Filling the Federal Reserve Board Vacancies?

(See updates below, 2/13, 2/24, 6/12, 6/15, 7/27, 8/12, 9/8.)

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.”

Update 6/12/17:

On June 3, 2017, the New York Times reported that the Trump administration has settled on Marvin Goodfriend and Randal K. Quarles for two of the three open Federal Reserve Board positions.

Goodfriend, a prominent figure in the Shadow Open Market Committee, would be an excellent choice for the Board, or even for the position of Chair that opens up next January with the expiration of Janet Yellen’s term. At the May 5, 2017 meeting of the SOMC, Goodfriend called for the Fed to have a stronger commitment to price stability. Although he goes along with the FOMC’s 2012 choice of 2% inflation as representing “price stability”, he calls on Congress to explicitly reinforce this target and to require to the Fed to compare its actions to a “Taylor-type reference rule for monetary policy.”

Goodfriend was formerly Research Director and Policy Advisor at the Federal Reserve Bank of Richmond, 1993-2005, and is the Friends of Allan Meltzer Professor of Economics at the Tepper School of Business, Carnegie Mellon University.

Randal Quarles, who is less well-known than Goodfriend, is expected to be nominated as Fed Vice-Chair for Bank Supervision, according to the Wall St. Journal, April 16, 2017. David Nason, who had earlier been bruited for this position, withdrew from consideration in March. Quarles runs the Cynosure Group, an investment firm he co-founded in Salt Lake City. He has criticized Dodd-Frank as being in some respects “not ambitious enough,” while “overly ambitious” in other ways. He has spoken in favor of rules-based monetary policy. Unlike Nason, he is not identified with the 2008 bailouts.

Unfortunately, Jeffrey Lacker has resigned his position as President of the Federal Reserve Bank of Richmond, effective April 4, 2017, after admitting that he inappropriately leaked details of the September 2012 FOMC meeting to a market analyst before the official minutes were released. He is therefore presumably out of the running for one of the Board positions.

Update 6/15

The June 14 Wall St. Journal reports a list of potential Fed Chair candidates that have been put forward by market observers. The list includes several strong candidates, including John Taylor, Marvin Goodfriend, who have been advocated above, plus Glenn Hubbard, Dean of the Columbia Business School and chairman of the Council of Economic Advisers, 2001-03.

I would add to the list Charles W. Calomiris, Henry Kaufman Professor of Financial Institutions at Columbia Business School, and, like Goodfriend, a member of the Shadow Open Market Committee. His book on Reforming Financial Regulation after Dodd-Frank was just published by the Manhattan Institute. He would be particularly appropriate for the still-vacant position of Vice Chair for Bank Supervision, and a much better choice than Randal Quarles, discussed above.

Unfortunately, Gary Cohn, COO of Goldman Sachs from 2006 to 2017 and head of Trump’s National Economic Council is in charge of the search for a new Fed Chair, and is named by the article as a leading potential candidate for the job himself. He has not formally put himself in the running, but according to the article, “former colleagues said he has cultivated an appreciation for the power of the Fed during his long career on Wall Street…” Recall that it was Goldman Sach’s own Hank Paulson who led the 2008 bailouts that directly benefitted Goldman with TARP preferred stock on cheaper terms than they had obtained from Warren Buffett’s Berkshire Hathaway. Goldman also benefitted indirectly from the Fed’s AIG bailout. Cohn could be expected to likewise continue to serve Goldman’s interests if he were head of the Federal Reserve.

The article does not rule out a reappointment of Janet Yellen. It notes that shortly after his inauguration, President Trump met with Yellen, and told her that “he considered her, like himself a ‘low-interest-rate’ person,” according to those familiar with the exchange.

See “Trump Said to Pick Nominees for 2 Positions on Fed Board,” New York Times online June 2, 2017, “Search for Fed Chief Begins, Led by Goldman Veteran,” Wall St. Journal, June 13, 2017 online.

Update 7/27

In a July 26 interview with the Wall St. Journal, President Trump named Gary Cohn as a possible replacement for Janet Yellen as Federal Reserve Board Chair, but at the same time said that Yellen is also “in the running, absolutely,” adding “I’d like to see rates stay low. She’s historically been a low-interest-rate person.” He added that there are “two or three” other candidates in the mix, without providing any names, and indicated that he would not make a decision until the end of the year.

At this writing, there have still been no nominations for the three vacant seats on the Board, despite the June 3 announcement that Marvin Goodfriend and Randal Quarles would be named for two of the positions.

Update 8/12

In a rare threefer, Randal Quarles was in fact nominated on July 11 for three positions on the Fed: to the lame duck seat expiring at the end of January 2018, to the new 14 year term beginning at the beginning of February 2018, and to a four-year term in new position of Vice Chair for Supervision. Hearings were held July 27, but was neither confirmed or rejected before the Senate adjourned (de facto if not officially) for August. See New York Times article on the hearings, July 28.

However, Marvin Goodfriend has unfortunately not yet been nominated as expected for one of the other two vacant seats on the Fed.

If Goodfriend is nominated and he and Quarles are both confirmed, President Trump would have to either hold the remaining position on the Board vacant or fill it with his choice for Chair if he is considering replacing Janet Yellen when her term as Chair expires at the end of January.

Update 9/8

On Sept. 6, Fed Vice Chair Stanley Fischer announced that he will resign from the Federal Reserve Board in mid-October rather than staying on as Vice Chair until his term expires on June 12, 2018, or as a Board member until that term expires Jan. 31, 2020. This brings to four the number of seats that Donald Trump could potentially fill during his first year as President.

On Sept. 7, the Senate Banking Committee approved Randal Quarles to be Vice Chair for Regulation (a new position created by Dodd-Frank but not yet filled). The full Senate has yet to vote on his confirmation. Unless Quarles is confirmed before Fischer departs, the 7-position Board will be reduced to only 3 members.

The Sept. 7 Wall St. Journal also reported that Administration insiders now regard it as unlikely that Gary Cohn, the director of the National Economic Council who has been in charge of the Administration’s search for a new Fed Chair, will be appointed to that position. “The shift in Mr. Cohn’s prospects for the top Fed job arises largely from his criticism of Mr. Trump’s response to the violence in Charlottesville, Va., the people familiar with the matter said.”

Public domain image of Eccles Building from FRB website.

* * *

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.

J. Huston McCulloch is Professor Emeritus of Economics and Finance at the Ohio State University, and Adjunct Professor of Economics, New York University.
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