The fact that Barack Obama could name three people at one crack to the Federal Reserve’s Board of Governors shows how far the system envisioned in 1935 has broken down.
Fortunately, neither these appointments nor ones made under similar circumstances by George W. Bush display any of the political partisanship feared by those who designed an intricate system to insulate those who set monetary policy from political interference. But that system has not been playing out as designed lately, and citizens ought to think about whether that really is prudent.
The 1935 legislation that thoroughly overhauled the Federal Reserve system was designed to prevent the Fed from making some of the mistakes it made in the 1920s and during the start of the Great Depression. It is set up so that no president can appoint a majority of the seven members of the board until near the end of a two-term administration.
Each governor is supposed to serve a 14-year term starting in an even-numbered year. So Barack Obama, elected in November 2008 and inaugurated in January 2009, should have expected to appoint people to serve terms starting in January of 2010 and 2012. If re-elected, he also make could appointments for 2014 and 2016. This fourth appointee would take office only 12 months before the wearing in of Obama’s successor.
Instead, less than 16 months into his first term, Obama has already named four of seven members (having earlier named Daniel Tarullo to fill an open seat).
George W. Bush also named four governors in his first term, though not as quickly as Obama. One of them, Kevin Warsh, was young and had little experience. Some muttered that as the son-in-law of a prominent Republican campaign donor, Warsh represented a new low in Fed Board appointments. I myself wrote a column criticizing his selection.
But I need to eat crow. By all accounts, Warsh proved to be an energetic and capable governor, reportedly playing the second-most active role (after Ben Bernanke) in the Fed’s response to the crisis events of 2007-2009. And Bush’s other appointments, including Donald Kohn, a veteran Fed senior staffer, and Elizabeth Duke, an experienced banker in Virginia and North Carolina, were well qualified.
So are Obama’s recent appointments. Janet Yellen, also named to replace Kohn as vice-chair, is president of the San Francisco Fed. She served on Clinton’s Council of Economic Advisers and sat on the Fed Board for two years in the early 1990s. Yellen also has a career as a respected academic economist, largely at University of California Berkeley.
Peter Diamond is a distinguished economist from MIT who is unusual because at the advanced age of 70, he has been willing to cast off the intellectual shackles of basing all economic theory on the assumption that human decision-making is entirely rational. Most of his fellow “behavioral economists” are 20 to 30 years younger.
Diamond brings expertise in a key fiscal policy topic, how to reform spending on big entitlement programs like Social Security. This is not part of the Fed’s mandate, but things have reached a point where the Fed can no longer make decisions about the money supply and interest rates without considering the constraints posed by the nation’s deteriorating fiscal position.
The third appointee, Sarah Bloom Raskin, is less well known, at least among economists, because she is a financial regulator and not a banker or economist. Her appointment echoes that of Tarullo, a law professor specializing in financial regulation, who Obama appointed to the board in 2009.
Together they show the current administration’s determination to make effective regulation a much higher priority for the Fed than during the era when Alan Greenspan’s faith in self-regulation by unfettered free markets dominated Fed policy.
So the fact that circumstances once again permitted a president to name a majority of Fed Board members years before anticipated by statute does not promise to lead to a bad outcome.
Indeed, the direct political interference in Fed policymaking feared by Congress in 1935 has been rare. The only case occurred when officials in the Reagan Administration recruited two new Fed appointees for the specific purpose of opposing Paul Volcker’s ongoing campaign to reduce inflation through tight money. Volcker headed off the initial revolt by Wayne Angell and Manuel Johnson, the appointees in question, but ongoing opposition to Volcker by Reagan cabinet and staff members led him to step down in 1987.
When he did, James Baker, Reagan’s Treasury secretary, exultantly crowed, “We got the son of a bitch.” This was a shameful episode in the history of U.S. monetary policy but not one that was ever repeated.
A key problem is that it is hard to find people willing to hold a position like this for 14 years. Unlike the Supreme Court, few people want to stay on the Fed Board for life. Sporadic resignations — combined with Senate refusals to confirm appointees when a president of the opposite party nears the end of a term — create situations where multiple seats open up in a short period of time.
Some suggest amending the act so that governors serve seven-year terms rather than 14, with one appointed each year rather than every other year. Yes, a president would be able to name a fourth member early in a second term, but that usually happens anyway under the current system. And a more manageable length for a full term might motivate appointees to stay the course. Bailing out early on a 14-year term has become the norm, but people might commit to seven. One can only hope.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.