerome Powell, with a background at the Carlyle Group, could be said to already represent financial interests, so that there is no glaring need on this score for a second financial representative like Nason.

Although the Dodd-Frank amendments to the Federal Reserve Act call for a Vice President for Supervision, this is a suspicious investment of a lot of power in one person who, once appointed, is no longer answerable to the President, somewhat like the controversial position of Director of the Consumer Financial Protection Bureau. Perhaps because of fear of Senate opposition on this score, this position has been unfilled since its creation in 2010. But even if Congress repeals this provision, someone like Bair, Hoenig or Lacker would be a far better choice for one of the vacancies than Nason.

Update 2/24/17:

Today’s Wall St. Journal reports that the Trump administration is now looking beyond bailout co-mastermind David Nason for the position of Vice Chair for Supervision. The article reports that Trump’s advisors have met with Richard Davis, the chief executive of US BankCorp, and Hal Scott, a chaired professor at Harvard Law School.

A spokesman for Davis reported that he is “not a candidate for the Fed position,” and therefore is presumably not in the running. However, Scott, the author of a lawschool textbook on financial regulation, now in its 19th edition, sounds like an interesting possibility. He had “no comment” for the Wall St. Journal, but at least did not reject the possibility.

Another strong candidate for Vice Chair for Supervision would be Federal Reserve Governor Jerome (“Jay”) Powell, a BOG specialist on financial regulation and an outspoken critic of “Too Big to Fail.” (See his 2013 speech “Ending ‘Too Big to Fail.'”) I heard him speak last Tuesday at the Forecasters’ Club in Manhattan, and was very favorably impressed. Powell, a veteran of the G.H.W. Bush administration, was appointed to the Board in 2012 by Barak Obama in an effort to obtain bipartisan support for a package that included Jeremy Stein. He was re-appointed in 2014 to a full term expiring in 2028, along with Stanley Fischer and Lael Brainard. Since he has already been cleared by Senate Democrats twice and has had five years of experience on the Board, he should be an easy confirmation for the position of Vice Chair. There is no reason this position has to be filled from outside the Board. However, appointing him to this position would mean that there would still be three positions on the Board to be filled immediately, counting Tarullo’s seat.

Another good candidate for one of the three vacancies would be Kevin Warsh, who served on the Board 2006-2011 and is currently a distinguished visiting fellow at the Hoover Institution. Although he followed the (misguided, in my view) Board custom of always voting with the majority, it is assumed that his departure arose from his dissatisfaction with the Board’s Quantitative Easing measures. In his January 31, 2017 Wall St. Journal op-ed, “America Needs a Steady, Strategic Fed,” he states that “seeking in the short run to exploit a Phillips curve trade-off between inflation and employment is bound to end badly.”

Public domain image of Eccles Building from FRB website.

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Also please see the following Independent Institute books:

Boom and Bust Banking: The Causes and Cures of the Great Recession, edited by David Beckworth

Money and the Nation State: The Financial Revolution, Government and the World Monetary System, edited by Kevin Dowd and Richard H. Timberlake, Jr.

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