A New Direction For the Fed?

Yellen may be better than Larry Summers, but she’s not the reformer the Fed needs.

David Moberg

Janet Yellen is the likely candidate for chair of the Federal Reserve Board—but is she enough of a reformer to lead the Fed in the direction the country needs?

With Lar­ry Sum­mers’ with­draw­al from con­sid­er­a­tion as chair of the Fed­er­al Reserve Board, the odds jump dra­mat­i­cal­ly for the nom­i­na­tion of Janet Yellen, the cur­rent Fed vice-chair, for the head of the insti­tu­tion that, accord­ing to jour­nal­ist William Grei­der, runs the country.”

Even before Sum­mers’ with­draw­al, many pro­gres­sives had cho­sen to back Yellen to step in when cur­rent chair Ben Bernanke’s term ends in Jan­u­ary. Sum­mers, a well-con­nect­ed, star-qual­i­ty econ­o­mist, is close to the Wall Street Democ­rats who have dom­i­nat­ed the party’s eco­nom­ic pol­i­cy since the Clin­ton admin­is­tra­tion. As Trea­sury Sec­re­tary, he arguably served big finance more than the pub­lic by push­ing for nation­al and glob­al finan­cial dereg­u­la­tion — which, in turn, led to the 2008 finan­cial cri­sis and Great Reces­sion. He has also enriched his own per­son­al cap­i­tal by work­ing for sev­er­al Wall Street finan­cial insti­tu­tions, includ­ing Citigroup.

Yellen, by con­trast, is a respect­ed aca­d­e­m­ic econ­o­mist who has held var­i­ous posi­tions in the Fed­er­al Reserve sys­tem for 13 years but has nev­er worked for finan­cial busi­ness­es. She is iden­ti­fied with the Fed fac­tion most com­mit­ted to reduc­ing unem­ploy­ment and to tight­en­ing reg­u­la­tions of the finan­cial sec­tor. If picked, she would be the first woman chair.

It’s not supris­ing that, giv­en the choice of those two can­di­dates, many pro­gres­sives had jumped on the band­wag­on for Yellen. When it appeared Oba­ma would nom­i­nate Sum­mers, some mem­bers of the Sen­ate Bank­ing Com­mit­tee — Sen. Sher­rod Brown (D‑Ohio), Jeff Merkley (D‑Ore.), and John Tester (D‑Mont.) — announced they would vote against him, and Sen. Eliz­a­beth War­ren (D‑Mass.) was expect­ed to oppose him. The sec­ond-high­est rank­ing Repub­li­can in the Sen­ate, John Cornyn (R‑Texas), also announced he would not back him for the posi­tion. Sum­mers said he with­drew to avoid a big fight.

But beyond the per­son­al­i­ties in any con­test for office, pro­gres­sives need to take this oppor­tu­ni­ty to begin a larg­er debate about how the Fed has failed to do its job under Bernanke, and how it must trans­form both itself and the finan­cial sec­tor to avoid con­tin­u­ing the bub­ble and bust insta­bil­i­ty of the econ­o­my in recent decades. And if one takes a more in-depth look at Fed poli­cies, Yellen seems at best a cau­tious reformer, and her record as Fed vice-chair sug­gests that she is not as like­ly to rein in the spec­u­la­tion of big, inter­con­nect­ed banks or to use the Fed to aggres­sive­ly pro­mote jobs as some equal­ly qual­i­fied econ­o­mists whom Oba­ma is unlike­ly to con­sid­er, such as Nobel lau­re­ates Joseph Stiglitz and Paul Krugman. 

Fel­low econ­o­mists and some pro­gres­sives praise Yellen for her rel­a­tive­ly pre­scient fore­casts and recog­ni­tion of the hous­ing bub­ble, and she has gen­er­al­ly sup­port­ed oth­er Fed gov­er­nors who take seri­ous­ly their respon­si­bil­i­ty to main­tain high employ­ment as well as low infla­tion (although she has not always tak­en that posi­tion; in the late 90s, Cen­ter for Eco­nom­ic and Pol­i­cy Research co-direc­tor Dean Bak­er says, Yellen urged the Fed to raise inter­est rates as unem­ploy­ment dropped, while chair Alan Greenspan bucked such con­ven­tion­al wis­dom, ulti­mate­ly demon­strat­ing that low unem­ploy­ment need not trig­ger prob­lem­at­ic infla­tion). But while Yellen, as Fed vice-chair, has sup­port­ed an inno­v­a­tive vari­ety of Fed actions since the start of the finan­cial cri­sis, many pro­gres­sives see those poli­cies as hav­ing tilt­ed towards sav­ing bankers rather than reviv­ing the economy.

As Fed vice-chair, Yellen gen­er­al­ly sided with Bernanke on the bailout of the banks, which Bloomberg News report­ed in 2011 as hav­ing involved $7.7 tril­lion in large­ly secret loans, and the Fed sub­si­dies to the big banks of about $83 bil­lion a year. She also sup­port­ed many aspects of the bailout that favored banks with­out giv­ing the pub­lic ade­quate con­trol or pay­back in the form of job cre­ation. For exam­ple, in the cri­sis lead­ing to the Great Reces­sion, the Bernanke-head­ed Fed­er­al Reserve did not act like a lender of last resort,” as clas­sic eco­nom­ic the­o­ry would dic­tate. Accord­ing to an April 2013 Levy Insti­tute report writ­ten by Uni­ver­si­ty of Mis­souri-Kansas City econ­o­mist L. Ran­dall Wray, the Fed didn’t lim­it itself to pro­vid­ing banks that met tough stan­dards the need­ed cash to get through the cri­sis. Rather, it made what Wray esti­mates as $29 tril­lion avail­able to a range of finan­cial insti­tu­tions, many of them essen­tial­ly insol­vent (or bank­rupt). It went beyond pro­vid­ing banks liq­uid­i­ty and saved fail­ing — even fraud­u­lent — firms instead of seiz­ing and recon­sti­tut­ing them. The Fed’s more recent pol­i­cy of quan­ti­ta­tive eas­ing,” or buy­ing Trea­sury notes and mort­gage-backed secu­ri­ties, con­tin­ued the big-bank bailout, which helped the banks grow both in size (despite com­mit­ments to avoid more too big to fail” crises) and prof­its. These ini­tia­tives pro­vid­ed lit­tle stim­u­lus to the broad­er econ­o­my. Rather, the Fed pro­vid­ed near­ly free mon­ey to big banks that resumed spec­u­la­tion in deriv­a­tives and made preda­to­ry loans to finan­cial­ly trou­bled munic­i­pal­i­ties (like Detroit).

