REGULATORS OCTOBER 9, 2013
Much has been written about Janet Yellen’s views on the proper tradeoff between unemployment and inflation, and about her economic forecasting powers. We know a lot less about her views on financial regulation, a third key responsibility of the Fed chairman. Given that this responsibility took on added importance after the 2008 crash, and given that it was one of the key reasons Senate Democrats rejected Larry Summers, Barack Obama’s first choice for the Fed, it’s worth thinking through how Yellen will fare as a regulator.
In its 4,000-word write-up on Yellen Wednesday, the Times distilled her entire record on financial regulation into three short paragraphs. The first said that she generally considers markets prone to failure and in need of regulation, but that she nonetheless supported the formation of megabanks like Citigroup in the 1990s and has never (that we know of) reversed that position. The other two paragraphs noted that a few large mortgage lenders on the West Coast, like Countrywide Financial and Wells Fargo (to varying degrees), got carried away with subprime mortgages while she was president of the San Francisco Fed and therefore nominally responsible for regulating them. But the piece explained that actual regulatory authority lay in Washington, not with Yellen, and that she did try to call attention to these problems and encourage the mothership to act.
Which raises a question: Is this good enough? Or, perhaps more to the point, is this appreciably better than Larry Summers, whom many Democrats considered an inferior candidate?
The question isn’t as obvious as you might think. While Summers famously helped end restrictions on bank mergers and shield derivatives from regulation in the ‘90s, he emerged as a big-bank skeptic during the Obama administration. He became convinced that the megabanks’ accounting statements were fraudulent in early 2009, when he was the top White House economic adviser. He wanted to vet the banks much more aggressively than his counterparts at Treasury and the Fed. He was sufficiently alarmed at the state of the banks that he was willing to entertain nationalizing them, at least in some form. Though I don’t know what Yellen was thinking during this period, it would be hard to imagine her being appreciably more hawkish.
And yet I do think that, in the end, Yellen is more trustworthy on financial regulation. It’s not just that Summers subsequently sent worrying signals on this front, like his dogged opposition to the Volcker Rule, which aspired to prevent megabanks from speculating with government-backed money. It has to do with a more fundamental question about the nature of each candidate’s biases.
My sense is that both Yellen and Summers take a more benign view of big banks—and the financial sector generally—than your average Democrat. But, as I read her, Yellen’s biases tend to be more institutional than personal. That is, Yellen has spent years as a top official at the Federal Reserve. In the course of doing its job, the Fed must implicitly accept the legitimacy of large financial institutions. It routinely interacts with these banks to gather information about the condition of financial markets. It has ongoing conversations with them about their own financial health. It buys and sells securities to them as a way of conducting monetary policy. No one who had spent time as a Fed governor, regional Fed president, and vice chairman, as Yellen has, would see financial institutions as inherently sinister.
Summers, on the other hand, has less of an institutional bias toward big financial firms (though he surely developed some of this while at Treasury in the 1990s) and more of a personal bias. Many of his close friends and colleagues over the years—not least his mentor Robert Rubin—were high-ranking officials at big banks. Others were accomplished hedge fund managers. (Indeed, as I note in my recent book, Summers’s skepticism of the megabanks in early 2009 didn’t reflect some innate populism; it reflected the view of leading hedge fund managers that the banks had stupidly gorged themselves on subprime mortgage securities.) And, of course, Summers has personally worked for a number of large, or at least wealthy, financial firms during his stints outside government, from the hedge fund D.E. Shaw to the venture capital firm Andreessen Horowitz to Citigroup itself. Summers personally knows dozens if not hundreds of financial sector employees. He clearly regards more than a few of them as smart and respectable and a source of brave thinking.
When all is said and done, I guess I’d much prefer someone with a mild institutional bias like Yellen to someone with a big personal blind spot like Summers. Summers’s defenders periodically argued that it was important to inject new blood into the Fed, an institution that’s more than capable of insularity and self-delusion. (Just ask Ben Bernanke, who followed Alan Greenspan’s lead in asserting that a nationwide housing bubble was essentially impossible, up until the moment when it became self-evidently possible.) This was fair enough as far as it went. But the problem with sending over the new blood in the physical form of Larry Summers was that it was just as likely that his personal relationships, and his general deference toward big shots, would exacerbate the Fed’s blind spots rather than mitigate them. Ideologically, there’s little that’s more revealing about a person than who they hang out with after-hours. (I should note that there are some terrifically accomplished regulators who come from the financial world—Commodity Futures Trading Commission chairman Gary Gensler, a former Goldman Sachs executive, to name one. But in order for these people to succeed as regulators, they must typically break with their old social circle, or have never been especially social creatures in the first place. My book explains how this worked in Gensler’s case.)
Yellen’s social circle, on the other hand, consists mostly of tweedy professors and government officials. She strikes me as sufficiently devoid of attachments to bankers and money managers that she can imagine them having some truly terrible ideas—even the smart, witty, seemingly upstanding ones. This is in fact more true of her than the average senior Fed official in New York or Washington. Much of her tenure at the Fed was in San Francisco, thousands of miles away from Wall Street special pleaders.
Put it this way: When the bias is largely abstract and impersonal, you may be capable of revising your opinion of important and powerful people and their important and powerful employers, as was apparently the case for Yellen. (See Fargo, Wells.) When these people are your closest friends, even the most damning evidence may not discredit them in your eyes.
Noam Scheiber is a senior editor at The New Republic. Follow @noamscheiber
Update: A reader points me to this Yellen speech on financial regulation this past June. It's a little more descriptive than prescriptive, but the basic takeaway is that Yellen believes you can solve the too-big-to-fail problem, and the problem too-risky banks (i.e., banks taking on too much debt and making themselves prone to runs), by raising the amount of capital they're required to keep on hand. She's not a fan of more aggressive measures like breaking up the banks. This is basically where Summers was in principle. The question is how much she cares about regulation relative to the other responsibilities of the Fed, and how willing she is to be a hardass in practice. If your preferred approach to financial reform is writing new rules and making sure the banks follow them, then success depends on how closely you keep an eye them.