Obama's Dangerously Heroic View of the Fed

By Felix Salmon, Reuters

17 August 13

he trial balloon, it seems, has floated: Albert Hunt, today, puts Larry Summers's chances of getting nominated as Fed Chair at 65%, saying that he has the support of just about everybody in the Obama administration not named Valerie Jarrett.

"The Summers camp includes several top Obama economic advisers: director of the National Economic Council Gene Sperling, chairman of the president's Council of Economic Advisers Jason Furman, director of the White House Office of Management and Budget Sylvia Burwell and Treasury Secretary Jack Lew...

When Obama discusses the choice, in private as well as public, he stresses the importance of selecting a chairman who can handle a financial crisis similar to 2008-09. Insiders believe that's code for Summers."

This argument is of utmost importance: it is pretty much the only argument that Summers has going in his favor, and as such, if Summers does end up getting Obama's nod, it will be thanks to this particular piece of logic.

So, how compelling is Obama's argument here? The answer is, not very.

It is worth applauding Obama's decision to concentrate on potential fat tails - such things are notoriously easy to ignore. That said, the chances of the next Fed chair encountering a financial crisis similar to 2008-9 are pretty slim: realistically, Obama's appointee will not have to deal with such a crisis. In order for this argument to carry water, then, you need to believe either that the job of Fed chairman is essentially a firefighter role, which has very little importance when there isn't a crisis, or else that it is so easy enough to do the right thing as Fed chair when there isn't a crisis that it doesn't really matter, most of the time, whom you appoint.

This is actually the exact opposite of the truth. The actions of the Fed chair during normal times are of paramount importance: they determine how much growth there is in the economy, how much unemployment there is in the economy, how much the country's bonds and stocks are worth, and even how likely it is that we might encounter another crisis. The Fed chair is one of the two most important offices in the USA, the other one being the presidency.

That said, however, there's one time that it doesn't really matter who the Fed chair is - and that's when you're in the midst of a fully-blown financial crisis. At that point, the Fed just moves straight in to Global Firefighter mode, turning on the liquidity taps to full blast and lending as freely as possible to as many counterparties as possible against just about any collateral conceivable. It's the correct response, it's an automatic response, and there isn't a central banker in the world who won't do it.

Look, indeed, at what happened in 2008-9: the world's major central banks all responded in pretty much the same way, and indeed coordinated their actions very effectively. They easily agreed on a system of unlimited swap lines, which provided abundant liquidity, in any currency, in any affected country. Certainly there were stupid decisions made during the crisis, but those stupid decisions were made by finance ministers, not by central bankers. There was Ireland's decision to guarantee all of its banks' debts, for instance - a decision made by the finance minister, not the central banker. Or there was the US Treasury's determination that it had no legal authority to bail out Lehman Brothers, along with its failure to effectively communicate that decision to UK authorities.

The world's central bankers, by contrast, pretty much batted 1,000 through the crisis: while it's possible to criticize their actions during the recovery, they all did exactly what they needed to do when the credit crunch was at its height and there was a serious risk that the entire global flow of money could come to a screeching halt.

In other words, when there's a crisis, it really doesn't matter whether you're Ben Bernanke or Mervyn King or Jean-Claude Trichet - or Janet Yellen or Larry Summers or pretty much anybody else bar Rand Paul. The central banker's crisis playbook is a thin document, and easy enough for anyone to master. It's what central bankers do when there isn't a crisis that matters, since they're all going to do exactly the same thing when there is one.

More importantly, financial crises aren't things which just happen, like asteroids or earthquakes. They have causes - which means that they can also be prevented. Crisis management is an important skill, and it's one where Larry Summers has a lot of experience. But crisis prevention is the thing which really matters. Summers has demonstrated essentially zero crisis-prevention skills: his deregulatory instincts helped make the financial crisis more likely and more severe when it happened. Mark Carney, to take one obvious example, is a better central banker than Larry Summers will ever be, because he did something vastly more praiseworthy than managing a crisis: he prevented a crisis from ever happening in the first place.

As a result, Obama should be bending over backwards to appoint not the candidate who can best manage a financial crisis, but rather the candidate who is most likely to stop a crisis from happening in the first place. That candidate is Janet Yellen. (Or maybe Mark Carney, but he's taken.)

Obama, it seems, has a dangerously heroic view of what the Fed chair does. There's the day-to-day managing-the-economy thing, which, meh, there's no difference between the candidates. And then there's the swing-into-action thing when a crisis hits, and you want to be able to call upon the great Larry Summers to reprise his role as a key member of the Committee to Save the World.

The reality, by contrast, is that the day-to-day actions of the Fed chair, both in terms of monetary policy and in terms of bank regulation, are all that really matters. If a crisis hits, we already know what the Fed will do, whoever is in charge. And, of course, if the president (or the Fed chair, for that matter) ever wants Larry's advice, I'm sure that Larry will be right there, willing to give it. In the mean time, Summers should simply continue to make gazillions of dollars consulting for Citigroup. And should take his name out of the running.