While the Fed mis­tak­en­ly saw enabling banks to make loans as its main objec­tive, Wray and oth­er pro­gres­sives say that the real prob­lems for the econ­o­my dur­ing the cri­sis includ­ed unem­ploy­ment, lack of wage growth, income inequal­i­ty, a col­lapsed hous­ing mar­ket, state and local bud­get crises, and lack of invest­ment in pro­duc­tive assets like infra­struc­ture and research. The banks did vir­tu­al­ly noth­ing with their pub­lic bailout and sub­si­dies to address any of these prob­lems, except to block use­ful actions (say, on hous­ing) or make mat­ters worse (pub­lic debt). Yellen was an inte­gral part of Bernanke’s team, and would like­ly con­tin­ue poli­cies in a sim­i­lar vein, even if she tend­ed slight­ly toward more stim­u­lus or reg­u­la­tion. It is unclear whether she would act to stop the bub­bles, like the one in the hous­ing mar­ket that trig­gered this lat­est reces­sion, which have so plagued the U.S. econ­o­my for the past sev­er­al decades.

Pro­gres­sives want a Fed that focus­es on the Main Street econ­o­my and rig­or­ous­ly reg­u­lates the preda­tors of Wall Street, not one that bails big banks out when they fail and defraud. Its crit­ics, led in the Sen­ate by Bernard Sanders (I‑Vt.) and Eliz­a­beth War­ren, want the Fed above all to aid in job cre­ation. They ask: Why can’t the Fed loan direct­ly at the low rates they offer the banks for infra­struc­ture improve­ments or oth­er pub­lic, job-cre­at­ing pur­pos­es, rather than give the mon­ey to banks that are like­ly either to charge extor­tion­ate rates or spec­u­late? (The Fed could, of course, but that would upset bankers and con­ser­v­a­tives.) Pro­gres­sives also want tougher reg­u­la­tion — includ­ing a return to the sep­a­ra­tion of invest­ment and com­mer­cial bank­ing enact­ed dur­ing the New Deal, and in most cas­es, a breakup of the biggest banks.

There is, how­ev­er, an alter­na­tive to breakups: The largest banks could be sub­ject to increas­ing­ly strict con­trols or, if they fail or pose a sys­temic risk, they could be effec­tive­ly nationalized.

There is a his­tor­i­cal basis for the Fed, togeth­er with Con­gress, tak­ing this step towards nation­al­iza­tion or social­iza­tion. James Liv­ingston, a his­to­ri­an of the Fed at Rut­gers Uni­ver­si­ty, writes in an unpub­lished man­u­script that Con­gress cre­at­ed the Fed a cen­tu­ry ago to social­ize” an anar­chic and self-destruc­tive pri­vate mar­ket, to make it the eco­nom­ic means to the social ends we, the peo­ple, have defined.” After the bank fail­ures of the 1930s, the Fed social­ized the risk of people’s sav­ings in reg­u­lat­ed banks with deposit insur­ance. Dur­ing the Great Depres­sion, Keynes also argued that cap­i­tal­ism need­ed the gov­ern­ment to allo­cate cap­i­tal in part because it had the long-term per­spec­tive and resources to over­come an eco­nom­ic col­lapse. In this sys­tem, banks, espe­cial­ly big ones, would be pub­lic agen­cies that would fol­low sound poli­cies aimed at Main Street” growth and jobs, not spec­u­la­tive enrich­ment of the finan­cial sec­tor at the expense of the rest of the econ­o­my. Now, even more, as Liv­ingston writes, we need to social­ize the allo­ca­tion of these immense resources” to serve the Con­sti­tu­tion­al goal of pro­vid­ing for the gen­er­al welfare.

The choice of a new Fed chair takes on addi­tion­al impor­tance with Repub­li­cans block­ing even mod­est pro­pos­als to stim­u­late the econ­o­my, and the big banks and their allies delay­ing imple­men­ta­tion of the 2010 Dodd-Frank finan­cial reforms. Fed­er­al Reserve pol­i­cy will deeply influ­ence the strength of the recov­ery and prospects for both jobs and high­er incomes across the work­force. Yellen may be bet­ter than Sum­mers, but she is unlike­ly to try to lead the Fed in the bold new direc­tion the coun­try needs. To this end, Oba­ma would do bet­ter to nom­i­nate some­one else — like Stiglitz or Krugman.

David Moberg, a senior edi­tor of In These Times, has been on the staff of the mag­a­zine since it began pub­lish­ing in 1976. Before join­ing In These Times, he com­plet­ed his work for a Ph.D. in anthro­pol­o­gy at the Uni­ver­si­ty of Chica­go and worked for Newsweek. He has received fel­low­ships from the John D. and Cather­ine T. MacArthur Foun­da­tion and the Nation Insti­tute for research on the new glob­al economy.

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